Blueprint for sustainable growth | Sunday Observer

Blueprint for sustainable growth

At one time, Sri Lanka was predominantly agricultural: tea, rubber and coconut. Now it is more garments and services, but other industries and services must flourish   Pic: Lake House Media Library
At one time, Sri Lanka was predominantly agricultural: tea, rubber and coconut. Now it is more garments and services, but other industries and services must flourish Pic: Lake House Media Library

One of the most important things that voters expect from a government is an improvement in living standards. This usually takes place when the value of goods and services produced in an economy increases. As the economy grows, living standards rise.

What determines growth? The goods and services produced in an economy are dependent on the resources – land, labour, capital-and the extent to which they can be harnessed to productive purposes through entrepreneurship. These are the ‘factors of production’- the building blocks of the economy; they are what people use to produce goods and services.

Input-led stage of growth

In the early stages, a poor country can grow by bringing previously idle factors of production –land, labour, capital into productive use. This process continues for some time.

With growth, there is an increase in savings which in turn gets reinvested causing further growth. This stage of growth is termed input-led and is determined by the amount of resources that a country can bring to production.

When a country reaches middle-income, especially, upper middle income levels, the growth rate inevitably slows. The country runs out of factors to bring into production: available land gets used, labour is fully employed, the population ages.

This model of growth no longer works, so the economy stagnates. At this stage, people will generally be richer than when the country was poor, but there will still be people who are relatively poor, so the country must continue to grow if they are to experience a better life.

The total value of goods and services produced must increase, but the nation no longer has much idle ‘factors’ to bring to production – it has reached the limits of its input. This is the problem that Sri Lanka faces. We have reached lower-middle income status but are now close to exhausting the supply of inputs.

Output-led stage of growth

Once the limits of input-lead growth are reached, the only way to grow is through increasing the value of outputs. The country must use the available inputs to produce more, in other words what is needed is what economists call an increase in ‘productivity’.

In economic terms, productivity depends on the value of a nation’s products and services, measured by the prices they can command in open markets, and the efficiency with which they can be produced. In business terms, it must move up the value chain, which involves a structural shift in the economy.

Rich economies produce, consume, and invest in entirely different goods and services than poor economies. Economies typically move from primary products such as agriculture into manufacturing and services; the ‘factors of production’ shift across the economy and between firms.

“Productivity isn’t everything, but, in the long run, it is almost everything. A country’s ability to improve its standards of living over time depends almost entirely on its ability to raise its output per worker.”

At one time, Sri Lanka was predominantly agricultural: tea, rubber and coconut. Now it is more garments and services, but other industries and services must flourish.

The challenge for a middle income country such as Sri Lanka is how to create the conditions for rapid and sustained productivity growth.

Michael Porter identifies two stages of productivity led growth: an investment driven stage where new investment improves productivity and a later innovation-driven stage, where technology plays the key role.

Encouraging foreign investment, especially in new industries, is very important because this is how new technology and ideas are introduced. Eventually, with the right support, investments in education, Research and Development, innovation starts to take place.

Promoting competition by allowing new investment and opening markets also forces firms to be more productive. A series of studies by Stephen Nickell of the LSE showed that increases in competition provided a large and persistent boost to firm productivity. Openness to trade, which opens the door to competition from abroad and lower barriers of entry, which allow more firms to set up locally are the principal means by which competition may be increased.

Multi-national production

“Greater openness to multi-national production leads to tougher competition in host-country product and factor markets, which can result in a reallocation of resources within each domestic firm, from domestic to foreign multi-national firms, and from less productive to more productive firms.

These resource reallocations force the least efficient domestic firms to exit the market, increase the market share of the most productive firms, and motivate domestic firms to become more specialised at core advantage goods, all of which raise host-country aggregate productivity.”

It is through the reallocation of resources from less efficient to more efficient uses that overall productivity rises. It is all about how well the available resources are utilised.

Porter said, “Productivity is the goal, not whether firms operating in the country are domestic or foreign owned. What matters most is not ownership, but the nature and productivity of the companies’ activities in a particular country.”

For small countries, market size with limited opportunities for growth, the primary focus should be on exports, but the domestic market must also be competitive.

Cost-of-living

“Purely local industries also matter for competitiveness because their productivity has a major influence on the cost of living and the cost of doing business, not to mention their level of wages. The productivity of the entire economy matters for the standards of living, not just the traded goods sector.”

The benefits of improved productivity in domestic industries flow through three channels:

First, it lowers prices, benefitting consumers by increasing purchasing power (pro-competitive effect), second; it forces less competitive firms out of the market, reallocating resources to more competitive ones (selection effect), finally; induces innovation to improve productivity (innovation effect).

Higher productivity growth causes not just one-off price reductions but a sequence of reductions across time, increasingly benefiting present and future consumers

The country should encourage foreign investment particularly new industries. To do so, it must aggressively cut the barriers to FDI.

These include excessive red tape, access to industrial land, poor industrial water and wastewater treatment facilities, poor transport infrastructure and policy inconsistency.

New ideas come with new minds. Encouraging skilled people to live, work and invest in Si Lanka is vital. India’s booming IT industry was set up by returnees.

While the primary focus of new investments is exports, increasing competition in the domestic market is also necessary.

Certain low-productivity activities will be forced to close which will free resources (land, labour, capital) to flow to more productive activities.

While there will be new jobs created in higher productivity sectors, jobs will be lost in lower productivity sectors.

This is a highly disruptive process so the human costs must be managed. Policies must address temporary unemployment, retraining and encourage active job matching

The government must ensure a regulatory regime that does not hinder the reallocation of factors among firms and sectors, ensure product markets, remain competitive and encourage investment that will bring in new technology. It must also manage the costs of the transformation. 

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