Sri Lanka needs economic knowhow

Prof. Ricardo Hausmannn. Picture by Saliya Rupasinghe

Professor Ricardo Hausmann of the Harvard Kennedy School of Government delivered a lecture entitled “Increasing your chances of success while leaving your comfort zone: adapting Sri Lanka’s growth model to new constraints,” yesterday at BMICH.

Hausmann, who runs the Kennedy School’s Center for International Development, and his team have been studying Sri Lanka’s economy for the past year. His lecture spanned over two hours and covered the country’s current economic shortcomings and its paths to increased growth. His findings, to be frank, are not entirely optimistic about the future of the economy.

He did mention, however, that Sri Lanka scores well in the human development index and has excellent levels of adult literacy and life expectancy, leading South Asia in these categories. Poverty has also been markedly reduced.

The problem, though, is that the post-war growth has slowed over the past four years, hovering at around 4% annually. Why has this occurred?

Export growth

“What is clear is that the boom that happened in the post-war period was associated with a widening credit deficit. These growth accelerations in Sri Lanka have tended to happen with a widening current account deficit,” Hausmann said.

While government spending propped up economic growth in the years after 2009, export growth did not keep pace. When GDP increases, imports tend to increase as well. If exports do not keep up with imports, the current account deficit widens and growth then necessarily slows down.

“There is importance in the speed at which you can grow your exports so that they can accompany the growth of the rest of the economy,” he said, while adding that Sri Lanka’s export growth lags far behind those of countries like Thailand, Malaysia and Vietnam.

Central to this dearth of exports is a lack of diversity in exports. Between the years 2000 and 2015, China added 76 products to its export basket that were worth $245 per capita. Thailand added 70 products for a gain of $326 per capita. By comparison, Sri Lanka started producing a measly five products worth seven dollars per capita.

It is clear, according to Hausmann, that Sri Lanka is very much in need of export-diversification. Whereas the island’s main exports of tea, rubber, precious stones, and garments have remained somewhat static for many years, China has diversified into higher-productivity sectors like electronics, machinery, and chemicals, allowing it to become increasingly wealthy.

But how does a country diversify into new, more complicated industries?

For Hausmann, the key is increasing a country’s “knowhow,” which, though it sounds akin to knowledge, cannot be easily communicated. Knowhow is learned over a long period of time through imitation and repetition.“You don’t teach your kids to walk by explaining it to them. They learn by repeating the process and imitating other people. Knowhow is the capacity of the brain to recognize patterns that it has seen in the past and respond accordingly. It is the wiring of the brain,” he said.

Possess different skills

People in underdeveloped societies, though they possess the knowhow to farm, create tools, and survive in their environments, do not have a wide range of knowhow.

For example, most Inuits know how to build igloos and catch fish, but they would not know how to build a cell phone. Someone in a developed society wouldn’t know how to build a cell phone herself, but a team of people from that society would be able to work together to build a phone.

These teams of individuals who possess different skills and knowhow are crucial to diversifying and developing economies. By putting heads together, you can create more complicated, higher-value products.

It is here that Hausmann explained the Scrabble Theory of economic development, wherein he likened sets of skills to letters used to play scrabble. If you have the letter “A,” you can make one word. If you have four letters, you can make nine words, and with 10 letters you can make 595 words that are complex and long.

Hausmann’s supposition is that developed countries with diverse export baskets have access to many letters, or skill sets, that they can combine in order to make complicated and valuable products.

“If a country has little knowhow, it can make only a few short words that are relatively easy to make. Places that have many letters can make many products that are harder to make,” he said.

There is a very strong correlation, according to Hausmann, between having many letters and wealth.

The Scrabble theory holds true across countries, as France has more letters than a country like Pakistan, but it is also true when one examines regions within countries. In Sri Lanka, those in the Colombo area make more products and enjoy greater wealth than those in Mullaitivu and Mannar.

Overall, Sri Lanka holds a middling number of letters, which leads to a lack of complexity in its exports: “Sri Lanka’s economic complexity was low in 1995 compared with other comparable countries, and it remains low now,” he said.

“The problem you have in Sri Lanka is that you don’t have enough knowhow and don’t have enough letters, or skills to become richer. So, how do you get more letters,” he asked.

Acquiring more skills is difficult; you don’t know how to make the things you don’t know how to make. As Hausmann said, you cannot make watches without watchmakers.

This problem can be eased, however, by starting to make products that are similar to things you can already make. For example, countries that make women’s shirts will easily be able to make women’s suits. On the other hand, if you can drill holes for oil, a very specialized skill, you will not be able to transfer that skill onto other industries.

By creating a product map, one can see how diverse and connected a country’s products are. China, for instance, is very adept at making garments, construction materials, machinery and electronics. This diverse product map allows it to manufacture very complicated, valuable products.

Manufacturing electronics

Sri Lanka’s products, conversely, are not very well connected, which means that the country lacks the knowhow to expand into new sectors. In short, Sri Lanka’s knowledge of tea cultivation does not transfer to manufacturing electronics.

To make matters worse, Sri Lanka has shown very little diversification over the past twenty years. Vietnam, a country that ranked below Sri Lanka in terms of export diversity in 1995, has now surpassed the island, mostly due to its expansion into electronics.

“We think about growth as the accumulation of knowhow. It’s not going from dumb to genius. It is going from a society where everybody knows how to do the same thing to a society where people know how to make many different things. This means a society where people can make electronics, cars and pharmaceuticals,” he said.

These diagnoses, though useful, do not offer a clear blueprint for improving the economic diversity of Sri Lanka.

The last section of his speech dealt with the problem of moving knowhow across boarders, which is very difficult since it cannot simply be explained.

Hausmann concentrated the last section of his lecture on five mechanisms that have traditionally been used to diffuse knowhow: labour mobility between firms, immigration, Diasporas, business travel and foreign direct investment (FDI).

The first mechanism, labour mobility between firms, is not that useful in Sri Lanka’s case because there is a general lack of knowhow within the country. More important, then, is immigration reform and opening up of the country to foreigners.

“1% of people living in Sri Lanka are foreign-born, and 99% of those were born in India. If you look at a country like Singapore, about 40% of the residents were born outside the country. This mixing allows for great diffusion of knowhow, as people from different areas bring different skills to the table,” he said.

Productive development policies

Moreover, Sri Lanka should try to take advantage of its large Diaspora in order to gain skills and knowhow. Improved engagement with Sri Lankans living abroad is currently not taking place.

Sri Lanka does not benefit much from business travel, and it has not seen a sustained increase in FDI since the end of the conflict. Furthermore, Hausmann explained that many potential projects with neighbouring countries have been turned down since 2010, and he recommended that Sri Lanka do its best to engage with foreign countries on joint ventures that would spread knowhow and be economically profitable.

He therefore recommended immigration and Diaspora policy reforms and called for productive development policies for economic complexity. In order to increase economic complexity, Hausmann recommended Sri Lanka ask itself how to better serve the industries that exist and how it can improve the environment so that new industries would come to the country.

With regard to industries that already operate in the country, he recommended better cooperation between the government and private sector, a higher focus on productivity instead of profitability, and increased willingness for joint projects. He also said that increased transparency is key for creating better conditions for companies that operate here.

In terms of attracting new industries, he recommended setting up institutions to search for possibilities and their related obstacles.

Finally, he encouraged active investment seeking, spearheaded by direct marketing campaigns, and conversations with investors that reveal opportunities.

 


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