Impact of Inflation on Labour Productivity in Sri Lanka

Abstract

Inflation and labour productivity has been a longstanding research interest in developed and industrialized countries compared to developing countries, showing the importance of concept related to efficiency and competitiveness when the economies are growing. Capacity of the economy in Sri Lanka doubled within six years during the period from 2006 to 2012. However, aging populations, raising dependency ratio, lower labour force participation rate, are emphasized as labour force related problems that required to address. Further Sri Lanka has been identified as a country that stuck in middle income trap for a long period of time due to less economic diversification, inelastic and inefficient labour market. In these context, educational reforms to address the skills and knowledge gap in labour market demand and supply, improvement in labour productivity and efficiency-based productivity, are identified to overcome the challenges. This study explores the impact of inflation on labour productivity in Sri Lanka during the period from 2006 to 2020 by employing, univariate Vector Auto Regression model for secondary, monthly seasonally adjusted data. Model was estimated subject to conducting basic test to check unit root and cointegration of the variables. Lag order 16th for the model, was selected subject to lag length criteria, significant of the lag exclusion test, stability test and residual tests to consider the appropriateness of the model. As per the dynamic analysis of the results, labour productivity is strongly impacted by variable itself. Accordingly, previous period realization of labour productivity is associated to increase labour productivity in current period significantly by 0.54 per cent. Further, there is a negative relationship between inflation and labour productivity in short run. Accordingly, one percent increase of inflation in previous two months, are associated to decrease labour productivity by 0.014 and 0.324 on average ceteris paribus. Inverse relationship between variables is supported with the findings in empirical evidences. As per variance decompositions, labour productivity and inflation are forecasted by itself. Therefore, labour productivity and inflation are identified as strongly endogenous and strongly exogenous variables respectively. No granger causality relationships are existed between variables. Negative relationship between inflation and labour productivity is identified that imply, inflation can be effectively used in achieving higher labour productivity. Therefore, suggestions are made to keep a lower level, single digit inflation in enhancing labour productivity.