Practise calculating absolute and comparative advantage, tracing gains from specialisation and free trade and interpreting terms-of-trade changes and their limitations.
Will an increase in exports lead Sri Lanka back into economic growth?
In May 2022, Sri Lanka had to admit that it was unable to pay its debts to other countries for the first time in its history. As a result, in February 2023 it was forced to obtain a loan of US$3bn from the International Monetary Fund (IMF). The question is now, can Sri Lanka trade its way out of trouble?
The main problem faced by Sri Lanka for many years has been a lack of international competitiveness. Despite a growth in exports between 2000 and 2018, over the same period, they fell as a share of the economy from to of Gross Domestic Product (GDP). As a result, the country has found itself unable to earn enough foreign currency to pay for essential imports of food and fuel.
Table 1.1: Sri Lanka balance of trade in goods and services, US\$ million, January 2022 to January 2023.
For many years, Sri Lanka has enjoyed a comparative advantage in growing and exporting tea. However, the ban on imports of fertilisers in 2021 which cut yields by a fifth and an overreliance on outdated methods of production have had a disastrous impact. Another major export is textiles, but these rely heavily on imported raw materials that have rapidly increased in price following the COVID-19 pandemic and the conflict in Ukraine. So, what alternatives exist for Sri Lanka?
Unlike in other Asian nations, Sri Lanka does not appear to have a plan to develop any new comparative advantage. Probably the most likely option would appear to be to take full use of its position at the centre of Indian Ocean shipping lanes by developing its ports. Sri Lanka could become a major shipping hub which would extend opportunities for exports. For example, approximately a third of the world's oil is transported across the Indian Ocean.
Other options include allowing the Sri Lankan rupee to depreciate to boost exports because it is felt that the currency is overvalued. There are also suggestions that all import tariffs should be removed. Sri Lanka is currently one of the most protected economies in the World and removing tariffs may help attract much needed foreign investment and encourage local industries to become more efficient.
The question now is, could the introduction of these options lead Sri Lanka back into economic growth?
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Source: Adapted from Ben Chu, Economics Editor, BBC Newsnight article and tradingeconomics.com, February 2023
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Explain what is meant by 'Sri Lanka has enjoyed a comparative advantage in growing and exporting tea.'.
Countries X and Y both produce goods M and N . They decide to specialise and trade freely in the goods.
Under which conditions are the gains from specialisation and free trade likely to be smallest?
mobility of factors of
production between
goods M and N
mobility of factors of
production between
countries X and Y
high
high
high
low
low
high
low
low
The terms of trade for a country increased from 100 to 120.
Which statements are correct?
1 The terms of trade have deteriorated.
2 Fewer exports are needed to buy the same quantity of imports.
3 The balance of payments must improve.
1 and 2
1 only
2 and 3
2 only