Finding Sri Lanka’s strategic economic ‘fit’

The global financial crisis and the resultant global economic downturn in 2008/09 had a debilitating impact on the strength and dynamism of many of the Western economies. Yet, this was but another crack (albeit a more discernible one) in a region that had already begun losing its edge.

The balance began to change in the late 20th century. After 25 years of growth and extreme consumerism, much of the West began to lose its competitive advantage as full employment and inflation eroded the profitability of mainstream manufacturing. East Asia slowly emerged as a manufacturing powerhouse, and the Asian tigers were unleashed.

They adapted Western technology to win markets abroad. By the 1980s, China had joined the Asian tigers – Taiwan, Hong Kong, Singapore and South Korea, soon to be joined by Indonesia, Malaysia, Thailand and the Philippines. By the mid-1990s, India joined the club of high growth Asian economies.

Economic vigour is shifting East

So, the balance of economic power is shifting decidedly from West to East, with China, India, and East Asian tiger economies leading the global economic recovery. Global production hubs have, and continue to, shift to India and the East not only because of lower costs, but also increasingly because it is being complemented by improved industrial, technological, and knowledge-driven capabilities. China and India are the veritable engines of growth of the world economy, much like Germany and Japan were in the late 1970s.

For decades now, Sri Lanka has relied on Western markets for its export earnings. For much of the last decade, the bulk of the Sri Lankan exports (60%) have been to the US and EU. However, with the weak recovery, sluggish consumer spending, depressed job market, woes due to austerity measures (mainly in Europe), and the withdrawal of the EU GSP-Plus concession, Sri Lankan exports to these markets are now under stress.

In 2011 and 2012, the US is projected to grow at 2.8% and 2.9%, while the EU is projected to grow at 1.6% and 1.8%, respectively. Meanwhile, Asian economies attain a strong post-crisis growth trajectory, and thus, an era of ‘two-speed growth’ is visibly taking root.

In its latest World Economic Outlook (WEO) (April 2011), the IMF forecasts that growth of ‘advanced economies’ will languish at 2.4% in 2011, while ‘developing Asia’ will grow at 8.4%. Boasting a high level of domestic demand, Asian growth champions, China and India – ‘Chindia’ – are predicted to grow at an impressive 9.6% and 8.2%, respectively.

Sri Lanka is yet to effectively ‘plug in’ to the dynamic growth centres that are emerging in its vicinity – India, East and South East Asia, and China. It needs to look at developing stronger linkages with these healthier economies of Asia, explore new trading opportunities and move away from the excessive dependence on the US and EU.

There appears to be some policy impetus for this, with the Export Development Board (EDB) stating that it aims to help reduce the country’s export dependence to the US and EU from the 61% at present to 50% by 2015.

Critical to this effort however, will be a careful and comprehensive evaluation of what type of product categories could succeed in these new markets, what level of quality and branding is required, how to effectively to link into their supply chains and what tariff and non-tariff barriers need to be addressed in tapping these markets.

A tighter South Asia?

Intra-regional trade in South Asia is less than 5%. Although Sri Lanka is a signatory to the region’s second multilateral trade deal, the South Asian Free Trade Agreement (SAFTA), utilisation of the SAFTA preferences have been remarkably low.

However, Sri Lanka’s bilateral economic relations with India have been growing, with increased trade taking place under the India-Sri Lanka FTA (ISFTA) which has been in force for just over 10 years now.

Yet, the two countries have not been able to expand this FTA to cover services and investment by signing a Comprehensive Economic Partnership Agreement (CEPA), despite years of discussions, due to domestic resistance from certain quarters.

India is increasingly demonstrating its strong economic potential and heightened international economic standing, and is the new cynosure in the eyes of emerging markets analysts. India is growing strongly with a large domestic market as well as growing industrial and services potential, and there is a need to find ways of productively ‘piggy-backing’ on this, through a mutually-beneficial, suitably phased, comprehensive partnership.

With India pursuing stronger economic relations with the wider Asian region, closer economic integration with India would open new doors of opportunity for Sri Lanka. India has already signed Comprehensive Economic Cooperation Agreements (CECAs) with Japan, Malaysia, Singapore and South Korea, and a Trade in Goods Agreement with ASEAN (soon to be expanded to an FTA in services). India has also begun negotiations on an FTA with the Gulf Cooperation Council (GCC) and the European Union (EU).

While economists in the region have begun exploring the potential for ‘intra-industry trade’ within South Asia to strengthen regional value chains (RVCs), this has yet to feature heavily on the agenda of regional policymakers.

In developing greater intra-regional trade and investment in South Asia, several issues would have to be addressed aggressively – tariff and non-tariff barriers, poor physical connectivity, burdensome behind-the-border procedures, ambiguity in terms of related trade procedures, corruption, and visa facilitation for businessmen.

Twenty five years since its establishment, the South Asian Association for Regional Cooperation (SAARC) struggles to prove itself as an effective institution in shaping the South Asian region as a formidable economic bloc.

“SAARC-ists” like Dr. Rajiv Kumar, Director General of the premiere Indian private sector body FICCI, believe that while SAARC as an institution leaves much to be desired, SAARC as a concept still holds much currency. He has advocated on moving fast on issues like energy cooperation and tourism to provide some ‘quick wins’ to build confidence in the notion of closer South Asian integration, and demonstrate to SAARC’s citizens that progress is possible.

Yet, movement on SAARC agenda items proceeds unhurriedly. So, while continuing to play an active role in strengthening SAARC and advancing its goals, Sri Lanka needs to also explore ways to engage more intensively with more dynamic blocs in other nearby regions, and their economies; for example, in South East Asia through the ASEAN, and in the Middle East through the GCC.

Smarter foreign policy for economic goals

Sri Lanka ought to take a ‘long view’ with respect to its foreign policy. It is important to bear in mind that the implications of the country’s foreign policy are not confined to the diplomatic sphere alone, but also permeates strongly into the economic sphere as well. It has implications, directly and indirectly, on Sri Lanka’s participation in the global economy, and thus on trade, investment, and, consequently, economic growth.

Sri Lanka should consider formulating a strategic foreign policy that fosters a strategic balance between her neighbours in South Asia, dynamic East Asia, and her traditional trading partners in the West.

With South Asia, Sri Lanka ought to move faster on cooperating not only on intra-regional trade, but also on intra-regional connectivity, people-to-people contact, energy, tourism, etc., as well. With East Asia, Sri Lanka ought to leverage on their current and potential economic strength, and their growing clout on the global scene (the last G-20 summit in October 2010 was held, not in a Western capital, but in Seoul, South Korea).

With the West, Sri Lanka must guard against her antagonism stemming from the issues surrounding the end to the armed conflict spilling over into our economic relationships. Sri Lanka still depends heavily on their exports markets, and needs cordial ties in order to attract greater FDI and needs to foster links for technology-transfer to spur innovation as the nation aspires to faster and faster economic growth.

Latching on to the BRICS?

Meanwhile, Sri Lanka must stay acutely aware of the tectonic shifts in the centre of gravity of global economic governance that are slowly taking place. The G20 – set up to ensure a coherent and concerted effort in tackling the fallout global economic crisis – was an unprecedented coming together of the richest Western economies and the most commercially important emerging economies.

Although earlier touted as, potentially, the new platform for international economic co-operation in light of the stalemate in the WTO and friction in other multilateral fora, it appears to have little longevity beyond the crisis response efforts it originally mandated itself to do. Rather, what is now emerging as a key power bloc is the BRIC (Brazil, Russia, India, and China) group.

The BRIC countries, which showed strong resilience during the global economic crisis, account for 45% of the world’s population, 25% of global GDP, and a whopping 60% of the world’s foreign currency reserves. In its most recent summit in April this year, South Africa was invited to join the grouping, expanding the group to ‘BRICS’, further solidifying the grouping as a powerful player on the global stage.

BRICS already have a couple of impressive triumphs to boast of. They have just agreed that instead of lending to each other in the international reserve currency, the US dollar, they will lend in their own currencies. Following last year’s BRIC summit, they managed to successfully lobby for greater voting representation in supranational financial bodies like the IMF and World Bank – a long overdue reform.

This gradual emergence of the BRICS could, eventually, provide an effective platform for developing countries as a whole to rally around. They could link up productively through their own (albeit relatively weak) G-15 group, and thus find themselves a stronger voice in the global economic arena. This has direct implications for smaller developing economies like Sri Lanka.

Despite being un-associated with the initial financial markets crisis, developing countries like Sri Lanka were badly hit by the global downturn that followed, and therefore have a strong desire to see the developing world gain a stronger voice in reforming global economic governance. By finding ways to strategically link up to this type of new, stronger ‘South-South’ cooperative voice, Sri Lanka could create more avenues to seek support for its economic goals internationally.

The West is not a ‘weak horse’ yet

Despite the economic crisis that has threatened their entire economic model, several Western developed economies remain fundamentally strong, have developed and refined their institutions and policies over a longer time, and more importantly, possess the ingredients to adapt to the changing tides. Their hegemony cannot be dismissed too quickly, at this stage.

The population of the United States is growing with vitality, compared with every other Western industrialised country where populations are shrinking. Unlike China (which is now gradually seeing straining labour market symptoms of its ‘one child’ policy) the fertility rate in America remains high enough to sustain economic expansion for at least another generation.

America’s population strength also comes from a welcoming immigration policy that has attracted both the best minds from East Asia, and ample labour from South America, for example. America’s edge in innovation will not wane that easily, despite Asia catching up fast.

The Harvard political scientist, Joseph Nye, considered the father of the concept of ‘soft power,’ points out in his book ‘The Future of Power’ that Chinese- or Indian-born engineers run more than a quarter of all high-tech companies in Silicon Valley. By 2005, one in four technology start-ups had been launched by immigrants. According to Nye, America’s greatest long-term strategic asset is “its ability to attract the best and brightest from the rest of the world and meld them into a diverse culture of creativity”.

Despite the continuing ‘austerity fever’ in many of the region’s countries, Europe has its own champions too. Germany emerged strongest in the region from the economic meltdown, growing at 3.5% in 2010 (compared to average EU growth of 1.7%) and forecast to grow at 2.5% in 2011 (compared to the EU-average of 1.6%).

Germany, the world’s fourth largest economy, boasts of not only industry-leading firms but also one of the world’s strongest small and medium-sized enterprise sectors – the powerhouse of its economy. Products ‘Made in Germany’ still command an unrivalled global position, re-known for their quality and cutting-edge technology.

In 2008, Germany spent around 2.6% of its GDP on R&D, well above the EU average of 1.9%. In 2009, firms based in Germany registered around 11% of worldwide patents – the third highest in the world. Germany’s leadership in innovation and its sustained focus on developing a highly skilled workforce would undoubtedly help it adapt its economy well to the changing economic power balance.

So, while adopting a ‘look East’ policy to latch on to the emerging centres of growth and economic vitality, Sri Lanka cannot write off the West as a complete ‘weak horse’ just yet. Finding a strategic balance and carving a strategic place for herself in this changing global economic geography will be the key medium- to long-term challenge for Sri Lanka.

(Anushka Wijesinha is a Research Officer at Sri Lanka’s apex economic policy think tank, the Institute of Policy Studies – IPS, and is Editor of its blog ‘Talking Economics’ – www.ipslk.blogspot.com. He is also a Visiting Lecturer at the Bandaranaike Centre for International Studies. Anushka holds a Masters in Economics from Leeds University Business School and a BSc. (Hons) in Economics from University College London. He can be reached via [email protected].)