W A Wijewardena: Services sector growth - an unstable growth component or
a sustainable wealth creator? The case of Sri Lanka
Text of the Professor Sirisena Tilakaratna Memorial Lecture - 2006 by Mr W A Wijewardena, Deputy
Governor of the Central Bank of Sri Lanka, at the Center for Banking Studies, Rajagiriya,
15 December 2006.
The views expressed in this paper are those of the author and should in no way be construed as those of the Central Bank of
Sri Lanka.
* * *
I consider it a unique honour to be invited to deliver the Professor Sirisena Tilakaratna Memorial
Lecture 2006. Four eminent authorities did the honour of delivering the same during the last four
years. All of them were either his colleagues or his seniors. Against this background, a student of
Professor Sirisena Tilakaratna being invited to do the honours this year is a departure from the past
tradition. It is in this context that I consider it a unique honour bestowed on me.
Professor Sirisena Tilakaratna comes from the same place as I do. He was schooled in one of the
leading schools of the day, namely, Taxila Central College at Horana. He belongs to the rare category
of students who did their studies in English medium, but equally fluent in Sinhala as well. Because of
my relationship with him, I used to visit his house very often as a kid. What attracted me most at that
Free
time was the collection of journals he, as a college student, was having in different subjects:
World from the US Embassy; Commonwealth Today from the British High Commission; Nawa Yugaya
Rasawahini
from the Lake House; from the Times Group etc. I had the habit of leafing through those
magazines and enjoying the titles and photographs. He did not mind our bothering him. He, in fact,
encouraged us to write to the respective Missions for complimentary copies. When I entered the
Vidyodaya University (now, the University of Sri Jayawardenapura) to do my undergraduate studies in
management in late 1960s, Professor Tilakaratna had just returned to the island having completed his
doctorate at the prestigious Queen's University in Canada. He took all our courses in economics:
micro, macro, welfare economics, international finance, international trade, public finance,
development economics etc. Hence, we could safely say that our whole undergraduate knowledge of
economics was imparted to us by him. He had referred to all the latest text-books, meticulously
prepared his notes and updated them continuously. I still recall that the students were eagerly waiting
for his lectures. This was because of the comprehensiveness of the lectures and the unique method of
delivery. He used to explain the technical terms again and again as and when they emerged in his
lectures, until their meaning was permanently implanted in our minds. We were all benefited by his up
to date treatment of the subject. When I went to the UK for my post-graduate studies in mid 1970s, it
was only in the case of subjects he had covered that I did not have the so called knowledge gap.
Professor Tilakaratna was not only an academic, but also a policy advisor, manager and administrator.
In early 1970s, he functioned as an advisor to the Ministry of Plantations Industry and was appointed
as Chairman of the newly established Coconut Marketing Board. Unlike other academics who thought
that they knew all, he had the modesty and humility to learn from industry. A big magnate in coconut
industry recently related to me how he once visited a coconut factory and insisted on learning a to z of
everything there. My frequent visits to him either at the Coconut Marketing Board or at his residence
were intellectual and academic journeys through all aspects of and issues relating to the coconut
industry. We always returned home being much wiser than before.
The university authorities too recognized his academic excellence and erudition fairly early. He was
elevated, by double promotion, to the post of Professor of Economics and Head of Department at such
a young age as 34. Immediately after that, he re-organized the Department of Economics, introduced
a Post Graduate Diploma in Applied Social Statistics and strengthened the Department with new staff.
I was one of the students who completed this Diploma in its first batch.
Professor Tilakaratna's greatest contribution to economics was his continuous upgrading of the
standards of the syllabuses and examination papers in economics at the GCE (Advanced Level)
Examination to be on par with international standards. New theories, trends and ideas in economics
were all built into his examination structures with a time gap of only one or two years. This strategy
forced students, teachers and, above all, tuition masters, to continuously update their knowledge. The
failure to do so would have meant failure at the examinations. From his side, to help them, he wrote
text books, appeared on the educational services of both Rupavahini and the Broadcasting
Corporation and attended frequent public and teachers' seminars. When the Central Bank broadened
the definition of money supply and introduced the concept of high powered money, it took only less
than two years for these new subjects to be a part of the examination paper. He confessed to us that
he had to learn these concepts anew in order to handle them safely as examination material.
He was also an administrator par excellence as the Chairman of the University Grants Commission. In
this position, he was able to perform his duty without fear or favour. He had the remarkable ability of
effectively managing politicians, friends and even relatives who made unreasonable demands which
were against the approved rules and regulations. His contributions to the nation were suddenly halted
by his untimely death at the prime age of 63, an age which is relatively low for an academic. When a
person dies, he is normally missed only by his family members and close relatives. But in the case of
Professor Tilakaratna, he is missed by all, his colleagues, students, academics and the rest of the
people in the country.
I choose an appropriate topic for my lecture, based on Professor Tilakaratna's long conviction that Sri
Lanka's economy should move forward on the basis of its comparative advantage. Being a trade
specialist, he always believed that any other mixture of economic policy would lead to a sub-optimal
solution. He cautioned that economic policies, not supported by solid economic principles, but merely
guided by narrow emotion-driven ideologies, would be non-sustainable. This led me to examine the
current controversy surrounding the services sector as a viable and sustainable wealth creator for Sri
Lanka.
The services sector is often quoted as a sector that does not or cannot create real wealth. This view is
sometimes expressed by even mainstream economists. According to them, real wealth in a society is
created only by visible products that are generated by agriculture or industry. On the contrary, the
services sector which produces invisibles does not lead to any improvement of wealth on a long-term
basis. Hence, any preponderant growth in the services sector over the real-good producing sectors is
considered as a risk. The skepticism about the services sector would have been spawned by the
inability to store the products of the sector for future use which could be considered as a symbol of
wealth of a nation. Hence, its growth over and above the growth of storable product sectors would
make a country dependent on the rest of the world, specifically in times of wars, disturbances to
international free movement of goods etc. The underlying argument is that, if a country is self-sufficient
in all its requirements, it can manage its affairs even in the worst conditions. In contrast, a country
dependent on others, will have to follow a complaisant foreign policy so as not to antagonize them. It
does not enjoy the freedom which self-sufficient countries have in charting their domestic and foreign
policies based on national ideologies. Raymond Lim, Singapore's Minister for Transport and Second
Minister for Foreign Affairs, referred to this limitation in the context of a country dependent on global
trade, as "....... not having the luxury of pursuing a foreign policy of abstract ideals".1 It is, however, to
be noted that such freedoms should not necessarily imply higher welfare. This is because the level of
welfare of a country is dependent on the quantum of wealth created and the level of real consumption
and quality of life of its people. Yet, the critiques of the services sector based growth have often voiced
these concerns and labeled such growth as illusive.
The examination of the economic history of countries shows that there is a set pattern of the
transformation of the structure of economies. The pattern has been from agriculture to industry and
then to services. This trend has been equally observed in both developed and developing economies
alike. In the first stage, which covers the pre-industrial era, the almost entirety of the economic value
was created by agriculture. With fast industrialization, the source of a country's economic value got
shifted to industry. The wide-spread development of markets, first internally and then globally, led to
the creation of a new growth sector in the form of services. This is because, the existence of an
efficient services sector was necessary for further growth in both the agriculture and industry. When
the natural resource endowment of countries set an effective limit on further expansion of agriculture
or industry, the vacuum was filled by a sudden boom in services. Good examples of this phenomenal
development from the modern era are Hong Kong and Singapore. Both these countries have been
able to create wealth through rapid industrialization supported by a strong and dynamic services
sector.
Throughout its history, Sri Lanka has been a beneficiary of being an active partner in global trade. In
addition to be located on a very convenient naval route, conducive policies adopted by successive
rulers have been a booster to international trade, and through it, to wealth creation. The pinnacle of
country's trade performance was recorded during the reign of the King Parakramabahu, the Great, in
the late 12th century. The evidence suggests that it was a complete free market economy policy that
was followed during this whole period. According to the Great Chronicle of Sri Lanka, Mahavansa, the
king is recorded to have set-up the first ever export processing zone called Antharaanga Dhuura,
Kalu Ganga, Bentara Ganga
bordering the present and Sinharaja forest. In this zone, elephants, ivory,
timber, gems, pearls and spices were processed for export to India, China and the Middle East2. In
order to facilitate trading with many different nations, the King Parakramabahu made it mandatory for
state officials to be fluent in foreign languages. During this period, Sri Lanka is reported to have
entrepot trade
functioned as a vibrant centre, the role played by Singapore in the modern world.
According to some authors, Sri Lanka had simultaneously imported and exported the same
commodity, such as textiles and fabrics3. This is considered as a very advanced form of trading known
as intra-industry trade by modern economists. The same high profile of the country in foreign trade
Sinhala
was continued unabated in the period afterwards. According to Dr S Arsaratnam4, both the
kings and the Dutch used Arabic traders to export elephants, gems, areca nuts and spices, and import
rice, textiles and other requirements in the 16th to early 18th centuries. The British period that followed
the Dutch rule is marked by a continuation of the open-economy policy pursued by ancient Sinhala
kings. During this period, the country continued to rely on foreign trade for wealth creation and
maintaining high standards of living. Hence, the reliance on services, especially commercial services,
for wealth creation was not a new policy paradigm for Sri Lanka.
Around the time Sri Lanka gained independence from the British rule, the country's GDP was
distributed in the proportion of 46 percent for agriculture, 20 percent for industry and the balance 34
percent for services. The high share of both agriculture and industry amounting to about a two-third of
GDP indicated the prevalence of a limit for their continued growth devoid of a vibrant and efficient
services sector. This anomaly was to be gradually, and in a slow pace, corrected in the subsequent
five decades. In 1960, a slight improvement in the respective shares was observed with agriculture
falling to 38 percent and services rising to 45 percent. The period since then recorded a virtual
stagnation of services till early 1980s when the country moved to an open economy regime. During the
period from 1980 - 2005, the agriculture sector further declined in relative terms from around 28
percent to 17 percent, while the industry remained unchanged at around 25 - 26 percent. But the
services sector increased its share from 43 percent in 1980 to 56 percent in 2005. In the recent past,
services have been the main and the significant contributor to economic growth in Sri Lanka, pushing
industry and agriculture to the second and third places, respectively. It is this phenomenal growth in
the share and the contribution of services which has caused concerns for and attracted criticism by
some quarters.
Sri Lanka's current stage of the development of the services sector can be contrasted with some
selected developed countries and countries in the region. According to the World Bank data5, between
1960 and 2004, the share of the services sector in some selected countries was as follows:
The share of the services sector
Percent of GDP
1960 1980 1995 2004
UK 53 54 66 72
Australia 51 58 70 71
France 52 62 71 73
Japan 42 54 60 68
USA 58 64 72 75
Singapore 78 61 64 65
Hong Kong 62 67 83 88
China 20 21 31 35
India 30 36 41 52
Sri Lanka 48 43 52 58
The statistics show that the current level of services in Sri Lanka is more or less equivalent to the
status which the services enjoyed in developed countries in 1960s. While Sri Lanka is far ahead of the
two giant growth machines in the region, viz., China and India, it would not be too long for these two
countries to overtake it, given their current services promoting policies.
It is also observed that the services sector has been growing in importance in all the countries during
the past five decades or so. Some countries have now attained the optimal level of services above 70
percent. This indicates that the countries which are still below that level have an enormous potential
for further growth. But the question posed has been whether such growth would be sustainable or not
in the long run. In other words, whether it could continue to create wealth and improve the standard of
living of the people.
It has also been observed that countries which generate a share of 60 percent and above from the
services sector have been able to record a sustainable GDP expansion over the years. The larger
share of services, as claimed by critiques, has in no way contributed to retard their growth. In fact, the
preponderant growth in the services sector has helped them to improve both agriculture and the
industry sectors on efficiency grounds, infusing sustainability to those two sectors as well. Hence, it
can be safely concluded that a share of about 65 to 70 percent in the services sector would provide a
country with immense prospects for wealth creation, provided it gains competitive advantage in the
production of such services. In this context, the future growth prospects available to China are
enormous, since its services sector still accounts for only 35 percent of its GDP. Both India and Sri
Lanka too stand to gain on account of the leeway available for them to push the services sector's
contribution to above 65 percent. Hence, it is important that they should exploit this growth potential
without further delay.
Let's now turn to why Sri Lanka should exploit its growth opportunities in the services sector.
First, the widely held view that Sri Lanka is an agricultural economy and it should continue to be so in
the future as well has entailed certain limitations on its future growth. This belief would have been
nurtured by the historical experience of high prosperity which the country attained through agriculture,
specifically through subsistence paddy farming, in both Anuradhapura and Polonnaruwa eras. In these
periods, when the country was subject to frequent foreign invasions, it would not have been unusual to
regard food security as the number one priority of the nation. Hence, a larger share of growth, output
and employment was occupied by agriculture. But today, these issues are not of grave concern to a
nation open to the rest of the world. This is because international markets have developed both
intensively and extensively to cater to the every possible demand of consumers. Hence, countries in
the present era could easily replenish food shortages, provided they have the required purchasing
power. Agriculture faces a serious man-power shortage too, because it is not the most preferred
occupation by many. This is because, Sri Lanka's universal free educational system, an enviable pride
among other developing nations, has been instrumental in creating a generation of educated youth
with an urban ideology, based on a marked preference for white-collar jobs. Even in the predominantly
agricultural areas, the trend has been the same. Consequently, it has become a nearly impossible task
to keep the rural youth occupied in agricultural activities. This has made it necessary for opening new
employment avenues for such youth. An additional factor has been the natural limitation for growth of
agriculture due both to the slow growth in demand for agricultural products and the supply constraints
of land for further extensive cultivation practices. Hence, in the beginning, agriculture may be the
growth promoter, but later, its growth would slow down due to the above limitations. The global
experience has been that the average rate of growth in agriculture has been less than 2 percent per
annum during the last 100 years. With higher and higher numbers being added to the job market every
year, agriculture has, therefore, a limitation for providing jobs for all.
Sri Lanka's agriculture sector has made its utmost contribution to create wealth and employment in the
past. Its current ability to do so has been a matter for debate. With employment in agriculture being
seasonal and the concentration of a large farm-based work-force on a limited extent of cultivable land,
underemployment has been the natural corollary in Sri Lanka. The new evidence shows that 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 Bank6, the
underemployment in the agriculture sector in 1996/97 stood at 31 percent of the employed. This rose
to 36 percent by 2003/04. In contrast, the underemployment in the services sector fell from 20 percent
to 18 percent between the two reference periods, while that in the industry remained unchanged at 20
percent. The message conveyed by this unfavorable development is clear: remove a greater part of
those employed in the agriculture sector in order to raise its efficiency and future sustainability. Hence,
the appropriate policy strategy should be to raise productivity in agriculture through intensification of
farming with high-yielding varieties by employing a lesser number of work-force.
Agriculture has a further limitation in the form of low productivity and low contribution to GDP. Since
about a one third of the labor force is engaged in agriculture, its total output is distributed among a
large number of workers. According to the World Bank data7, the agricultural value added per
agricultural worker in Sri Lanka, measured in 2000 dollars, has been $ 696 for 1989 - 91. This rose
marginally to $ 737 in 2001 - 03. The comparable figures for other countries have been much higher
than this: USA $ 26,105 and $ 47,566; Australia $ 26,601 and 26,957; Sweden $ 20,416 and $ 30,469;
Malaysia $ 3694 and $4,571. As a result, the income of agricultural workers in Sri Lanka has been
very low, keeping them below the poverty line. This has been further exacerbated by the low value
addition of the agriculture sector in the economy. While the contribution of the crop sector amounts
only to 14 percent of GDP, the individual contribution by the sub-crops has been negligible with tea
contributing 1 percent, rubber 0.4 percent, coconut 1 percent and paddy 3 percent. Hence, even if the
output of agriculture is doubled, it would not make a significant contribution to country's wealth
creation.
If agriculture has its limited capacity for an accelerated growth, why not concentrate on industry? This
may be a pertinent issue to be addressed at this stage. Certainly, unlike the agriculture, which is faced
with the limitation of land, industry does not have any capacity or demand limitations. The
nonavailability of raw materials or essential inputs or even the domestic demand for the output does no
longer inhibit industrial growth. With globalization of trade and services and the advancements in
information and communication technology (ICT), the previous bottlenecks for industrial growth have
been efficiently sorted out. In today's context, industrial outputs do not belong to a particular nation or
country. They are jointly held products to which many nations or countries would have contributed.
Countries with cost-advantages, driven by technology and innovation, have been able to attain
specialization in sub-components of given final industrial products which are assembled in global
factories. As reported by the World Bank8 , the Ford Escort Motor Car which is finally assembled in the
UK or Germany, had main components manufactured in 15 different countries. In the modern
production processes, it has been observed that product development relating to personal computers
takes place in USA. The components for them are manufactured in Taiwan. The final assembly takes
place in Malaysia. The marketing is undertaken in Singapore. The inquiries relating to the products are
handled by call centers in India. It, therefore, behooves developing countries like Sri Lanka to be a
part of this 'global factory process' in order to raise their industrial production capacity and wealth. But
the prime pre-requisite for that is the existence of a vibrant and dynamic services sector equipped with
a free flow of information and capacity to impart knowledge on time. In other words, the modern
industry cannot survive or sustain without services. Hence, any attempt at developing industry in
isolation would drain it of a vital requirement for growth and sustenance, viz., competitive advantage.
The importance of the services sector for both industry and agriculture can be identified by examining
the full-range of modern production flows. In fact, this is something which many have tended to
disregard and therefore assign a lower value to services than real productions like agriculture and
industry. Such a flow which should come one stage after the other in the order given, is presented in
the following tabular exposition:
Modern production flows
Stage Process Identity
1 Basic Research Service
2 Applied Research Service
3 Incubation and Testing Service
4 Commercial Development Service
5 Planning and Financing Service
6 Manufacturing Industry
7 Warehousing, Transporting and Marketing Service
8 Financing Service
9 After-sale services and maintenance Service
10 Continued Research and Development for Service
Next Generation Products
It is apparent that only one out of the 10 different production stages constitutes industry (or agriculture)
and all others are services. If one is concerned about developing agriculture or industry, he cannot
ignore all the essential service ingredients that should precede and follow the actual act of production.
Since people see only the visible output, they fail to observe the full range of other services that have
contributed to its creation as well as subsequent continuation. Many industrial outputs of developing
countries have failed to make a mark in the international markets because of the absence of
welldeveloped after sale and maintenance services. The Indian auto-maker, Maruti, failed to sell its fuel
economy car until Suzuki of Japan stepped in with technology and after-sale services. Therefore,
without the attendant services, it is not possible for either industry or agriculture to sustain itself.
Sri Lanka which is devoid of a sufficient natural resource base would find it difficult to enhance growth
through industry or agriculture alone. The country's available land is limited and its population density
at 293 persons per square kilometer is one of the highest. In comparison, Canada has a density of 3,
USA 31, New Zealand 14, Australia 3 and Russia 9. While the latter group of countries could
conveniently move into extensive farming, Sri Lanka's choice is limited only to improved productivity
through intensive cultivation. That again is through innovation which comes from services.
The second factor that would drive Sri Lanka to the services sector is the ever rising globalization of
services. In the past, services which, by nature, cannot be stored, were non-tradable. Hence, there
was no any prospect of selling, services beyond the borders of a country limiting its clientele to its own
citizens. If any foreigner desired to avail himself of any services, he should necessarily have traveled
to the country of services at great costs in terms of both time and money. This is why cross-border
services were limited only to areas where foreigners could have them relatively at a low transaction
cost. In this context, the services which played a prominent role in the global arena were shipping and
insurance services where the service provider visited the buyer and travel, education and health
services where the buyer visited the service provider. In all these areas, Sri Lanka had an upstart over
other competitive countries. Sri Lanka's university system at the time of gaining independence was
one of the best in the world. It also had a very reliable and high quality curative health system. For
shipping services, it had the best comparative advantage by being located on a very important naval
route. Its ports in Colombo and Trincomalee had the best cost-advantage. Its highly literate work-force
with professional qualifications from the UK and other advanced countries could have provided the
best insurance and banking services to the rest of the world. But, due to the inward orientation of the
policies adopted since independence, these comparative advantages got shifted to other countries
such as Singapore, Hong Kong and Australia. For Sri Lanka, it is, therefore, a story of missed
opportunities.
It is too late now to lament over the failed past. What the country should do is to plan for the future, so
that Sri Lanka could conveniently get itself integrated to the globalised services industry. As argued by
Thomas L Friedman9, the world has become flat and the world nations, including USA, should
recognize the flattening process of the world. If a country stubbornly and arrogantly refuses to accept
this fact, it stands to lose, while others continue to move forward on an accelerated high gear. India,
being one such country, has identified many areas which were previously non-tradable and took action
to promote them actively. The advancements in ICT through a wired globe have enabled India to do so
at a rapid pace. As indicated by Friedman, business process outsourcing (BPO) coupled with such
personal services as secretarial services, provision of tuition, accounting and tax advisory services,
on-line medical consultancy etc. are booming in the southern part of the Indian sub-continent, creating
wealth and opening new opportunities to otherwise unemployed educated youth. Though India started
its ICT much later than Sri Lanka, its export of software now amounts to US $10 billion per annum.
India's present plan is to raise it US $20 billion by 2010. This indicates the tremendous capacity which
ICT alone would have for a country to create new wealth for its citizens. Ireland and Israel have
exploited this opportunity profitably.
India's ascent to a formidable global ICT power has been mainly driven by economic reforms,
establishment of a free market democracy, perseverance of some unbeatable private entrepreneurs
and above all, continuous human capital development in engineering and electronic fields.10 The last
development came from the high educational standards maintained by a web of reputed state owned
Indian Institutes of Technology (IITs) and permission given to private sector to set up higher learning
institutes. This is definitely an eye opener for Sri Lanka. Even in the midst of growing evidence from
India and elsewhere that privately owned institutes of higher learning could make a significant
contribution to the globalization of education and training, Sri Lanka still keeps education as a
closelyguarded relic in the public sector. As a result, its capacity to meet the demand for higher education is
woefully low with one place being offered to satisfy about 16 aspirants. This has led aspiring youth to
seek higher education in other countries at a high personal investment cost. Since every investment
should yield commensurate returns, it also has compelled them to seek employment elsewhere.
Whatever the intention, the closely protected public university education system has become a waste
of scarce public resources, since only a fraction of the total registered students is reported to be in
attendance in classes.11 Hence, to gain reputation as a global centre of learning, it is necessary that
the Sri Lanka's university education system should undergo a complete overhaul and reform.
A further benefit which Sri Lanka could gain by promoting a global market based services sector is the
possibility of narrowing the current account deficit of the balance of payments through enhanced
service income. Historically, Sri Lanka is having an ever ballooning deficit in the merchandise account.
With high international oil prices and rising intermediate and investment goods imports, this deficit has
risen to a very high and unsustainable level of about 13 percent of GDP by 2006. Countries with such
large trade deficits should perforce attempt to generate an equivalent surplus in the services account
so as to finance the same. However, the surplus being generated by Sri Lanka in its services account
has not been sufficient to fully off-set the trade deficit. As a result, Sri Lanka normally runs a current
account deficit of 5-6 percent of GDP which has to be financed through capital flows. This level of a
current account deficit, occurring year after year, is not sustainable. Given this scenario, the
enhancement of the income from services by promoting the services sector would definitely help the
country to have a stable balance of payments position.
What should the country do to attain the goal of having a vibrant and efficient services sector? First of
all, it should invest heavily in infrastructure so as to facilitate the production of services. In this
connection, the proposed international airport and the port in Hambantota and the attendant
roadnetwork would make a significant contribution to facilitate the promotion of global services. But the
country should not stop there. As a top-most priority, the road network should be improved to be on
par with global standards. Roads would create access to markets and reduce transaction costs. Since
the services, like the visibles, should be produced at the cheapest costs to attract global customers,
the maintenance of efficiency at all levels of the economy is a must. For this purpose, the country need
be wired electronically covered by a reliable road network. The most important requirement for a
sustainable services sector is the continuation of the development and supply of the needed human
resources. The plan made by Singapore at the turn of the new millennium in this regard is a guidance
for other countries. The Singaporean Ministry of Education is reported to have instructed, in 1999, all
the tertiary educational institutions and universities to concentrate on courses on genetic engineering,
ICT, nano-technology and entertainment so as to provide the skilled human resources