The World Bank in its report “Sri Lanka – Ending poverty and promoting shared prosperity : a systematic country diagnostic” states that Sri Lanka is in many respects a development success story.
With economic growth averaging more than 7 percent a year over the past five years on top of an average growth of 6 percent the preceding five years, Sri Lanka has made notable strides towards the goals of ending extreme poverty and promoting shared prosperity (the ‘twin goals’). The national poverty headcount rate declined from 22.7 to 6.7 percent between 2002 and 2012/13, while consumption per capita of the bottom 40 percent grew at 3.3 percent a year, compared to 2.8 percent for the total population. Other human development indicators are also impressive by regional and lower middle-income country standards.
Sri Lanka has also succeeded in ending decades of internal conflict in 2009 and steps have been taken towards reconciliation. Sri Lanka’s has had impressive development gains but there are strong indications that drivers of past progress are not sustainable. Solid economic growth, strong poverty reduction, overcoming internal conflict, effecting a remarkable democratic transition in recent months, and overall strong human development outcomes are a track record that would make any country proud.
However, the country’s inward looking growth model based on non-tradable sectors and domestic demand amplified by public investment cannot be expected to lead to sustained inclusive growth going forward. A systematic diagnostic points to fiscal, competitiveness, and inclusion challenges as well as cross-cutting governance and sustainability challenges as priority areas of focus for sustaining progress in ending poverty and promoting shared prosperity.
Sri Lanka’s has had impressive development gains but there are strong indications that drivers of past progress are not sustainable. Solid economic growth, strong poverty reduction, overcoming internal conflict, effecting a remarkable democratic transition in recent months, and overall strong human development outcomes are a track record that would make any country proud. However, the country’s inward looking growth model based on non-tradable sectors and domestic demand amplified by public investment cannot be expected to lead to sustained inclusive growth going forward.
Identifying a Path Forward
Sri Lanka’s development trajectory has shown impressive gains but there are strong indications that drivers of past progress are not sustainable. The country has experienced strong growth and a rapid reduction in poverty over the past decade. It has ended a 30-year debilitating internal conflict and rapidly addressed many of the needs of the conflict-affected population. It has just gone through a remarkable democratic transition and has embarked on far-reaching institutional reforms to provide for greater effectiveness and probity of government. Its human development outcomes remain impressive, even if continued improvement is becoming more challenging. However, the country’s inward-looking growth model based on non-tradable sectors and domestic demand amplified by public investment cannot be expected to lead to sustained inclusive growth going forward.
The systematic diagnostic set out in this report points to fiscal, competitiveness, and inclusion challenges as well as governance and sustainability cross-cutting challenges as priority areas of focus for sustaining progress in ending poverty and promoting shared prosperity. These overarching challenges were identified through the SCD’s systematic “leave-no-stone unturned” review of the many possible factors that constrain or drive progress on the twin goals.
The identified challenges represent an aggregate of discrete constraints identified by the analysis, filtered by five criteria: the potential impact on twin goals, the time horizon for this impact, strength of the evidence base, complementarities, and whether addressing the constraint is a precondition for dealing with other constraints. The extent to which criteria have been met is derived from observation of where Sri Lanka’s current performance falls below that of appropriate comparator countries (mainly in South and Southeast Asia) and/or the country’s own past, and where Sri Lankan stakeholders have identified major issues over the course of drafting the SCD. The resulting list of areas may not be an exhaustive tracking of all of the country’s development challenges, but it sets out what is most significant in relation to the twin goals. Priority Areas of Focus to End Poverty and Promote Shared Prosperity in a Sustainable Way.
The fiscal challenge is marked above all by constraints brought about by poor revenue collection. Chronically disappointing revenue performance and the persistently narrow tax base despite growth is a first order issue. Continued strong commitment to fiscal sustainability urgently requires long-term domestic revenue mobilization efforts. This diagnostic identifies a range of tax administration and policy issues that may be driving low revenue performance, but substantial additional analysis into many areas, most notably tax exemptions and enforcement, is required. Greater effectiveness and efficiency on the expenditure side through improvements in public-sector management can also help increase fiscal space. Ultimately, more fiscal space is a precondition for addressing other constraints.
Low revenue has led to a lean and rigid budget where low levels of public spending on health, education and social protection undercut Sri Lanka’s past strong gains in human development and leave it less well equipped to face changing human development needs as a MIC. This is especially important in light of the need to reduce inequality of opportunity and invest in skills to enhance competitiveness. Beyond increasing fiscal space for these priority projects, there is room to improve efficiency of spending on social protection and public-sector personnel management that undermines the effectiveness of the state. Reducing fragmentation and improving targeting of the existing social protection system can ensure that every dollar spent on social protection has a maximum impact in reducing poverty. Similarly, improving controls on public-sector remuneration and reducing political influence in civil service management could substantially improve the efficiency of public-service delivery.
The competitiveness challenge involves many areas where Sri Lanka can improve performance, with improving the skill sets of the labor force emerging as a major constraint for growth and good jobs for the bottom 40 percent. Sri Lanka’s educational system, particularly at tertiary levels, is not providing a sufficient volume of workers of the quality and skills demanded by the market. This, in part, reflects low public spending on the area, but also points to bottlenecks in expanding the availability of university slots, and the adequacy and quality of the curricula. Efforts in this regard could include steps to ensure: high-quality general education and development of soft skills; greater private-sector participation in higher education, improvements in technical and vocational training; better coordination with potential employer needs; and that youth are inclined to pursue degrees in the industries where demand is the highest.
Trade policy and a host of land, labor and other regulatory barriers further hamper the country’s development. It will be important to review and revise the country’s trade-related policies, including the para-tariff regime to encourage more foreign trade, simplify the VAT and corporate income tax regimes, and reduce or eliminate export taxes (cesses) on agricultural commodities. Continued focus on improving trade facilitation and the logistics environment, including streamlining licenses and permits required to export would help to promote export-led growth. Similarly, greater linkages between R&D institutions and networks of entrepreneurs can help competitiveness and a more outward-oriented economy, particularly for agriculture.
Moreover, there is need to improve the regulatory environment to allow firms to grow, reducing informality and allowing for economy-wide increases in productivity and allowing firms to reach economies of scale. Some aspects of the regulatory environment that appear to be significant obstacles are: upgrading the systems for land tenure and land-use planning in both agricultural and rural areas; modernizing labor legislation to encourage easier movement of labor and female labor participation; ensuring that the burden to business licensing and permits is minimal, particularly in regions where this is a problem, such as the North; and providing for speedier resolution of commercial disputes and enforcement of contracts in court or using alternative-dispute mechanisms. Bringing larger and more profitable firms into the formal system and improving enforcement could help formalization efforts. The definition of priorities for investment climate reforms to unleash firms’ potential should stem from regular dialogue between the public and private sectors.