GDP
Growth8 per cent or 10 per cent?
By Terrence Savundranayagam Retired Statistics Director, Central
Bank
Manifestos of the two main Presidential candidates say they will
take measures to increase GDP growth by 8 to 10 per cent. These
growth rates are very high by historical standards. Sri Lanka has
achieved growth rates of 8 per cent in only two years, 1968 and
1978 and growth rates of over 6 per cent in 1993 and 2000. In general
GDP growth rates of around 5.6 per cent appear to have been the
norm in good years. Hence the growth rates targeted in the two manifestos
whether 8 per cent or 10 per cent are a quantum increase over the
historical trend in GDP growth. The purpose of this article is to
examine the feasibility of achieving the high growth rates projected
in the two manifestos.
GDP is defined as the total value of goods and services produced
in a country in a given period of time. The growth rate is the real
increase (i.e. the money increase adjusted for prices) in the value
of goods and services produced. Therefore the increase in GDP growth
(the growth rate) is a measure of the increase in income, employment
and welfare. The importance of having high GDP growth is therefore
clear.
The GDP can be looked at from the production side (the value of
goods and services produced) or the expenditure side (the value
of expenditure on these goods and services). When looking at the
GDP from the production side we have to consider whether increasing
the production of goods and services by 8 or 10 per cent is feasible.
In other words from what production sectors can these high rates
of growth come.
In order to look at the prospects for high GDP growth we have made
an estimate of GDP for the current year 2005 using data available
up to September and projecting for the next three months. According
to our estimates the GDP will increase by 5.4 percent this year
(2005). We have then estimated GDP for 2006 using the 2005 estimate
as a base.
In
estimating GDP in 2006, we have assumed that the policies envisaged
in the two manifestos will result in high increases in growth mainly
in factory industry, small and medium scale industries and in services.
In projecting the increase in service sector growth, we have assumed
increases in government services and tourism that are well above
their trend rate of growth. For the agricultural sector we have
assumed increases in all crops based on past performances. The increases
in the trade and transport sectors have taken into account the increases
in production that have been assumed. On the basis of our estimates
the maximum rate of GDP growth that can be achieved can be as high
as 9 per cent. This estimate of GDP for 2006 is in fact an estimate
of Potential GDP (in National Accounts, potential output is derived
by breaking down real GDP growth into its cyclical and trend components).
In this exercise however, we have estimated the highest rate of
growth that can be achieved in each sector.
Our estimate of Potential GDP should be seen as a standalone estimate
and not as a projection based on past trends. Since the growth rate
of GDP for the year 2005 has been estimated at 5.5 per cent, achieving
9 per cent GDP growth in 2006 is virtually impossible. However the
estimate of Potential GDP is a useful benchmark to evaluate the
possibility of achieving growth rates of 8 to 10 per cent per year.
The
increase in GDP growth of 9 per cent assumes a substantial increase
in investment i.e. in Gross Domestic Capital Formation over present
levels. In Sri Lanka the investment/GDP ratio has ranged from 22
to 25 per cent.
A growth rate of 9 per cent implies a very much larger increase
in the Investment/GDP ratio (assuming productivity is unchanged).
A large increase in the Investment/GDP ratio is critical if a high
growth rate is to be achieved.
What then is the rate of investment required to achieve a high growth
rate of 9 per cent.? To answer this, we have to look at the concept
of the Incremental Capital Output Ratio (ICOR).
The ICOR is a measure of the productivity of capital and is obtained
by dividing the Investment/GDP ratio by the growth rate of GDP.
A higher ICOR means that capital has been less productively utilised
and vice versa. Thus a higher GDP growth rate is possible with a
lower ICOR and the same amount of investment. During the last three
years the ICOR has averaged 4.5 per cent. We have used the average
of the last three years because a reduction in the ICOR can only
be brought about in the medium to long term). If the average ICOR
of the last three years is assumed, the Investment/GDP ratio will
have to increase to 40 per cent if GDP growth of 9 per cent is to
be achieved. I do not think future policy measures will call for
a drastic cut in consumption.
An evaluation of how realistic the projected high growth rates are
then comes down to having a set of policies that will bring in a
substantial amount of foreign investment. Hence high growth rates
envisaged are critically dependent on creating a climate of investor
confidence. In this context a speedy solution to the ethnic problem
is imperative.
In the final analysis therefore the feasibility of achieving a GDP
growth of 8 to 10 per cent depends not merely on having the right
mix of economic policies. More crucial are the policies that will
help to increase the inflow of foreign investment into he country
i.e. policies that will bring about political stability and confidence
in the long term future of the country. This is particularly important
if high GDP growth is to be sustained over a number of years.
Our conclusion, when taking into account the constraints to high
growth in the short term  a favourable investment climate, a large
inflow of foreign investment, speedy and efficient utilisation of
resources and an increase in the demand for our exports  is that
GDP growth in 2006 can be at best around 6 to 7 per cent. However
our study indicates that in the medium to long term, we can achieve
GDP growth rates of over 8 per cent if the right policies are in
place.
Perhaps it would be more realistic to evaluate policies in the Manifestos
in terms of their commitment to increase the quality of economic
growth. That is, high economic growth should be accompanied by participatory
development, increased employment and good governance through accountable
institutions and a transparent legal framework.
