Globalization, Policy Reforms and Productivity Growth in Developing Countries: Evidence from Sri Lanka

Sri Lanka’s economic policy strategies radically moved away from inward-looking import-substituting industrialization to outward-looking export-oriented industrialization (EOI) in 1977. The EOI strategy was implemented through a broad agenda of reforms including trade liberalization, privatization of state owned enterprises and financial deregulation. These reforms had a profound impact on productivity in the export oriented production sector (primarily manufacturing) and laid the foundation for rapid growth and structural change. This study empirically analyzes the impact of policy reforms on the total factor productivity (TFP) of manufacturing industries in Sri Lanka. A balanced panel data set of all 27 manufacturing industries over 21 years is used. The industry heterogeneity effects are taken into account through the validation of a fixed effects model. The empirical results confirm, in general, that post 1977 pursuit of the EOI strategy has resulted in TFP growth. However, in an uncertain investment and economic climate due to the ethnic conflict that has engulfed Sri Lanka, TFP growth has reversed dramatically since 1994. The findings reinforce the view that in order to increase productivity and growth in developing countries in this era of Globalization the pursuit of open economy policies alone is insufficient. Fostering of a stable political environment is also necessary.