Trade, Development and Poverty: The Sri Lankan Experience

July, 2006
By Ms,Ranmini Vithanagama

Economic growth and development is one of the primary macro economic aims of any government. Development in a country is a wide phenomenon that covers not only the enhancements in Gross Domestic Product (GDP) and other economic indicators, but also in the quality of life that the community within that economy enjoys.

Trade is one vital source through which a country may achieve this macro economic goal of development. How trade contributes to development and poverty reduction is rather straightforward. Trade promotes economic growth and development, and this in turn leads to a reduction in poverty of a country. Having established a clear-cut connection thus, it is now sensible to take a closer look at the Sri Lankan experience on this interlink.

While the greatest part of the post independent era was marked by an inward looking agriculture-focused economy in Sri Lanka, a major turn around of this policy was brought about towards the latter part of the 1970s. In 1978, structural adjustments were introduced to bring vigour to an economy that had come to a point of stand still owing mostly to its inward orientation and protectionist stratagem employed.

A key area of focus of the adjustments was trade liberalization. However, it is important to note that trade liberalization was only part of the overall adjustment process which also included external payments liberalization, de control of prices and interest rates, promotion of the private sector in the development process and encouragement of foreign investment. The reforms introduced thus mainly consisted of tariff reforms, payment reforms, institutional reforms and other macro policy changes.

The pre reforms period was largely concentrated on import substitution and heavy qualitative restrictions were placed on imports. Under the adjustments made in this regard, almost all non-tariff barriers on imports that existed during the 1960s were lifted and were instead replaced with tariffs. The six-band tariff system initially introduced was gradually developed in to a simpler two-band system by year 2000. Restrictions placed on many of the consumer goods, and quite a number of intermediate and capital goods were removed, while the government monopoly in the importation and distribution of goods were also withdrawn except in the cases of certain food items, grain and petroleum products.

The balance of payment reforms that were also undertaken had complementary effects on trade liberalization. The immediate pre reforms era was marked by a dual exchange rate system under Foreign Exchange Entitlement Certificate scheme that was intended to encourage non-traditional exports and deter non-essential imports by the application of a premium over the nominal exchange rate. The unification of this discriminatory exchange rate system and bringing it under a managed float coupled with the depreciation of the rupee against the US dollar by more than 45 per cent had positive impacts on our export sector.

Under the institutional reforms taken on in the adjustment process, the Greater Colombo Economic Commission (GCEC) was established in 1978 (which was later changed into Board of Investment) with a view to promote foreign investment locally. Additionally Free Trade Zones were set up to encourage the inflow of Foreign Direct Investment into the country with attractive incentive schemes consisting of tax holidays, export credit insurance and financing at concessionary rates. In 1979, the Export Development Board was established to support and guide export-undertakings.

The extensive government intervention during the pre-reforms era largely prevented the free movement of market forces to ensure an efficient resource allocation. The lifting of controls placed on prices and interest rate along with the curtailment of subsidies that had been a key burden on the national budget since the days of independence gradually encouraged the market mechanism to operate more freely. While the monetary policy tools were used in a way that promoted domestic savings, deterred demand for credit particularly on non essential motives, and encouraged foreign investments, fiscal policy measures were aimed at cutting down on government expenditure through lifting of subsidies and introducing a food stamps scheme in its place for the low income earners. The focus shifted from a welfare orientation towards improving infrastructural facilities such as power stations, reservoirs and housing for the needy.

All these reforms together, as per the expectations, led initially to a rapid economic growth. The GDP, which registered a growth rate of 4.2 per cent in 1977, soared to 8.2 per cent by 1978. Afterwards the GDP growth rate has remained close to 6 per cent in the early 80s which then fell to 5 per cent towards the latter half of the 80s (Central Bank Annual Report: 2004) possibly due to the deceleration in the initial spirit of the adjustment period.

The end of 1980s was characterized by civil insurgencies in the South, which caused considerable slow down in the economic activity, heavy damage to infrastructure facilities, and much disruption in the lives of many people.

Partly in response to this uprising and partly to bring life to the economy that had lost vitality in the aftermath of that unrest, the second wave of trade reforms was introduced in 1989/1990 with a view to further relax the remaining restrictions upon the market mechanism; further relaxation of exchange rate restrictions, further incentives for foreign investment, further simplification of tariffs, further removal of import controls except on the ones deemed essential. The privatization of public ventures was also carried out with renewed enthusiasm. The Janasaviya programme was aimed at alleviating poverty too was undertaken during this phase of reforms.

The GDP growth rate in 1990 rose to 6.3 per cent, however to be followed by another high growth rate of nearly 7 per cent in 1993. The average growth rate over the period 1994-1999 has been 5 per cent, which cannot be considered too low for a country that was for the most part on the 1990s was also involved in a civil war which ate up a lot of finances that could have been used for development purposes.

Having analyzed how the policy reforms have been absorbed into the economy in the form of improved economic indicators, it is now important to focus on how the benefits of trade are channeled towards the poor. The main channel through which trade reaches out to the poor is through employment generation. How much the poor will gain will depend on the type of labour they possess and the type that is required by the trade reforms. A classic example is the garment factory sector that boomed after the opening up of the economy. The industry largely required semi skilled labour from young females and this created a large number of employment opportunities for the school leaving females, thus obviously improving their economic well being. In the late 1970s, this provided some 95000 employment opportunities for the semi skilled local youth. Apart from direct generation of jobs through the setting up of garment factories, many other employment opportunities arose indirectly in the setting up of such factories and developing the required the infrastructure. The construction activities, one classic example being the Accelerated Mahaweli Development Programme) ambitiously carried out by the government to complement the structural changes also generated numerous employment opportunities in the construction sector. Consequently the unemployment rate, which was as high as 24 per cent in 1973, reduced to nearly 15 per cent by 1979. (Central Bank Annual Report: Different issues) However, employment statistics need to be interpreted with some reservation since the differences in the definitions of unemployment used during different surveys. Although the unemployment rate again shot up to nearly 16 per cent by 1990 owing to a slow down of the growth momentum, the rate has been on the decline afterwards after the economy regained its pace.

However, it is not advisable to hail trade reforms as the singular driving force behind improved employment rates. There have been other factors that have contributed in bringing down the rates of unemployment. The opening up of the economy paved a new way of employment for the country through labour outflow to oil producing Middle-East countries where semi skilled and unskilled labour was in demand. On the other hand, the Sirima-Shasthri pact entered into in 1964 saw around 330,000 Indian Tamils who were originally brought here to work in the plantation sector being deported to India. Plus, the ethnic conflict that began to plague the country since 1983 provided employment for the youth particularly males in the armed forces. These issues cannot be ignored when appreciating the reduction of unemployment in a holistic view.

Paradoxically, the very trade reforms that boomed some industries, was a bane on another set of industries, particularly the domestic-oriented ones, a typical example being the traditional handloom industry. Many handloom factories were closed down unable to withstand the fierce competition posed by imported textiles. Consequently, many rural workers where such factories are largely located, lost their jobs, and due to the structural mismatch between the handloom technique and the garment technique, common sense suggests that it must have been difficult for the displaced workers to be absorbed in to the new employment opportunities created by the emergent garment factories.

Since the link is that trade ultimately leads to reduction of poverty, an analysis of poverty statistics would prove constructive in seeing how far the Sri Lankan experience relates to the link between trade development and poverty. The poverty headcount from 1990-91 to 2002 had only witnessed a moderately fall from 26 per cent to about 23 per cent. The poverty head count in the urban sector had almost halved over the same period while the rural sector has also slightly declined. But the estate sector poverty had risen from 20 to 30 per cent over the said decade. (World Bank: 2004). On the other hand the Gini co efficient (Income Receivers), which stood at 0.5 in 1953, was by 1978/79 still 0.5 and by 2003/04 it still remained at 0.5. (Central Bank Annual Report: 2004). Thus, it is plain that there has not been much reduction in the inequality in income distribution patterns over the years even after the trade reforms. While the per capita income has risen above 1000 US dollars by 2004 the fact that Gini coefficient has not undergone any significant decline suggests that though the absolute poverty level may have fallen over the years, the relative poverty levels may not have experienced such reductions.

On the other hand, inflation has been a key figure following both phases of trade reforms. After the 1977 structural adjustments the rate of inflation rose to an astronomical 26.1 in 1980. Ironically, again after the trade reforms introduced during 1989/1990, inflation registered a double-digit rate as high as 21.5 per cent. While a modest rate of inflation is acceptable in an economy, such gigantic levels of inflation is definitely detrimental to fixed income earners, which represent about 60 per cent of the employed, particularly those in the low and lower middle income percentiles.

The civil unrest in the South and the ethnic violence in the North also played their part in deteriorating local and foreign investor confidence in Sri Lanka as a lucrative site of investment. Additionally, the tourism industry, which proved to be a source of employment for unskilled youth in tourism-centered areas, tended to suffer major setbacks caused by insecurity and resultant instability, which prevailed during that point in time.

Thus, some benefits of trade reforms, to some extent, may have been offset, and some other benefits not fully captured, by the economy, owing to the repercussion-effects of high inflation and unstable economic and political conditions.

The bottom line is that Sri Lanka lacks a proper set of statistics on employment and poverty level to make a meaningful analysis, either because of the variations in definitions or because the true situation has not been captured in the figures. Therefore, to gallantly conclude that trade policy has led to economic development in Sri Lanka and in turn, a reduction of poverty is difficult. Then again, it is not also fair to conclude that trade, development and poverty reduction in Sri Lanka do not share a justifiable interlink. While it may be a futile attempt to establish a clear cut channel of causation where trade reforms enhanced economic indicators and those enhancements manifested themselves in reduced poverty levels, we cannot rule out the fact that trade reforms have definitely helped at least some of the people out of poverty through the economic development it has brought about.