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"The stubborn income inequality in Sri Lanka poses a serious question about the ultimate goal of the country’s growth efforts. The country’s 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 Lanka’s 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 growth’s 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 ‘MDG’s 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). OECD’s 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 Piketty’s work have been the Nobel Laureates Joseph Stiglitz and Paul Krugman (available at: https://www.youtube.com/watch?v=heOVJM2JZxI ).
Piketty’s 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 Lanka’s 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 country’s 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 Lanka’s 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 DCS’s 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 Lanka’s 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 DCS’s 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 country’s 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 country’s 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 Lanka’s historical heritage: High income inequality
Sri Lanka’s 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 country’s 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 Lanka’s 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 Director’s 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 country’s growth efforts. The country’s 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 Lanka’s 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 [email protected].)
