Trade Elasticities and the Marshall Lerner Condition: Evidence from Sri Lanka

Abstract

Sri Lanka is the pioneer in adopting market-friendly policies in South Asia and has gone through different foreign exchange rate regimes since 1977. Since then, the country has experienced rapid fluctuations in the trade balance and the exchange rate. The empirical studies on Marshall Lerner condition have suggested mixed results in the global context. However, this paper aims to estimate the import and export price elasticity to determine the validity of the Marshall Lerner condition in the Sri Lankan context. For this purpose, annual time series data for the period from 1980 to 2018 were used in estimating the elasticities. The results suggest that the addition of overall export price elasticity and overall import price elasticity as a ratio of export expenditure over import expenditure is less than one, which indicates that the trade balance of Sri Lanka deteriorates when the domestic currency depreciates against foreign currency. Hence, the findings of the study revealed that the Marshall Lerner condition is satisfied in the Sri Lankan context.