The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Can figures reflect the economy's true loss?
Everyone is aware that the Sri Lankan economy has had a major setback. The fisheries sector is nearly completely destroyed, agriculture in the Eastern and Northern districts have been affected, the booming tourist industry is fractured, transport and communications have been badly disrupted, railways and roads are seriously damaged, a considerable proportion of housing has been destroyed, and the livelihoods of a significant proportion of households are endangered. Yet the Central Bank tells us that the economic growth for this year would be hardly affected.

The Bank estimates that the setback to economic growth would be around 1-1.5 per cent of GDP. It has pointed out that the impact on several sectors of the economy is marginal in relation to the total economy. Surely this is confusing and appears to contradict commonsense.

The Central Bank's assessment about economic growth is statistically correct. In fact the economic growth rate this year could well exceed the rate of growth in 2004 and indeed of recent years. An economic growth rate of 7 per cent is not unlikely. An economy struggling to revive and a people so badly off economically could show a high economic growth. This is yet another instance when economic indicators could be misleading even erroneous.

It has been known for a very long time that the national accounts of a country has many deficiencies. Several contributions to the national economy are not reflected in the system of national accounting. Destructive and harmful goods and services such as defence expenditure, and tobacco production are added to the figures. Still other figures that are in the long run detrimental to the economy and society such as excessive felling of forests could be added on as significant figures for growth.

This is not an appropriate place to discuss all these shortcomings of the system of national accounts. They are in fact found in the standard textbooks in economics and in recent years have been popularised to the extent that environmentalists in particular have suggested that the system of national accounts be revised and also that alternate indicators be developed to reflect real growth rates. How is it that an economy that has had such serious setbacks could show a high growth rate?

First of all it must be recognised that the national accounts of a country does not take into account the destruction or demolition of any sector in the economy, except in some instances indirectly. For instance the loss in housing stock does not enter the national accounts as a negative figure. On the other hand, the construction of new houses enters the accounts and contributes to the economic growth rate. To put it bluntly, if a million houses are razed to the ground and the same million houses are restored to the equivalent status as before, despite there being no difference to the housing stock, the national accounts will add the value of the new houses to the national product. There would be no deduction of the losses. Instead there would be a contribution to that year's economic growth. Though not contributing to the welfare of people, national accounts would indicate an economic growth.

The growth rate is not an indicator of the net position. This is not of much concern in normal years, but in situations where there has been extensive destruction, even a partial reconstruction would show a rise in national output though there is no net gain. Paradoxically the economic growth rate for this year is likely to be high owing to the economic destruction. The reconstruction of roads, railways,bridges, houses and townships will all add up to a big figure in the national accounts. There would also be backward linkages to the construction and engineering industries. In fact the construction sector is likely to show a high contribution to GDP and be a significant contributor to economic growth.

In contrast, fisheries, agriculture, tourism are likely to decline. Since fisheries contribute only around 1 per cent of GDP its impact on the national product would not be much. In the case of agriculture that contributes around 16 per cent of GDP, the impact would be only on paddy production and food crops. Yet even here it would only be the cultivation in the coastal areas that would be affected. Therefore here too the effect on GDP will not be that significant, though it would mean that there would be a need to continue importing rice and fish. Much of the industrial sector is unaffected.

While the overall impact on the economic output would not be large, several sectors and sub sectors of the economy would reflect a decline in output. In the agricultural, fisheries and forestry sector, fishing, food crops and paddy sub sectors would reflect a decline, while tea, coconut and rubber remain unaffected. The industrial sector is largely unaffected except for a host of small and cottage industries in the coastal areas.

Transport and communications could however affect these to some extent in the first months of the year. The construction sector, especially of housing, will experience boom conditions as the rebuilding gains momentum.

The impact on the services sector would be mixed. Tourism would be the most seriously disadvantaged. It is not that tourists would not like to come, but the capacity to accommodate them in the coastal areas has been seriously reduced.

The financial services would be strained with a higher rate of loan defaults and need to extend repayment periods of hotels having to be extended. Insurance is no doubt even more directly affected owing to the vastness of the disaster that does not allow for an offsetting of losses from gains.

The exact picture of the strain on the reserves of insurance companies is yet to be assessed. The communications and transport sub sectors that suffered seriously would however show an increased output owing to the repair and reconstruction of communications.

The national accounts of the country is a misleading indicator of economic performance this year as the devastation that has occurred is not taken into account while the repair and reconstruction costs would boost the figures significantly. An assessment of this year's economic performance must take this into account. A qualitative assessment of the figures is indeed necessary to evaluate the performance of the economy. The fact is that the economy and society have suffered much. The manner of calculating national income and economic growth rate will not reflect these losses.

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