Ricardo Hausmanns message: Restructure

exports for growth choosing products over

which you can compete with others

Ricardo Hausmann-Monday,

11 January 2016

Sri Lankans strange psyche: Exports are good but Imports are bad
There is a popular economic belief among Sri Lankans that in order to build
Sri Lanka as a strong nation, it should produce everything within the
country and say goodbye to imports as far as possible.
It is so indelibly ingrained in the psyche of Sri Lankans that it is not a belief
that could easily be erased. Anyone who speaks against it is immediately
branded as somebody odd, without nationalistic sentiments and proWestern. Hence, politicians of every generation have used it as an effective
mantra to rally masses around them.
Historically, this belief was put into practice by directing public policy to
impose import controls and develop what were known as import
substitution industries. When these import substitution industries could not
survive without continuous Government protection and support, that policy
was temporarily abandoned in 1977 when the country moved for exportoriented economic growth. But subsequently, the nation, supported by
convincing arguments by some critics, began to experience that even the
export-oriented economic growth policies had failed to deliver their
promises.
True that policy transformed the economic structure and generated some
economic growth. But, that economic growth was not adequate to push Sri
Lanka to the rich country club status within a generation, the aspiration of
many.
Rechristening import substitution as import replacement
Hence, import substitution was rechristened during the last administration
by giving it a new name called import replacement economic strategies.
This new name was coined by its topmost economic policy official, Dr. P.B.
Jayasundera, possibly to remove the bad spells which the previous import
substitution policies had carried.
Thus, the policy package adopted by Sri Lanka since about 2005 paid lip
service to export growth and concentrated on developing a domestic
economy-based economic strategy as its policy thrust. The results are well
known: though exports increased in absolute terms, they failed to record an
increase compatible with either the domestic economic growth or world
export growth. This was manifested by a sharp decline in the exports to
GDP ratio from around 28% in 2004 to less than 15% in 2014. Similarly, Sri
Lankas exports as a percentage of the global exports too fell from 0.08 in
2000 to 0.05 in 2014.

Imports are necessary even to

promote exports
Sri Lanka, being a country with a small
domestic economy in terms of both size
and income, cannot think of generating
high economic growth continuously
without opening its borders for exports.
Since the country does not have a
sufficient supply of domestically available
raw materials, it also requires the country
to continue with an open import policy
program. As such, without imports, the
country cannot grow its exports. Hence,
imports are connected to exports through
a very strong umbilical cord and it can be
severed only at the risk of impeding both
exports and economic growth.
Increase the value added of importbased industries
If imports are necessary for exports then
how could the country grow continuously
since what it produces is leaked out in the
form of a higher import bill? The secret
lies in what the economists call the value
added in which the country would
contribute to produce a more valuecontained product by using its own labour
resources, facilities and services.
This positive value added will generate local income and if the product or
the service in question is sold to foreigners, it would then get sufficient
foreign exchange revenue to pay for imports. Hence, the trick which a
country should use is that it should produce by using imports a higher
proportion of exportable goods and services.
For instance, when the country went for garment and textile industry as an
exportable commodity after 1977, the local value added was just 5%. With
the development of a local supply chain, this has now increased to 45%.
Comparatively, tea generates a value added of 90%. But garments and

textiles now earn three times more than tea. Hence, the value added of the
garment and textile industry standing at $ 2.2 billion in 2014 has far
exceeded that of tea industry which amounted to just $ 1.4 billion. Hence, a
country can have a smaller percentage of value added but it can
compensate itself if it has a bigger volume of exports.
Past growth has come from domestic services and not from exports
Then, how has Sri Lanka gotten into a severe foreign exchange crisis in the
recent past? The blame goes to the domestic economy based economic
policies pursued by the Government in the last 10 years.
During this period there was a significantly high economic growth in the
country as announced by the Department of Census and Statistics
amounting to on average about 6.5%. Yet, the whole of that growth had
come from the domestic services sector comprising mainly trading
activities, telecommunication, government services and the banking
services.
Economists call these services non-tradables because they are mainly
meant for domestic consumption and not for selling to foreigners. Hence,
while the economy grew, its foreign exchange earnings did not grow in a
commensurate manner as the growth in the economy.
Foreign exchange crisis is due to domestic orientation of
production
The result was a higher import orientation by people who now had larger
domestic incomes. Accordingly, it increased the import bill while stunting
the export earnings generating a bigger and bigger trade deficit in each of
the passing years. The trade deficit was partially met out of the moneys
sent by Sri Lankans working abroad, called foreign remittances, according
to the Central Bank. But, the recipients of foreign remittances too had a
high import orientation. Hence, the money so received too leaked out of the
country over the years, further widening the trade deficit and thereby
augmentingthe foreign exchange crisis.
Accordingly, the proper economic strategy for the country should have
been to produce not just for the local market but for the wider global
economy. Having identified this dire need, the Economic Policy Statement of
the Prime Minister, delivered in Parliament in November 2015 had
announced that Sri Lanka should produce for a market much bigger than its
local market meaning that exports are to rescue the country.

Ricardo Hausmanns validation of policy strategy

This economic strategy was validated by Ricardo Hausmann of
Harvard Universitys Centre for Economic Development
delivering the main address at the Sri Lanka Economic Forum
concluded last week in Colombo.
Hausmann was responsible, along with MITs Cesar Hidalgo, for
compiling an economic complexity index and preparing an
economic complexity atlas for the world nations (available at:
http://atlas.cid.harvard.edu/).
This writer in a previous article arguing that Sri Lanka should
convert itself from a simple product producing economy to a
complex product producing economy in order to win the global
export markets introduced Hausmann and Hidalgo to Sri Lankas
readers (available at http://www.ft.lk/article/109904/SL-s-future--Convertthe-simple-economy-into-a-high-tech-based-complex-economy).
Both Hausmann and Hidalgo have used the historical data to map the
economic complexity of the export structure of the world nations and the
map pertaining to Sri Lanka has not changed even a little bit since the first
map so prepared for 1995. In his presentation in Colombo, Hausmann used
this rich data base liberally in the form of graphs, maps and historical
developments to prove his point.
Debunking the belief that growth should come only from the
domestic economy
He first debunked the popular belief that Sri Lanka could grow and generate
prosperity to its citizens merely by producing for the local economy. When
he plotted the export growth against the economic growth for the last 10
year period, it showed that both variables had moved one for one in the
same pattern over the period.
Accordingly, when exports went up, so did the economic growth. When
exports faltered, economic growth too faltered. Thus, if there is any
extraordinary growth that has been made by Sri Lanka over this period, that
growth has simply come from better-performance in the export sector. This
revealed that if Sri Lanka wishes to raise its growth and sustain it over the
period, it should necessarily concentrate on tradable goods and services.
Those tradable goods are used by people outside the country and therefore,
Sri Lanka should have better trade relationships with its main customers if it
is to promote them.

If on the other hand, Sri Lanka produces purely for the local market as it
had done over the previous 10 year period, it could still attain some
economic growth but that growth would not be adequate and sustainable.
This is the crucial policy dilemma which Sri Lanka has been facing right now
compelling the Prime Minister to choose a path leading along the export
sector. Hausmann very clearly validated the path so chosen by the
Government.
Sri Lankas simple product producing track record
Then, Hausmann went into the roots of the current crisis in the external
sector to find that Sri Lanka had been concentrating producing simple
technology products to the world market. There had not been any change in
the product mix between 1995 and 2014. In both years, about 98% of the
countrys exports had been simple-technology products like garments,
textiles, plantation crops, etc. The danger with such a product orientation is
that they are easily copiable and anyone with cheap labour could start
producing the same to the world market in competition with Sri Lanka.
Garment and textiles sector being threatened by new entrants
This has already happened in the case of Sri Lankas lifeline of exports,
namely, garment and textiles. With respect to these products, cheap labour
countries like Bangladesh, Myanmar and Cambodia have already begun to
compete with Sri Lanka away from the world markets.
Sri Lanka had a good fortune with the garment and textile sector in the
past. It helped the country to reduce its reliance on the plantation crop
sector and allowed it to provide employment to a sizeable portion of the
countrys aspiring youth. It over the years became a good contributor to
economic growth by increasing the value added from 5% to 45%. All these
pluses it has brought to the economy are granted.
Yet, the future of the garment industry in the midst of competition coming
from low wage countries as pointed out by Hausmann has been gloomy. It
may also be threatened by the introduction of new manufacturing
technologies like 3D Print Manufacturing by making it a household
production rather than a factory production. Hence, Sri Lanka should seek
out new production lines over which it still could command competitive and
comparative advantages.
Sri Lanka remaining a laggard while others becoming leaders
Hausmann used his data base to identify the countries which too shared Sri

Lankas product mix in 1995 in the past to find out where they are now.
Strangely, countries like Thailand, Turkey and Costa Rica had shared the
same product mix which Sri Lanka had at that time. That mix consisted of a
proportionately high percentage of goods that used simple technology for
production. The amount of high tech exports was negligible.
But those countries have now changed their product mix significantly into
mainly complex technology using products. What has happened is that
while Sri Lanka had been complacent with what it had in 1995, the other
countries have successfully changed their product mix to sustain economic
growth. Sri Lanka got itself elevated to the status of a lower middle income
country. But the three countries under consideration managed to become
higher middle income countries and are virtually at the doorstep of joining
the rich country world.
Thus, Sri Lanka had been a laggard, while the other three countries had
been leaders. This is a crucial lesson which Sri Lankas policymakers have
overlooked in the past and should take into account immediately when
framing its future growth strategies.
Sri Lankas competitive advantage in tourism and hi-tech products
The current challenge faced by Sri Lanka is how to catch up with the other
fast-growing countries in the world. Haussmann gave some hints about this
in his presentation.
According to him, the products in which Sri Lanka is doing well today such
as tea, garments and textiles have no promise for the future. That is
because Sri Lankas wage rates have increased over and above those of its
competitor countries in both these products.
Hence, Sri Lankas choice is clear with respect to these products. It cannot
reduce wage rates. But it can increase productivity in them and
accommodate the increase in costs due to increases in wage rates. If it is
not possible, it has to concentrate on other types of products over which it
has competitive advantage due to its wage rates still being lower than its
competitors. Haussmann opined that Sri Lanka can move into tourism
industry and hi-tech products because its wage rates are significantly lower
than the competitor countries. The biggest earners of tourism income today
have been the rich countries like France, UK and Spain. The wage rates in
those countries are significantly higher than those in Sri Lanka. Hence, with
proper marketing strategies and logistical support, Sri Lanka can move into
the tourism sector in a big way. Similarly, in the case of high tech products
too, Sri Lankas wages remain significantly lower than those in the close

competitor countries like Malaysia, Thailand and Indonesia.

Build the technological base over the next 10 to 15 years
What is therefore necessary is to build up the technological base of the
country in order to become a hi-tech product exporter country. This is
difficult, but not impossible as this writer has argued in a previous article on
the subject in this series (available at:
http://www.ft.lk/article/228844/Becoming-a-technologically-advancednation). But it is not a goal which Sri Lanka can attain tomorrow. It will take
at least another 10 to 15 years for Sri Lanka to become a nation with hitech products, provided it lays a firm foundation for it.
The outcome of the Sri Lanka Economic Forum 2016 should be to lead Sri
Lanka along this path.

What did Sri Lanka export in 1995

What did Sri Lanka export in 2014

(W.A. Wijewardena, a former Deputy Governor of the Central Bank
of Sri Lanka can be reached at waw1949@gmail.com)

Posted by Thavam