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Sri Lanka Journal of Social Sciences 2002 25(1&2) and 2003 26(1&2): 5-20

GLOBALISATIONAND SRI LANKA:THE ECONOMIC IMPACT'

Abst ract : Globalisation is the global integration of product and factormarkets. International experience shows th at countries that yieldedto the process of globalisation well in advance have reaped largebenefits, mainly by allowing access to the global consumer base. Itbenefits smaller c o ~ t r i e s ore, as those countries can gain fromeconomies of scale in production facilitated by access to largemarkets. It allows countries to identify inefficient economic activities,and replace them with productive activities. However, to reap fullbenefits of globalisation and to avoid harmful effects, a countryshould implement a wide range of regulatory and supervisorymeasures. Those are, financial sector regulation and supervision,ant i-t rus t legislation and other internationally recognised measuressuch as action against money laundering. At t he same time, excessiveresistance to the process of globalisation may marginalise countries,yielding more serious repercussions. Countries should be mindful ofth e fact th at t her e a re other more important factors affectingeconomic growth such a s technological development, hum an capitalaccumulation, enhancing law and order, enhancing democracy andmechanisms to counter negative externalities arising from individualselfish actions.

"As i t is the power of exchanging that gives occasion to the division oflabour, so the extent of this division must always be limited by theextent of that power, or, in other words, by the extent of the market.When the market isvery small, no person can have any encouragementto dedicate himself entirely to one employment, for want of the powerto exchange all that surplus part of the produce of his own labour, whichis over and above his own consumption, for such parts of the produce ofother men's labour a s he has occasion for".

(Adam Smith, 1776)'An earlier version of this paper was presented a t the seminar on "Globalisation and itsImpact: Economic, Social and Cultural DimensionBn organised by the NSF's WorkingCommittee on Social Sciences and the Sri Lanka Foundation, on 06'hJuly 2001 at theSLFI, Colombo."~ l t h o u g hhe author is attached to the Economic Research Department of the CentralBank of Sri Lanka ( see inside back cover), the views expressed in this paper a re his ownand do not necessarily represent those of th e Central Bank of Sr i Lanka.


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IntroductionGlobalisation is the international integration of product and factormarkets. The process of globalisation began a long time ago, since theinternational movement of goods and persons became feasible. Theprocess was facilitated by the philosophical inputs of various economists,thrust by international institutions and revolutionary developments ininformation technology. The seminal work of classical economists suchas Adam Smith and David Ricardo on the absolute and comparativeadvantage of nations, fuelled the process of globalisation. The GeneralAgreement on Tariff an d f i a d e (GATT) and t he World TradeOrganization (WTO) helped the process grow faster through efforts onbringing down border tariff and other barriers on the movement of goodsand services and establishing the rule based system on trade.

The success generated by many economies as a result of allowingforeign investment, encouraged the rest of the world to relax theirrestrictions on international capital mobility. To attract internationalcapital, financial markets were developed in many countries with greaterflexibility. The intense competition and the high profits of innovationencouraged firms in developed countries to hire skilled workers fromany country in the world. Global financial investors have made use ofliberal policies on capital mobility and have begun shiFng funds fromcountry to country, seeking the highest return. The advances ininformation technology have helped disseminate information throughthe electronic media without national boundaries, thus furtherenhancing the trade, capital and labour flows.

-Process of GlobalisationCuriosity of human beings is a t the centre of the process of globalisation.The inherent curiosity to inquire into new ways of doing things and theurge to learn about other countries and nations have led to inventingways of cotnmunication and transportation. Thus, the process ofglobalisatipn began with the dawn of civilization.


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Globalisation: Impact on the SriLankan Economy 7The new inventions have had a remarkable impact on transportation

and communication as shown in Figures 1-3. he information technologyapplications have ljecome cheaper, paving the way for different countries tobe integrated at very low costs. The development of low cost technologyhasbeen endogenous, thus the process of globalisation is autonomous.

Figure 1: Transportation Cost

Figure 2: Cost of Telecommunication and Computers (US$)


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PersonalRadio c~~~~~~~elevision wo rld Wide

Figure 3: Technology AcquisitionSource: World Bank

Globalisation of Sri LankaSri Lanka has made significant progress in integration into the goodsmarket, but has not shown sufficient progress in factor marketintegration.Goods Market IntegrationSri Lanka too has been a trading post since era of ancient kings. Manyforeign traders have visited Sri Lanka in search of new goods and toexchange their goods for Sri Lankan goods. Greed and superior warpower had made Sri Lanka a colony of the Europeans. During the colonialera, the country was integrated with the rest of the world.After independence, Sri Lanka was from time to time governed bypolitical leaders who believed in self sufficiency', a notion that contrastswith the notion of comparative and absolute advantage explained inthe theory of international trade. If a nation produces all the goods andservices needed, it is undoubtedly producing some goods which are notefficiently produced. Such production imposes a large opportunity coston a country's resources, and it affects both domestic and global welfare.


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Globalisation: Impact on the Sri Lan kan Economy 9The economic policy change of 1977 brought in several

fundamental changes to the economy. The policies supporting 'selfsufficiency'were affected due to the liberalisation of the economy. Theconsumer and producer choice was for imported consumer goods andproduction inputs, thereby causing a heavy damage to domesticindustries tha t were surviving under import barriers. The two decadessince 1977 have sharpened Sr i Lanka's export competitiveness. Tradeliberalisation was culminated in Sri Lanka accepting Article VIII of theIMF in March 1994. Sri Lanka has evidenced sharp increases in exportearnings a s well as import expenditure during the past two decades asseen in Table 1.The weighted average tariff rate has been falling asshown in Table 1.Table 1: Sri Lanka's Exports, Im po rt s and Average Tariff

Year Exports Imports Weighted Average Ta+iffUS $mn US $mn Rates

Source: CentralBank ofSriLanka

Although the policy shift in 1977 favoured integration into thegoods market, i t did not address the integrationof factor markets: capitaland labour.


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Table 2: Capital Account Restrictions and Per Capita Income 'Restrictions and Per Capita Income India Sri Lanka South Korea SingRestrictions onCapital market securities Yes Yes Yes YMoney market securities Yes Yes Yes Collective investment securities Yes Yes Yes Derivatives and other instruments yes Yes Yes YCommercial credit Yes Yes YesFinancial credit P S Yes YesGuarantees, sureties,and financial backup facilities Yes Yes YesDirect investment Yes Yes Yes Liquidation of direct investment Yes Yes YesReal estate transactions Yes Yes Yes YPersonal capital movements Yes Yes YesPer Capita Income $ (1999) 450 820 8,490 29Source: MF (1999) ndWorld Bank (200012001)


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Globalisation: Impact on the Sri Lankan EconomyCapital Mark et IntegrationCapital market integration in Sri Lanka has been limited by the concernson foreign exchange availability. The capital account remainssignificantly closed even after the liberalisation of the economy in 1977.According to the IMF (2000) Sri Lanka maintains restrictions on a broadspectrum of capital transactions as illustrated in Table 2.Labour Market IntegrationCountries around the world have shown resistance to labour marketintegration, purely for non-economic reasons. However, high qualityhuman capital is being tapped by countries for economic gains. Underthe liberalisation efforts of the WTO, professional services areearmarked for further liberalisation.Impac t of Globalisation

Globalisation could bring in benefits to a country primarily in threemajor ways. Firstly, i t can offer access to a large market. Secondly, itcan intensify competition. Thirdly, it facilitates technology andknowledge spillovers to countries. A large market could enhance thedegree of product specialisation by a country as explained by AdamSmith (1776). Even a small country like Singapore could reach highper capita income as globalisation has enabled i t to overcome theconstraint of a small domestic market. Globalisation eliminatesdomestic protection and intensifies competition. Governments will notbe able to grant protection through tariff or subsidies in the face offalling production, transportation and telecommunication costs. Thus,countries will have to enhance macroeconomic as well a s firm levelcompetitiveness.

Competition also helps countries through the process of "creativedestruction" where old firms are replaced by new firms as the economydiscards old goods and services in favour of new goods and services. Inthe history of technological innovations, for example, the "slide-rule"industry was replaced by the "calculator" industry in the seventies,and he t acuum tube'industry was replaced by the 'transistor'industry.


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If the old industry were given any protection, it would have hinderedthe new industry a s well as all the other industries which are inter-dependent.

The final outcome of globalisation is increased per capita incomeand lower inflation in countries. Econometric studies show a positiverelationship between the openness of a country and its per capitaincome, and a negative correlation between a country's openness andinflation ra te a s explained in Appendix 1and Figures A1 and A2.l

Globalisation also provides a series of indirect benefits to a country.The need to be competitive enhances efficiency in many facets asexplained by the Central Bank (2000).t also forces a country to enhancethe quality of education and build up human capital. Furthermore, theincreased integration with the rest of the world forces a country to betr an sp ar en t in it s policies as well as maintain credibility anda~countability.~International Reaction

Some view .globalisation as an unfriendly and unhealthy developmentboth in developing and developed countries. In many international fora,developing country groupings such as G-15, G-24 and G-77 haveexpressed their concern over the negative impact of globalisation andmarginalization of developing countries.

Since the exposition made by Adam Smith in the eighteenthcentury, the world has benefited from international trade. Themercantilist ideas of saving precious gold by restricting imports havecaused a reduction in welfare in individual countries as well as theworld as a whole.3 However, even in the most democratic and free marketoriented countries, protection occurs and disturbs the global economicgrowth. Examples are the heavy protection in rice farming in Japanand agriculture in the USA and the European Community.

Many countries have resorted to imposing selective tariff andnon-)ariff barriers, aswell as imposingWTO permitted indirect controls


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Globalisation: Impact on the Sri Lankan Economy 13to discourage international trade. Such controls come in the form ofsafeguard measures, technical specifications and anti-dumpingmeasures.

Alan Greenspan (2001) explains that 'the campaign to expandfree trade i s never won.4 I t is a continuing battle. Though tariffs inindustrial countries have come down sharply over the past half-century,other barriers have become more prevalent. Administrative protectionin the form of antidumping suits and countervailing duties is a case inpoint. These forms of protection have often been imposed under thelabel of promoting "fair trade," but oftentimes they are ust simple guisesfor inhibiting competition. Typically, antidumping duties are levied whenforeign average prices are below the average cost of production. Butthat also describes a practice that often emerges as a wholly appropriateresponse to a softening in demand. I t is the ra re case that prices fallbelow marginal cost, which would be a more relevant standard. In theview of many economists, antidumping initiatives should be reservedfor those cases in which anticompetitive behaviour is involved. Contraryto popular notions about antidumping suits, under U.S. law, there is norequirement to show evidence of predatory behaviour, or of intention tomonopolize, or of any other intentional efforts to drive competitors outof business.'

Greenspan (2001) fur the r states that 'in t he end, economicprogress clearly rests on competition. I t would be a great tragedy werewe to stop th e wheels of progress because of an incapacity to assist thevictims of progress. Protectionism will also slow the inevitable transitionof the workforce to more productive endeavours. To be sure, an addedfew years may enable some workers to reach retirement with dignity,but i t will also keep frozen in place younger workers whose opportunitiesto secure jobs with better long-run prospects diminish with time.'StrategiesIn developing strategies we should be mindful of several facts. Thefundamental fact is that globalisation is a n unstoppable process, as i t isa natural development of human efforts in finding ways and means of


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overcoming the barriers imposed by 'distance'. Countries that opposeglobalisation, or countries that do not have the conducive environmentwill be ousted from the process and will be marginalised. As Greenspan(2001) noted, the globalisation process may generate 'victims of theprogress'.

A country should develop competitiveness along the lines discussedby authors such as Porter (1994) and outlined by the Central Bank(2000).A country should develop its macroeconomic and microeconomiccompetitiveness to be able to integrate seamlessly into the process ofglobalisation.

Sri Lanka could use the negotiating opportunities available a tinternational fora such as the WTO. The liberalisation of the servicessector (GATS - General Agreement on Trade in Services) under theWTOrequests countries to liberalise professional services. As Sri Lanka isendowed with skilled labour a mechanism to utilise this comparativeadvantage may be pursued.

Efforts should also be directed a t job skills enhancement andretraining - a process in which the private market is already engaged- and, if necessary, selected income maintenance programmes for thoseover a certain age, where retraining is a problem. Thwarting competition,by placing barriers on imports, will prevent markets in all nations fromdeploying capital to their most productive uses, tha t is, th e mostcost-effective production of those goods and services most highly valuedby consumers.Beyond GlobalisationAs many growth economists such as Solow (1956), Lucas (1988) andRomer (1986), have illustrated, growth arises from technologicalimprovements and development in human capital and knowledge.Globalisation could help raise the economic growth of a country to theextent th at the country is receptive to change and is willing to adoptmeasures needed to raise i ts economic growth. According to illustrationsby Barro (1997), many economies do not grow, due to factors other than


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Globalisation: Impact on the Sri Lankan Economy 15globalisation (or the lack of it). Those factors are mainly, lack of law andorder, low level of democracy, high inflation, excessive governmentconsumption and low levels of human capital.

Countries also suffer from externalities arising from efforts ofindividual utility maximisation (as illustrated in the tragedy of thecommons). External effects are prominent in the third world, where asophisticated mechanism design is not available to internalise costsarising from such effects. The third world also suffers from the lack of acritical mass of human capital that is needed to generate a positivegrowth effect.The fiaged y of the CommonsAs Gibbons (1992) explains, since a t least Hume (1739), politicalphilosophers and economists have understood that if citizens respondonly to private incentives, public goods will be under-provided and publicresources over-~ ti liz ed.~n illustration using Hardin (1968) shows thatif common grazing lands are opened to farmers, cattle could have ahealthy growth, and grazing land is not badly affected if only a fewcattle are sent for grazing.

Similarto the tragedy of the commons, is the fact that each privatedecision or government decision (or failure to make such decisions)imposes large external impacts, both positive and negative, oneconomies. If a country does not have a mechanism to internalise thoseexternal costs, the country will face growth retardation.Lack of a Critical Mass of Human CapitalA critical mass of human capital is needed to generate a catalytic effect.Poorer countries have witnessed brain drain, or physical movement ofhuman capita l t o destination s wh ere th e crit ical mass, exists(Thenuwara, 1997). In such an environment a rich country will continueto grow richer, whereas the third world will remain entrapped in thelow growth cycle.


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Notes

H N Thenuwara

Econometric study was conducted using the data published in theIMF (2000).This refers to the enhanced transparency, credibility and account-ability in corporate governance.Thenuwara (1997)

Alan Greenspan is the Chairman of the US Federal Reserve Board,the central bank responsible for US monetary policy.Hume, D., 1739, Gibbons, Robert, 1992

References

Barro, Robert J. (1997). De te rm inan ts of Economic Growth,Massachusetts: MIT Press.Central Bank of Sri Lanka (2000). Box Article on Competitiveness,Annual Report, Colombo, Sri Lanka.Gibbons, Robert (19923. Game Theory for Applied Economists, Princeton,New Jersey: Princeton University Press.Greenspan, Alan (2001). Speeches, Federal Reserve Board, USA.Hume, D. (1739).A Deatise of Human Nature, Reprint. London: J. M.Dent, 1952.International Monetary Fund (1999). Annual Report on ExchangeArrangements and Exchange Restrictions, Washington D.C., IMF.Lucas, Robert E. Jr. (1988). On the Mechanics of Economic Development,Journal of Monetary Economics, 22, 3-42.


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Globalisation: Impact on the Sri Lankan Economy 17Porter, Michael E. (1994). The Competitiveness of Nations, London:MacMillan.Romer, Paul M. (1986), Increasing Returns and Long-Run Growth,Jou rna l of Political Economy, 94,1002-1037.Smith, Adam (1776).An Inquiry into the Nature and Causes of the Wealthof Nations, Chapter 111, That the Division of Labour is Limited by theExtent of the Market, Adam Smith Institute, 2001.

Solow, Robert (1956). AContribution to the Theory of Economic Growth,Quarterly Journal of Economics, 32, 65-94.Thenuwara (1997). Ph. D. Dissertation, University of Iowa.World Bank, 2000/2001, World Development Report, WashingtonD. C. '


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Appendix 1Econometric Results of Openness, Per Capita Income andInflationIn this study, capital restrictions on over 125 countries were examinedin relation to the per capita income and inflation rate. The list ofrestrictions are a s follows:1 Capital market securities2 Money market securities3 Collective investment securities4 Derivatives and other instruments

' 5 Commercial credit6 Financial credit7 Guarantees, sureties, and financial back-up facilities8 Direct investment9 Liquidation of direct investment10 Real Estate transactions11 Personal capital movementsDifferent countries impose different numbers of restrictions. The averageinflation rate during 1988-1997 and per capita income during this periodwere regressed against the number of capital account restrictions.Results a re summarised in Table A1 and Figures A1 andA2. Sources ofdata are IMF (1999) and World Bank 1999).


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Figure Al: Behaviour of Capital Account Openness and PerCapita Income

FigureA2: Behaviour of Capital Account Openness andInflation

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