Foreign Debt, Trade Openness, Labor Force and Economic Growth: Evidence From Sri Lanka

Author:Paudel, Ramesh Chandra

This study examines the role of foreign debt, trade openness and labor force in the economic growth of Sri Lanka, by employing the Johansen maximum likelihood approach of cointegration. It analyzes the data for the period, 1950-2006. The study finds that there is a cointegration relationship between economic growth and foreign debt, trade openness and labor force. Further the results suggest that ... (see full summary)


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The factors affecting economic growth in developing countries have been a topic of continuing debate over the last few decades. These factors include foreign debt, labor force and trade openness. It is argued that foreign debt works in form of capital, labor force contributes to the national output, and trade openness contributes to the improvement of overall economic growth. In early 1960s and 1970s, economists have argued that foreign capital and its proper utilization is one of the factors that contribute to economic growth in developing countries. Geiger (1990), Chowdhury (1994), Karagol (1999), Were (2001), Kalima (2002), Pattillo et al. (2004), and Schclarek (2004) studied the role of foreign debt in economic growth in different countries. Ram (1985), Summers (1997), Rodríguez and Rodrik (2000), Afonso (2001), Hamori and Razafimahefa (2003), and Strydom (2003) studied the relationship between trade openness and economic growth. Pissarides (2000), Krichel and Levine (2002), Stadler (2003), and Mortensen (2004) explored the role of labor force in economic growth. The findings of these studies show varying results and it has been concluded that the effectiveness of labor force on economic growth differs from country-to-country. The main objective of this paper is to investigate the role of these three variables-foreign debt, trade openness and labor force-in the economic growth of Sri Lanka, by using the time series data for the period, 1950-2006. Sri Lanka is an interesting case study because of two reasons. First, Sri Lanka followed different economic policies, the economy was closed until 1978 and was liberalized thereafter, and second, despite the changes in government and internal conflict, the liberal economic policies have been continuously applied for the past 30 years. The contribution of this paper is different from the previous studies in two ways. Firstly, it uses a longer time series data, and secondly, it aims at investigating the joint role of foreign debt, trade openness and labor force in economic growth when most of the other papers have investigated the individual role of these variables in economic growth. Next, the paper provides a brief summary of theoretical considerations on role of foreign debt, trade openness, and labor force in economic growth. This is followed by the explanation of the methodology of the paper and the data used for estimation. Next, the paper discusses the empirical results and finally concludes.

Theoretical Considerations

As mentioned earlier most of the previous studies have analyzed the individual role of the variables-foreign debt, trade openness and labor force-in economic growth. Foreign debt in developing countries can be used to acquire technology and other factors of production to increase employment opportunities and national productivity. Labor force is another key determinant of economic growth being a major factor of production. Trade openness indicates the degree of trade liberalization which motivates the two-way flow of goods and technology in the economy.

In the 1990s, a number of studies investigated the phenomenon of high external indebtedness of developing countries to find out whether it had negatively affected the performance of those countries. Geiger (1990) argues that there is a statistically...

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