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Trends in the factor markets and their effects on labour absorption: A study on the Sri Lankan manufacturing industry

Nearly one in ten labour force participants is out of work in Sri Lanka currently. This unemployment rate is much higher than that of most countries in the Asian region which have been following economic policies similar to those of Sri Lanka. By examining output-employment data of the last 5 decades along with the behaviour of major mismatches, the study arrives at the conclusion that insufficient demand for labour at aggregate level in the economy has been more responsible than other reasons for the emergence of a high level of unemployment in Sri Lanka. During the above period it was found that the retardation of labour demand in the manufacturing sector, in particular, contributed much to exacerbate the unemployment issue of the country. The failure to create sufficient amount of employment through import-substitution industrialisation (ISI) strategy from the late 1950s paved the way to change the industrial strategy to export-oriented industrialisation (EOI) under the 1977 economic reforms. Although the latter strategy brought about a substantially higher growth in manufacturing output and labour absorption, the manufacturing sector's employment share after 1996 has become stagnated around 16 per cent. Also, the examination of the manufacturing sector output-employment data by this study reveals a widening gap between the industrial output and employment in the 1990 decade, indicating a weak trend in labour absorption by manufacturing industries. This inadequacy in employment creation, in this study is assumed to have come into being on account of the factor market distortions, labour productivity behaviour, increasing trends in capital intensity, real wage behaviour and the lower level of backward linkages in the manufacturing sector. The study, therefore, attempted to assess the impact of these factors on labour absorption in the manufacturing industry by making a set of prior hypotheses at the beginning of the study and testing them in the subsequent chapters. The comparison of selected labour regulations with the other countries in the region discloses that regulations related to the employment security, social security, and holidays and leave, along with poor state of industrial relations have increased labour market distortions in Sri Lanka even after the 1977 economic reforms. Further, the test results of the other hypotheses reveal that although the financial market reforms carried out from 1977 onwards have been substantially successful in reducing capital market distortions its progress has been considerably retarded by the currency appreciation in most of the time in the reform period. Consequently, factor market distortions entrenched in the regulated regime before 1977 have not been significantly removed in the reform period. Labour productivity measured through the traditional growth accounting (Solow Residual) procedure by the study, shows a moderate increase in the private sector industries while it has gone down in the public sector industries during the 1990s. Capital intensity in the private free trade zone (FTZ) sector shows somewhat declining trend while it has increased in the private non-FTZ sector after 1996 and the public sector throughout the1990s. The real wage behaviour throughout the reform period was found to be not increasing and therefore it has not discouraged labour demand. However, the study observes that backward linkages in the Sri Lankan industries remain at a very low level and the manufacturing industry's dependence on less value added products has further increased over time, limiting the employment generation in the manufacturing sector. Finally, the study attempted to find whether further changes in relative factor prices (costs) through removing factor market distortions could have any impact on increasing labour absorption by estimating the long-run own-wage elasticity of the manufacturing industry in Sri Lanka. The estimation results of the flexible and data dependent Box-Cox function for labour demand based on 4-digit manufacturing data for the period 1990-98 show that employment weighted, average long-run own-wage elasticities of the major branches of manufacturing industry is as high as -0.80. However, this elasticity considered only wage cost of labour, not non-wage costs arising from high costs associated with labour termination, other costs of undue regulatory impositions on labour and costs of poor industrial relations. To the extent that these non-wage costs remain high, the potential for labour absorption, indicating by this relatively higher average wage elasticity may not be realised. Consequently, the study concludes that there should be a great potential to increase labour absorption in the manufacturing industry by reducing the all aspects of non-wage costs of labour, particularly, in an environment of already having a low level of real wages, and by reducing the relative cost of labour to capital through removing capital market distortions.
Type of thesis
Patabendige, A. J. (2004). Trends in the factor markets and their effects on labour absorption: A study on the Sri Lankan manufacturing industry (Thesis, Doctor of Philosophy (PhD)). The University of Waikato, Hamilton, New Zealand. Retrieved from https://hdl.handle.net/10289/13490
The University of Waikato
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