Sri Lankas growth paradox: When poverty

yields, income gap holds stubbornly

Obsessive pursuit of economic growth-Sunday 11th May
2014
Economic growth is voted almost unanimously by everyone as good for society
because it enhances the material goods available for people to lead a better living. It
increases wealth of people and prosperity in society. High economic growth rates are
preferred to low economic growth rates because they bring in higher levels of wealth
and prosperity. Hence, all societies today rich, middle and poor pursue economic
growth as the single-most goal of society to offer a better deal for their members.
In the case of Sri Lanka, growth has become so predominant in its goals that the
policy authorities are planning to double the average income per person, known as per
capita income or PCI, from $ 2,000 six years ago to $ 4,000 by 2015 and increase the
size of the economy from its current size of $ 67 billion to $ 100 billion by 2016.

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stubborn income inequality in Sri Lanka poses a serious question about the ultimate
goal of the countrys growth efforts. The countrys rich have been able to maintain their
relative position undiminished while the poor have been worse-off. The middle class,
on the contrary, has fattened itself. The high income inequality, as noted by many
economists, threatens the social and political instability of the country. Thomas Piketty
described it as terrifying and urged world nations to take immediate action to reduce
the global income gaps. Pursuing a goal of doubling PCI and increasing the size of the
economy to $ 100 billion will become purposeless when the income gap stubbornly
refuses to yield to be moderated. It is therefore time for Sri Lankas policy authorities to
take this message seriously
For a country which had been embroiled in a costly and destructive war for more than
three decades and experienced slow economic growth throughout its post-
independence history, such high economic growth promises should surely receive
applause from everyone. Hence, Sri Lanka is presently following a high economic
growth target virtually as an obsession.
For instance, the Central Bank has been announcing every year in its Annual Reports
a high economic growth target for the subsequent five years though the actual
realisation has been far from these targets. Yet, it continues to follow
this practice obsessively. Thus, in its Annual Report for 2013 (p 24), the
bank has projected that the annual average economic growth in the
next two to four years will be over 8%, a comfortable growth rate
compared to the average growth rate of about 6.5% achieved during
2008-13.
Need for ensuring equity in growth
But growths good role is considered incomplete if it is not accompanied
by equity in the system. Equity in economic growth requires everyone to
share the benefits of growth which economists call inclusiveness of
growth. It then leads to two important outcomes in the economy:
reduction in poverty and reduction in the income gap. Of these two
outcomes, the first outcome relating to the reduction in poverty has been included in
the millennium development goals or MDGs introduced by the United Nations for
member countries.
Accordingly, member countries are required to reduce by a half the number of people
living below the income level of a dollar a day and those who suffer from hunger
between 1990 and 2015. According to UN, an income of $1.25 a day is the minimum
requirement for a poor man to sustain himself and if he can cross this threshold, he
crosses the threshold of poverty as well.
Income gaps being a blind-spot in MDGs
However, MDGs have not targeted the reduction in income gaps as an important
achievement in global development and this omission has led many critics to name it
as MDGs blind-spot.
Nobel Laureate Joseph Stiglitz, addressing the 4th OECD World Forum in October
2012 in New Delhi has emphasised the need for addressing the issues relating to
inequality since it affects the wellbeing of nations. He has specifically downgraded the
initiatives by countries to increase PCI as their development goal since when PCI goes
up, many members in society can become worse-off due to unequal distribution of the
benefits from growth.
His prescription was that governments should pay equal attention to narrow the
inequality in society (available at: http://audioboo.fm/boos/1010898-professor-joseph-
stiglitz-well-being-and-inequality). OECDs Director of Statistics and Chief Statistician
Enrico Giovannini has indicated that it is the equitable and sustainable wellbeing that
leads to progress and when there is inequality in society a nation cannot attain that
wellbeing. Hence, according to him, it is necessary to go beyond GDP and have
alternative measures to assess the wellbeing of nations (available at:
http://audioboo.fm/boos/1011110-enrico-giovannini-beyond-gdp#t=1m28s).
Claire Melamed, Head of Growth, Poverty and Inequality at the UK based think-tank
Overseas Development Institute has suggested that in the post MDG arrangements
coming into effect in 2015, it is desirable to have a target for the Gini Coefficient of
income inequality to address this issue (available at:
http://www.odi.org.uk/resources/docs/7599.pdf). Thus, it is the considered view today
that poverty reduction and the reduction in income gaps should go hand in hand with
GDP if nations desire to have equitable and sustainable wellbeing for their people.
Bad side of worsening income gaps
While economic growth is good, rising inequality is bad for society. Claire Melamed in
the paper quoted above has identified three such undesirable features which
inequality will bring to a society.
Inequality impedes the growth of the talent pool: First, high levels of inequality harm
economic growth because they impede the access of low income groups to education,
human capital development, health, skills build up and credit which are necessary for
sustainable economic growth. The argument here is clear enough: Modern economies
are knowledge based economies and if a large segment of society is deprived of
attaining skills due to low income, the economy cannot feed itself with the growing
demand for skills. Thus, the episodes of growth attained by such societies become
short-lived just like the limitations of natural resources cut the supply of needed
nutrients that help economies to maintain the initially attained high economic growth.
Inequality places the poor in permanent poverty: Second, the rising inequality in
income slows down the poverty reduction efforts by governments. This is because
when a smaller percentage of income goes into the hands of the poor, their status
cannot be upgraded at the desired rate. In such societies, poverty becomes a
permanent feature. Some inequalities which are based on gender, race, or caste act
as a true barrier for alleviating poverty among them because of the deprivation of
basic rights such as right to education, health or skills and talent development.
Inequality leads to social and political instability: Third, inequality creates social
tensions leading to social and political instability. A society is unlikely to progress when
such instability is present due to the conflicts that persist among different groups in
society. Inequality creates fertile ground for low income people to harbour animosity
against the high income people making the two groups eternal enemies of each other.
It also contributes to high crime rates, political unrest and even mental illness making
the lives of people too unstable. They also prevent those in low income groups from
climbing the social ladder which sociologists have termed social mobility. Such
people are permanently trapped in poverty.
Thomas Piketty: Contributor par excellence to economics?
The income gap debate was fuelled recently by the French economist Thomas Piketty
who after fifteen years of research produced a masterpiece on the growing income
inequality in USA and Europe.
His book published in English in March 2014 under the title Capital in the Twenty First
Century has been widely recognised by mainstream economists as equivalent to the
contributions made by Adam Smith and John Maynard Keynes to the science of
economics. Two main admirers of the Pikettys work have been the Nobel Laureates
Joseph Stiglitz and Paul Krugman (available at: https://www.youtube.com/watch?
v=heOVJM2JZxI ).
Pikettys finding: Capital owners getting richer than labour owners
In this book, Piketty has argued that the return to capital holders those who own
physical capital and financial assets has been higher than economic growth in
Europe and the US causing an accumulation of income in the hands of capital owners
as against labour owners. In the long run, Piketty argues, this accumulation of wealth
in the hands of a few in society leads to potential threats to democratic societies and
to the values of social justice on which they are based (p 516).
Capital which includes the financial assets as well reproduces faster than the increase
in output and when capital owners get a higher share in income, labour owners have
to be content with having only a smaller share. This has been the experience,
according to Piketty, from late 19th to 20th century except during a brief period
between 1945 and 1980. However, it will continue to be the main feature in the 21st
century as well since no country with high technology can grow faster than 1-1.5% per
annum no matter what economic policies are adopted (p 517).
With an average income on capital at around 4-5% per annum, the return on capital
will continue to be bigger than the rate of growth in output making the problem more
complicated in the current century as well. To prevent this, he has suggested that the
private rate of return on capital should be reduced below the output growth by heavily
taxing the capital owners. His suggestion has been to introduce an income tax of 80%
and a wealth tax of 10% on the high income earning people.
Sri Lankas Official Poverty Line
Sri Lanka has a paradox of economic growth. Its poverty levels have declined steadily
over the past two decades according to the countrys Statistics Agency, Department of
Census and Statistics or DCS. Accordingly, the number of people below poverty in
1995-96 amounted to 28.8% of the total population. This ratio fell to 22.7% in 2002,
15.2% in 2006-7, 8.9% in 2009-10 and further to 6.5% in 2012.
This Head Count Index of poverty is based on Sri Lankas Official Poverty Line or OPL
established by DCS in 2002 taking into account a composite basic need of foods
accounting for 68% and non-foods accounting for the balance 32%. According to DCS,
the total basket containing both these items cost Rs. 1,423 per person per month in
terms of the prices that had prevailed in that year. Thus, a poor man in Sri Lanka could
meet his basic needs by spending Rs. 47 or 50 US cents a day.
According to DCSs split of income between foods and non-foods, a poor person could
satisfy his food requirements with an income of Rs. 32 or 34 US cents. This was pretty
much lower than the threshold fixed by the UN for poverty in the Millennium
Development Goals or MDGs that amounted to $ 1.25 a day. Hence, Sri Lankas
poverty reduction was not compatible with those specified in MDGs.
This was the threshold poverty level in Sri Lanka and for subsequent years, it was
updated by inflating the threshold value by using the Colombo Consumers Price
Index. Since Sri Lanka rupee had not depreciated on par with local price increases,
the dollar value of the poverty threshold has increased gradually over the years.
Accordingly, in 2010, it was 89 US cents and in 2012, it could be estimated to be at $
1.32 a day made up of 90 US cents for foods and 42 US cents for non-foods.
Overall poverty numbers distorts true poverty in the country
However, in many districts, according to the DCSs Household Income and
Expenditure Survey or HIES for 2012-13, the poverty levels have been pretty much
higher than the national average.
The notable outliers are Mannar with a poverty level of 20.1%, Mullaitivu 28.8%,
Kilinochchi 12.7%, Batticaloa 19.4%, Badulla 12.3%, Monaragala 20.8 and Ratnapura
10.4%. Out of the 25 districts, 16 had poverty levels above the national average of
6.5% which had been determined at that level by the extremely low level of poverty in
Colombo District at 1.4%. Hence, the national average is misleading about the
countrys overall poverty level.
Gini Coefficient: A measure of income gap
Despite these weaknesses, the overall reduction in poverty in the recent past has
moved in the desired direction. But the inequality in the countrys income distribution
has remained stubbornly high all throughout its post independence period. The usual
measure of income inequality has been the Gini Coefficient, named after the Italian
Statistician Corrado Gini who presented the formula in a paper published in 1912.
The value of Gini Coefficient ranges from zero to one where zero denotes that income
is equally distributed among all and one denotes that one family gets all the income.
Normally, a country with a low income inequality has a Gini Coefficient of 0.3 or less.
Countries with Gini Coefficient between 0.3 and 0.4 have a moderate inequality,
between 0.4 and 0.6 high inequality and above 0.6 extremely high inequality.
Sri Lankas historical heritage: High income inequality
Sri Lankas Gini Coefficient has ranged between 0.48 and 0.52 in the post
independence period though in 1973, it had declined to 0.41which it could not sustain
at that level thereafter. In 1950, the countrys Gini Coefficient had amounted to 0.5 and
it had remained at that level in both 2003-4 and 2006-7.
When it slightly declined to 0.48 in 2012-13 which still denotes a high income
inequality, the Central Bank had, ignoring its average at that level throughout the post-
independence history, had concluded in its Annual Report for 2013 that the slight
reduction had reflected a reduction in the income inequality in the country (p 100).
Such complacence about the income gap does not augur well for effective economic
policy making.
Sri Lankas Middle Class getting fatter at expense of poor
While the Gini had been stubbornly high, the rich had been rich and the poor had been
poor throughout the post independence period. Throughout this period, the top 20% of
income recipients had an income share of slightly over 51% except in 1973 when it
had declined to 46%. The average for the period had been 54%. In contrast, the poor
consisting of the lowest 20% of income recipients had an income share of only 4% on
average. In 1953, this group had an income share of 5.1% but it declined to 4.4% in
2012-13.
What this means is that while the rich had remained rich, the poor had become poorer
during this period. Then, who had benefited from the plight of the poor? That is the
middle class whose share had increased from 38% in 1953 to 42% in 2012-13. Thus,
the redistribution policies adopted by Sri Lanka in the post independence period have
fattened the middle class at the expense of the poor, conforming to a celebrated
economic law known as Directors Law named after the American Economist Aaron
Director of Chicago University fame.
Growth pursuits become purposeless if income gaps are high
The stubborn income inequality in Sri Lanka poses a serious question about the
ultimate goal of the countrys growth efforts. The countrys rich have been able to
maintain their relative position undiminished while the poor have been worse-off. The
middle class, on the contrary, has fattened itself.
The high income inequality, as noted by many economists, threatens the social and
political instability of the country. Thomas Piketty described it as terrifying and urged
world nations to take immediate action to reduce the global income gaps. Pursuing a
goal of doubling PCI and increasing the size of the economy to $ 100 billion will
become purposeless when the income gap stubbornly refuses to yield to be
moderated.
It is therefore time for Sri Lankas policy authorities to take this message seriously.
(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, could
be reached at waw1949@gmail.com.)