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Foreign direct investment and productivity : evidence from Sri Lanka

Mapa Pathirma, M.
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The recent reform measures undertaken by the government of Sri Lanka, and its continued efforts towards integration with the global economy in the last two decades have renewed interest in foreign direct investment (FDI) in the country. Though FDI dominates policy thinking in Sri Lanka, there is no study as to date that attempts to measure its impact on total factor productivity (TFP) at industry or aggregate level, nor its effect on the export orientation of specific industries. The main objective of this study is to investigate the effects of FDI on productivity in the manufacturing industry, as well as in the aggregate economy and its contribution to economic growth of Sri Lanka. To achieve these objectives, this research attempted several statistical/econometric exercises using firm level panel data and aggregate data. The results of the estimates show that the average growth of the TFP in the manufacturing sector across many industry categories had an increasing trend between 1980 and 1994 and a declining trend from 1994 - 1998. Furthermore, the growth of TFP has been dispersed across the sectors and between different sub-periods of liberalised trade regimes. The growth rate of labour productivity increased slightly in initial reform periods but declined in many industry categories during the period 1994 - 98. It is also revealed that labour absorption has been faster than the increase in capital stock. In fact, capital deepening does not seem to be an important factor in explaining productivity growth even in highly capital-intensive industries. Secondly, the positive externality impacts attributed to firms' productivity from industry level FDI showed only in three out of eight industry sectors. The industry sectors that exhibited positive externality effects are relatively more capital - and skill - intensive and are relatively small sectors in terms of value added. Thirdly, the effects of FDI on an industry's orientation to exports appear to be robust across all the sectors of the manufacturing industry evidencing that PDI intensity is associated with export intensity. Finally, the impact of FDI on economic growth of Sri Lanka seems to be negative prior to 1980 but positive as of 1980 onwards. This result suggests that FDI inflows might help to achieve faster economic growth in the liberalised environment that began in the 1980s and continued subsequently. Hopefully the findings of this study will lead to an understanding of differential effect of FDI across industries and may help to formulate strategies for channelling more foreign investment into those sectors where FDI creates larger benefits. The government and policymakers may identify the factors that deserve priority in policy formulation, planning and budgeting from the findings and recommendations of this study.
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