ReportNo. 7220-CE SriLanka A Breakwith the Past:The 1987-90Program of EconomicReforms and Adjustment (In Two Vc!umes) Volume II: Annexes Public Disclosure Authorized May27, 1988 AsiaCountry Department I FOR OFFICIAL USEONLY Public Disclosure Authorized Public Disclosure Authorized Documentof the World Bank Public Disclosure Authorized This reporthas a restricteddistribution and may be usedby recipients only in the performanceof theirofficial duties. Its contentsmay not otherwise be disclosedwithout WorldBank authorization. FOR OFmFCIALUSE ONLY SRI LAN&A - A BREAK WITH THE PAST: THE 1987-90 PROGRAM OF ECONOMIC REFORMS AND ADJUSTMENT Table of Contents Page No. ANNEXES (Volume II) Annex 1 An HistoricalPerspective on Sri Lanka's Development Policies ..... .......... 1 A. Introduction .............................. 1 B. The Expansion of the AgriculturalFrontier Emphasizing'Irrigated Rice Agriculture ........... 4 C. Industrial Policies .............................. 7 D. The Anti-Market Bias ... , ......................... 8 E. Macro-Economic Imbalances ........................ 9 F. The Liberalization of the Economy in 1977 ........ 13 Annex 2 Transfers to Households and Subsidies ................. 15 A. The National Food and Kerosene Stamp Program ..... 15 B. Fertilizer Subsidy ...... .......... .............. 18 Annex 3 Selected Cases of Treasury Support for Public Enterprises ......................................... 22 A. Air Lanka * ....................................... 22 R. Sri Lanka Sugar Corporation and Pelwatte ........ 26 C. Sri Lanka Cement Corporation ..... ................ 32 D. Ceylon Shipping Corporation ..... ................ 35 Annex 4 Public Investment in Power ...... ..................... 37 A. Background ............ 37 B. Public Investment in Power ..... ................. 40 C. Policy Options and Prioritiesfor the Next Decade 45 Annex 5 Public Expenditures in Transport .................... 50 A. Introduction . .......... ........ ................. 50 B. Public Expenditures in the Transport Sector ...... 51 This documenthas a restricteddistribuition and may be used by recipientsonly in the performance |of their officialduties. Its contents may not otherwisebe disclosedwithout WorldBank authorization.| -2- Annex 6 Public Investmentin Irrigation ...................... 61 A. Introduction ..................... .............. 61 B. Public Investmentin Irrigation ... 67 C* Conclusions ................ 72 Annex 7 An Overview of the AcceleratedMahaweli Development Program ....... * 74 A. HistoricalBackground . 74 B. Early FeasibilityStudies ...... 76 C. Estimatesof the AMDP Costs in Constant (1986) Prices . .... * R.. .........a 85 D. Settlementand EmploymentUnder the AMDP .... 85 Annex 8 Public Expendituresin Health and Education 89 A. Introduction............. .. 89 B. Populationand FamilyPlanning c c.c 90 C* Health 94 D. Education 101 Annex 9 Census of DecentralizedUnits of Governmentand CorporationSector Employment(1985) ............... 109 Annex 10 The CentralGovernment Administrative Structure Recommendedby the ARC .... .. ... c....cc 118 Annex 11 The Design of Sri Lanka's Main Domestic Taxes ..,... 120 Annex 12 Central-ProvincialTax and ExpenditureAssignments cc. 123 Annex 1 An Historical Perspectiveon Sri Lanka's DevelopmentPolicies A. Introduction 1.1 High unemploymentand macro-economicimbalances have been chronic problems in Sri Lanka. Pressures on the labor market began with the expan- sion of health programs in the early 1900's and acceleratedafter malaria was eradicated in the mid-1940's;thereafter Sri Lanka's populationgrowth rate tripled. There was a transitionfrom a land-surpluseconomy in need of immigrantworkers to develop its tea, rubber, coconuts and plantationsto a labor-surpluseconomy. Unemploymentrates rose from about 10-111 of the labor force during the 1940's and 1950's to a record high of 24% in the 1970's. The surge in private investment following the liberalizationof the economy in 1977 and the large public investmentprogram that was launched at that time helped in bringing the unemploymentrate down to 12Z in the early 1980's. This was an importantsuccess for a Government which had announced its prioritiesas "employmentfirst, employment second, and employment third". This improvementhas not been sustained. Conservativeestimates indicate that the unemploymentrate has risen to 18% of the labor force in 1987, with the labor force at 6.4 million and growing at 2.1% per year.l/ Only 70% of the 130,000new entrants (in real terms) in the labor force each year have found employment in the recent past. If this trend continues, the unemploymentrate will probably be at over 20% of the labor force in the early 1990's. 1.2 Awareness of the unemploymentproblem began in the 1950's. It was an importanttheme of the Ten-Year Plan,2/ as well as a theme of the papers prepared by a number of distinguishedeconomists who visited Sri Lanka during 1958-59.3/ The problem gained renewed attentionafter 1971 when, partly because of lack of employmentopportunities for the young and educated,an insurgencyparalyzed the country for several weeks and were only brought to an end at the cost of 10,000 lives. Unemploymentwas thus the focus of a 1/ See Irvin, G.W.; Sri Lanka: Current Prospects for Employment. Institute of Social Studies Advisory Service, Colombo, 1986. 2/ National Planning Council, The Ten Year Plan; Colombo, 1959. 3/ Planning Secretariat;Papers by Visicing Economists:J.R. Hicks; N. Kaldor; 0. Lange; J.K. Galbraith; U.K. Hicks; G. Myrdal, Colombo, 1959. -2- well known report prepared by the InternationalLabor Office (ILO) in 1971.1/ More recently,the Cabinet appointed a High Lcvel Committeeof officials, chaired by the Governor of the Central Bank, to propose a plan of action to reduce poverty, unemploymentand malnutrition,underlining that "increased unemploymentleads to increasedcorruption, instability and breakdown of discipline,law and order".2/ 1.3 While most reports on unemploymentrecognize the seriousnessof the problem and make useful suggestionson how it could be alleviated in the short-runthrough public works and training programs,none has addressed the puzzling long-term inabilityof Sri Lanka's economy to generate employment opportunitiesin line with the growth of the labor force. At about 2% per year, while it is not low, labor force growth is not excessive. In addition, Sri Lanka's labor force is educated, receptive to training;and adaptable to the modern enterpriseenvironment. Sri Lankan workers have had no difficul- ties in finding employmentoverseas, as indicatedby the large number of Sri Lankan dorkers employed abroad. According to 1984 data,/ close to half of those migrant workers were skilled and/or professionals. Chronic unemploy- ment is also not a problem of stagnation. Since Independencein 1948, offi- cial statisticsindicate that GDP grew at much higher rates than the labor force. Finally, unlike many developing countrieswhere high unemployment rates are the result of large scale rural-urbanmigration, the share of Sri Lanka's labor force employed in agriculturedeclined only slightly in the last century and has been remarkably stable for the last five decades. 1/ InternationalLabour Office, Matching EmploymentOpportunities and Expec- tations. A Program c. Action for Ceylon, Gereva, 1971. 2/ PovertyAlleviation through People-BasedDevelopment. Final Report on an Action Program submitted to the Cabinet by the High Level Committee of officials,January 11, 1988. 3/ In AthukoralaP; Lanka's Experience with InternationalContract Migrationand th~ i tegrationof Return Migrants. InternationalLabour Office, Geneva, 1. -3- Table 1.1: POPULATION,LABOR FORCE AND UNEMPLOYMENT- SELECTED INDICATORS (1870-1987 Period Averages) Growth Rate Share of the (2 per annum) Employed Labor Per Capita Labor Unemployment Force in Population GDP Force Rates (%) Agriculture(Z) 1870-1939 0.8 3.7 /a n.a. n.a. 63.8 1940-1959 2.4 1.2 2.2 11.6 53.0 1960-1969 2.6 2.4 2.1 14.0 55.0 1970-1979 1.6 2.4 2.2 17.5-23.8 54.0 1980-1987 1.8 3.1 2.1 12.0-17.0 53.0 /a Based on growth in the plantation sector only. Sources: Central Bank of Ceylon; Survey of Ceylon's Consumer Finance Colombo 1963 and Review of Economy, Several Issues; Snodgrass,D.R.; Ceylor, An Export Economy in Transition, Irwin; 1966; Irvin, G.W.; op.cit, Table 1.01 in the Statistical Appendix (Volume I). 1.4 High unemploymentrates probably are the result of a development approach which has retarded the transitionof Sri Lanka's economy from a rural-based,primary commodity,export-oriented economy, to a more urban-based,industrialized, manufactured goods export-orientedeconomy. Because the country'sland resources are so limited, agriculturecannot provide employmentto all the entrants in the labor force. Because Sri Lanka is a small economy, the domestic market alone cannot provide the basis for a sustainedexpansion of most industrialactivities. Therefore, the exploita- tion of the country'scomparative advantages should have led to a gradual process of urbanizationand industrialization,oriented to the external market making intensiveuse of the skilled and, by internationalstandards, low-cost labor force. 1.5 Instead, the Government dealt with populationpressures by expanding the agriculturalfrontier, mostly to promote irrigatedrice, and by sponsor- ing an inward looking industrializationrelying heavily on state enterprises. At a more general level, the Government took the lead in the development process in deciding which investmentsand/or activities in the economy should