Ajith Nivard Cabraal: The role of productivity improvement in achieving
economic prosperity
Keynote address by Mr Ajith Nivard Cabraal, Governor of the Central Bank of Sri Lanka, at
the Annual General Meeting 2007/08 of the International Chamber of Commerce Sri Lanka,
Colombo, 17 September 2008.
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Mr. Chairman, Distinguished Invitees, Ladies and Gentlemen,
I consider it a unique honour to be invited to deliver the Key Note Address at this Annual
General Meeting of International Chamber of Commerce Sri Lanka (ICC Sri Lanka). I also
consider it a great privilege to share my thoughts and views on a very timely topic, "The
Role of Productivity Improvement in achieving Economic Prosperity" since
productivity improvement is essential from both a micro and macro perspective.
Therefore, at the outset, I wish to thank the ICC Sri Lanka for inviting me to deliver the
keynote address on a vital theme at this important forum and giving me an opportunity to
plant a few seeds in your distinguished minds so that such seeds may be nurtured by you in
your future endeavours positioning the country at a higher level in the global environment.
As we all agree, as individuals, our main objective is to experience a better life and we think,
act and react aiming to achieve this. At the same time, the main objective of economic
management is to enhance standard of living of the people. Hence, relevant stakeholders in
the country formulate, implement, revise and re-implement economic and other policies to
achieve such goals. Whatever the policy we formulate and pursue, the ultimate aim is to
raise living standards of the nation.
At the same time, we are all aware that it is compulsory to have higher economic growth and
fair distribution of benefits of growth for achieving higher standards of living. The issue is,
how can we achieve higher rates of economic growth?
Theory will say savings, investments, diversification, technology, hard work, attitudes and
perceptions. Yes. All these are important and they have certain importance in a country's
overall performance. However, in a highly competitive, globalized environment with a limited
resource endowment all of these factors would be second to productivity. For sustained
prosperity, productivity is the key.
Why is the productivity so important? Economists agree that,
in the long-run, productivity
growth is the principal means of improving living standards. The rate of productivity
growth influences the economy in important ways, even in the short run, by affecting key
variables such as output growth, employment growth, and the rate of inflation. So, as a first
step, let us examine the need of productivity improvements in the current global and
domestic economic context and the lessons of success by emphasizing on productivity, so
that we could deal with this topic in a wider perspective.
In my view, our economy should focus on productivity due to two important reasons.
First, limits in expanding agriculture and industry sectors and the resultant hindrance of
economic expansion. Second, in the current economic context, a greater emphasis has to be
placed in not only expanding the services sector, but also improving its productivity in order
to achieve higher economic growth. Let me elaborate on these two reasons in a broader
manner.
The economic history of countries clearly shows that there is a set pattern of the
transformation of the structure of economies, typically from agriculture to industry
and then to services. It happens due to two major reasons. First, in the first stage, the
economic value was entirely created by agriculture, which is called the pre-industrial era.
Thereafter, the source of a country's economic value shifted to industry with fast
industrialization. However, the value creation through agriculture and industry was
constrained at a certain point as the performance in both the agriculture and industry
naturally depends mainly on the natural resource endowment. Therefore, when the
natural resource endowment of countries limits further expansion of agriculture or industry, a
greater need for improving productivity arises.
Second, when growth is limited due to constraints in agriculture and industry, the
vacuum has to be filled with some other more efficient economic activity. Otherwise,
the economy would be stagnant. Hence, the existence of an efficient and vibrant services
sector has become a necessity for further growth of the economy as a whole and the
agriculture and industry sector in particular. Although the services sector was often
criticized as a sector that does not create real wealth, both the theory and evidence prove
that the wide-spread development and also the saturation of agriculture and industry has led
to the creation of a new source of wealth through a more dynamic growth sector in the form
of services.
The services sector is currently the largest and fastest growing economic activity in
most of the developed and developing world. The World Bank estimates that the share of
services in the Gross Domestic Product of developed countries is typically between 60 and
70 percent. While these figures are generally lower in emerging and least developed
countries, they have steadily been increasing over the years. However, it is equally accepted
that existence of expanded services sector alone cannot generate wealth. It has to be
dynamic, vibrant and it should add high values to the economy. The services sector should
be more productive and efficient. Today's customer not only demands services, but
demands more productive, efficient and reasonably priced services.
Let's take a closer look at Sri Lanka now ....
Undoubtedly, Sri Lanka's agriculture sector has made its greatest contribution to create
wealth and employment in the past. As we all are aware, we have been self sufficient in rice
production over the millenniums. We have been producing and exporting agriculture
commodities for centuries. At the time of independence, the agriculture sector was
dominating with a share of 47 per cent of GDP. However, keeping with the global and
domestic economic trends, the relative importance of the agriculture sector has been
shrinking. Accordingly, the share in agriculture reduced to about 12 per cent of GDP by end
2007. What has been the impact?
It has not been able to create sufficient value or
wealth with the reduced share of sectoral importance.
While recognizing the historic importance of the agriculture sector we should
recognize the fact that it has a limitation in the form of low contribution to the national
output and low productivity in the current context. Notably, as about one third of the
labour force is engaged in agriculture, its total output is distributed among a large number of
workers. According to the World Development Report 2006 of the World Bank, the
agricultural value added per agricultural worker in Sri Lanka, measured in 2000 US dollars,
has been US dollars 696 for the period of 1989-91. This has increased only marginally to US
dollars 737 in 2001-03. However, the comparable figures for other countries, even in
emerging countries, have been much higher than these figures. What is the result? As a
result, the income of agricultural workers in Sri Lanka has been very low, keeping
them below the poverty line.
At the same time, underemployment has been the natural consequence since
employment in agriculture is seasonal and there is a higher concentration of a large
farm-based work-force on limited extents of cultivable land. Even disastrously, the
under-employment in agriculture in Sri Lanka is not only the highest but also on the increase.
According to the Consumer Finances and Socio-economic Survey of the Central Bank, the
underemployment in the agriculture sector in 1996/97 stood at 31 per cent of the employed
and it rose to 36 per cent by 2003/04. In contrast, the underemployment in the services
sector fell from 20 per cent to 18 per cent between the two reference periods and that in the
industry remained unchanged at 20 per cent.
This has to be seen as both a weakness and an opportunity. We know that food prices have
recorded an unprecedented increase in recent times. Hence, there are immense
opportunities arising from increased prices and resultant increase in production. At the same
time, food security has to be ensured in order to avoid adverse consequences of increased
food prices and also undue declines in stocks. Given these limitations, the obvious
strategy is to increase productivity. Accordingly, attempts need to be made to concentrate
on land, water, agricultural methods, seeds, harvesting, credit to agriculture, transport,
harvesting storage, stable prices, value addition etc. to raise productivity in agriculture.
If the growth is constrained by limited expansion in agriculture, can't we focus more on the
industry sector? Of course, we can. Unlike the agriculture, which is constrained with limited
land availability, industry does not have capacity or demand limitations. Even the
nonavailability of raw materials or essential inputs or the domestic demand for the output no
longer does inhibit industrial growth in view of globalization of trade and services and the
advancements in information and communication technology. Although the importance of
the agriculture sector in Sri Lanka is reducing, the share of industry has been
By end 2007, the share of industry remained at around 30 per cent of GDP
improving.
compared to 20 per cent in 1950.
However, there are still risks and weaknesses in industry sector as well. The higher
reliance of imported raw material, increased cost of economic infrastructure, higher wages
per unit of output, overall increase in cost structure, intense global competition and possible
abolition of various concessions certainly tells us there is an urgent need to improve
productivity in the industry sector as well. The demand for the country's industrial goods will
always depend on its comparative and competitive advantages. This requires local
industries to raise productivity and efficiency in production so as to successfully
compete with the rival producers in other parts of the world.
Since Sri Lanka does not have an unlimited natural resource base it would be difficult to
enhance growth through industry or agriculture alone. As mentioned above, services sector
is important for both industry and agriculture sector performance. Hence, we need to focus
more on services sector.
However, the focus should be placed on a "more productive" services sector. Although
we always stress the importance of improving productivity in agriculture and industry sectors,
a similar significance should be assigned to the services sector as well. Despite the growing
weight in services in economies, productivity growth in services has been slow in many
countries and the share of the working-age population employed in services remains low in
many countries. If we wish to strengthen economic growth and improve the foundations for
the future performance of our economy, the services sector will need to do better. But
strengthening growth performance is not the only challenge that we are facing. We are also
confronted with the growing globalization of services and with rapid technological change
posing the huge challenge of keeping the momentum in the services sector. Addressing such
challenges and strengthening the potential of services to foster employment would be
definitely through increased productivity and innovation. Certainly a productive services
sector would deliver more benefits in a highly competitive environment. Sri Lanka's
telecommunication sector is a good example.
In which areas have we been below par? Although Sri Lanka has a huge potential in
services such as education, health and tourism, we haven't done enough. So, also, has it
been in the case of ports, financial services, including banking. We have not been able to
reduce prices and charges through increased productivity.
We may need to open domestic services markets to create new job opportunities and foster
innovation and productivity. Further regulatory reform of services markets will create fresh
opportunities for firms to develop new services, meet emerging global demands and increase
employment. It will also increase the incentives for companies to innovate and improve
productivity growth. With all these, country would reach higher level of economic
growth.
Before I conclude, I would like to address three broader issues based on three important
macroeconomic fundamentals. First, unemployment; second, exchange rate and the third
is inflation.
What will unemployment reduction do? The declining trend in unemployment to its
lowest recorded level in Sri Lanka brings to focus the need for more efficient use of
labour through productivity improvements. Precisely, lower unemployment indicates a
potential hindrance to future higher growth prospects unless labour productivity is improved
substantially. It has been encouraging to observe the continuous improvements in labour
productivity over the years, especially in the industry and services sectors, which have
contributed well to higher economic growth. However, an increasing mismatch in labour
supply and demand is reflected by the high rate of youth unemployment, including graduates,
and their desire to join the already expanded public service, while certain sectors in the
private sector are finding it difficult to recruit necessary skilled labour. This together with
declining labour force available for agriculture employment indicates the need of improving
productivity as a prerequisite to achieve the envisaged higher growth targets and a more
balanced regional development.
What will the Exchange Rate do? Under the floating exchange rate regime, the Sri Lankan
currency can no longer be regarded as a steadily and continuously depreciating currency.
With the maturing domestic foreign exchange market, the exchange rate is now more
responsive to, and determined through, market forces of supply and demand, while the
intervention by the Central Bank is limited to mitigate excessive volatility in the market and to
build up official external reserves. The stabilization of the Sri Lanka rupee utmost
underlines the need for the export and import competing sectors to focus more on
productivity improvements and market access in order to maintain external
competitiveness. Instead of waiting for the exchange rate to depreciate and then for our
businesses to become competitive, it is time for all of us to improve our productivity in
whatever manner we can. The garment sector, I hear is trying to gain from higher productivity
and also through cost efficiencies.
How does inflation and productivity affect each other? Increased productivity is an
important prerequisite to achieve low and stable inflation levels in the long-run. The
lower productivity allows cost increases that flow through to product prices and thereby
raises inflation. Therefore, the lower productivity growth thus represents a negative supply
shock that generates inflationary pressures. In such context, it is necessary to pay due
attention to improving the productivity in order to prevent potential inflationary pressure
associated with high income arising from faster nominal growth and cost-push factors that
raise the cost of production. The long run containment in inflation necessarily relies on
containment of monetary expansion and increase in production in the country, particularly by
improving productivity.
As the Central Bank, what we can do? Obviously we cannot produce goods or services for
the consumption of the economy, but certainly we can create the right conducive
environment enabling the country's economic performance.
Why should the Central Bank be interested in productivity? Our role is to maintain
economic and price stability and financial system stability. We also provide necessary
payments and settlement infrastructure. We advise the government in economic affairs and
policy making, and we provide important agency services such as exchange control, public
debt management, provident fund management and regional development activity. In all
these functions, our Mission is to "contribute to Sri Lanka's prosperity". At the same time, the
Central Bank widely pronounces the theme of "success through productivity".
But, obviously this cannot be done by ourselves... The success through productivity
needs a consolidated national effort. That is why we all have to push ourselves to a
greater productivity level. We have to,
•
work smarter,
•
combine better,
•
deliver results,
•
get it right.
It should be noted that the private sector has continued to make commendable efforts in
order to improve productivity in the country. What can the ICC Sri Lanka do? ICC Sri
Lanka too can play a prominent and essential role. Since your organization establishes the
business stance on broad issues of trade and investment policy as well as on vital technical
or sectoral subjects including financial services, information technology, telecommunication,
marketing, environment, transportation and etc., a vital role can be played in articulating the
need for improving productivity.
Do it now. This will be a major contribution that you make to our country.