In 2022, a total of 367 items were added to Sri Lanka’s list of non-essential imports subject to restrictions, with the Government imposing heavy import restrictions due to the foreign exchange crisis. What do import controls mean for the Sri Lankan economy going forward and to what extent do import controls contribute to manufacturing growth?
Poised to embrace a production-based economy, Sri Lanka is looking to leverage its manufacturing capacities. Certain domestic industries, however, are known for inefficiencies, monopolies, and lack of supply, among other problems.
Fallacy of composition
Speaking to The Sunday Morning Business, University of Colombo (UOC) Senior Professor in Economics Sirimal Abeyratne observed how import controls affected consumers, noting: “Import controls give licences to certain companies that focus exclusively on the domestic market, resulting in a lack of competition, impacting prices as well as quality.”
However, production is not restricted to the impact on consumers but also has long-term development implications. Prof. Abeyratne added that the local market in Sri Lanka was inadequate, similar to the situation even in countries such as India and China, highlighting the increased emphasis by larger economies on the global market.
“If certain industries in the country are unable to enter the global market competitively, that is an indication that those industries are actually not performing well enough, which is also one of the reasons why the country’s business community is divided,” he explained.
He further noted that certain industries that had accessed the global market were unlikely to lobby for trade restrictions, while those which were unable to do so engaged in lobbying, highlighting a fallacy of composition.
“It is possible to expand a limited select number of businesses on this basis by letting them exploit the local market. However, in the long run, it will prove to be unsuccessful. Good policies consider long-term impact as well as macro-level impact. In both respects, import restrictions are not a favourable policy for Sri Lanka,” he said.
SL economy marked by high consumption levels
Commenting on the subject of import controls, Frontier Research Head of Macroeconomic Advisory Chayu Damsinghe noted that there were two aspects to the matter.
“Historically, as well as now, countries with strong manufacturing sectors tend to have some form of policy that incentivises the entire economy to prioritise and support manufacturing as opposed to consumption.”
There are different ways of achieving this, such as raising the expenses of imported goods or making consumption of certain imported goods challenging. As long as there is an economy that does not advocate excessive consumption and instead redirects resources towards the production side, it helps production.
“From a manufacturing perspective, another approach is lowering the cost of production and looking at cheaper salaries to reach a broader market. From a consumption perspective, functioning in local economies, Governments have an incentive to pay people sufficiently as people should have the ability to afford products. Therefore, it is a question of the nature of incentive structures.”
Damsinghe noted that in a manufacturing economy, incentives took effect to support manufacturing generally, as opposed to a select few sectors, as it was typically more successful, given historical and contemporary contexts. He added that focusing on just an individual sector may lead to missing out on the supply chain or differences in labour markets.
“Of course, an economy-wide incentive towards production is an economy-wide disincentive towards consumption,” he noted.
“Politically and socioeconomically Sri Lanka is marked by high consumption levels, perhaps resulting in these two forces pulling the economy into different environments. On top of all economic factors, ideological aspects such as protectionism and free market economics also come into play.”
Damsinghe added that if Sri Lanka’s path was inclined towards a production-based, export-oriented economy, it was important to identify the costs associated with that choice, such as higher tariffs, import controls, or depreciated currency affecting purchasing power or imports, with the possibility that the only economic state incentivised in the economy would be production.
“On the other hand, I am not particularly convinced that it is necessarily the way forward for Sri Lanka. Since the middle class is prevalent in Sri Lanka, with middle-class growth aspirations, it is crucial to consider whether those specific growth aspirations align with the production approach,” he said.
Damsinghe noted that part of the reason why Sri Lanka had historically struggled to build a production-based economy stemmed from the sociopolitical and economic structures of the country, which were not necessarily conducive.
Accordingly, being aware of various costs associated with these approaches might allow us to view trade concerns from a holistic perspective, enabling decisions on the most viable options.
“The structure of Sri Lanka’s social and political economy is such that there are constraints, which are not essentially limited to policies but also involve structural and institutional factors,” he added.
Addressing monopolies, Damsinghe noted that capital-intensive sectors may result in creating environments that obstructed other industries from entering, with existing players leveraging their position.
Historically, however, Sri Lanka has seen sectors that tend to have temporary monopolies resulting from immediate success, which are eventually replaced with proper competition. Monopolies, therefore, might not always be avoided.
Need for an export-oriented economy
Recently, requests made by domestic tyre producers faced significant backlash from social media users, who reacted negatively to these demands. Most of the concerns raised by commentators were along the lines of exploitation of consumers, potential monopolies, and vested interests, as well as concerns over quality, reliability, and safety.
The Sunday Morning Business learns from the Ministry of Trade that it is yet to take any decision in this regard.
Meanwhile, speaking to The Sunday Morning Business, University of Peradeniya (UOP) Department of Economics and Statistics Professor J.M.A. Jayawickrama noted that with trade being a two-way process, Sri Lanka was more dependent on imports.
“Since the country’s exports do not show significant growth, it leads to a dependence on more imports and a trade deficit. Historically, Sri Lanka’s economic policy from the 1950s has deviated from a more export-oriented economy to a more import-restricted economy, alternating between export promotion growth strategies and import substitution growth strategies,” said Prof. Jayawickrama.
However, he noted that following 1977, with the opening of the economy, this tendency had not been prominent. At present, import substitution and import restrictions cannot be taken as comprehensive economic policies, as they have their own limitations and therefore are not viable, long-lasting, or positive options.
Prof. Jayawickrama noted that even at present, the Sri Lankan garment industry and domestic agriculture were highly dependent on imports. Restricting imports can also result in restrictions on the domestic economy, reducing it to a low level of activity.
“Quality becomes a central issue that arises with import controls in a country like Sri Lanka, as certain industries are not sufficiently exposed to quality improvement. Manufacturing from countries such as Malaysia, Indonesia, or even China and India is of high quality and is therefore more competitive,” he observed.
In addition to cost, it is evident that quality matters significantly in an economic sense as well. Maximising consumer satisfaction also takes into account such quality differences.
Prof. Jayawickrama highlighted the need for the country to rely on export promotion, prioritise competitive production, and leverage certain products in supply chain networks. This approach, however, requires ensuring high quality, which, with the emergence of new technologies, has become more accessible.
“Many countries such as Singapore, Taiwan, South Korea, and Japan leverage these opportunities effectively. Increased import controls will affect the Sri Lankan economy negatively, especially impacting import-reliant sectors such as the garment, agriculture, and construction sectors heavily. Therefore, import restrictions are not a viable long-term policy that should be promoted,” he said.
Furthermore, research indicates that by the end of 2022, import controls implemented in response to the economic crisis accounted for roughly 30% of Sri Lanka’s total import value. These controls impacted several sectors, including consumption goods (46%), intermediate goods (31%), and capital goods (24%).
An Institute of Policy Studies of Sri Lanka (IPS) analysis on import controls in Sri Lanka highlights that the Government’s import control policies at the time prioritised less complex products, consumer goods, and food items, inadvertently creating an incentive structure for import substitution, even in the absence of protectionist intent.
Prolonged import controls on food items and low-tech manufacturing products, such as consumer electronics, have driven up domestic prices and enabled higher profit margins. Since these products are easily substitutable in a country like Sri Lanka, which has a comparative advantage in low-tech manufacturing and a significant agricultural workforce, import substitution may occur naturally without direct policy intervention.
The analysis also emphasises that to promote innovation and participation in global value chains, it is economically prudent to gradually remove import controls on intermediate goods. Additionally, revisions should extend to consumption goods, including food items.
Import controls increase domestic prices, resulting in the production of less complex consumer goods and food for local markets. This resource allocation hinders the growth of export industries, which are crucial for the country’s economic development.
It is important to highlight, however, that Sri Lanka must keep the external current account at sustainable levels in the medium term. According to the Central Bank of Sri Lanka’s (CBSL) ‘Policy Agenda for 2025 and Beyond,’ a gradual recovery in import expenditure is expected, particularly in the context of the planned relaxation of vehicle import restrictions in 2025 by the Government.
Attempts by The Sunday Morning Business to contact Minister of Trade, Commerce, Food Security, and Cooperative Development Wasantha Samarasinghe and Minister of Health and Mass Media Dr. Nalinda Jayatissa regarding the Government’s stance were unsuccessful.