Emerging Income Inequality and Widening Economic Divide: the Case of Sri Lanka

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Emerging Income Inequality and Widening Economic
Divide the Case of Sri Lanka
Upali Vidanapathirana

• IDEAs
• Conference on Policy Perspectives on Growth,
  Economic Structures and Poverty Reduction7-9,
  June, 2007
• Tsinghua University, Beijing, China

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The puzzle
Indicators / Country or category Low income countries Low middle income countries Sri Lanka (2004)
GNP per capita Life expectancy (female) Infant Mortality Under 5 mortality Adult Literacy Les than 825 58.1 79.1 122.0 71.5 826-3255 69.8 24 29.3 93.1 1010 74 13 15 92
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Introduction

• Liberalization orthodoxy claims that openness
  produces faster GDP growth rate on a sustainable
  basis
• Such growth engenders income equality
• Sri Lankas liberalization experience of about 30
  years is adequate to test this claim using
  context specific empirical data

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Theoretical base of inequality and openness

• Kuznets claims are not archetypical inequality
  is harmful to growth (Rodrik, 1996 Thorebecke,
  2002)
• Openness is not distribution neutral (Wood, 1999
  Anderson, 2005)
• HOSS fails in many countries to give jobs to
  unskilled labour (Carter and Barham, 1996
  Lipton, 1985 nd 2007)

• Inequality in open economies is explained in
  terms of archetypical Kuznet hypothesis where
  initial spurt in GDP growth increases inequality
  (Kuznet, 1955)
• Openness accelerates growth rate but it is
  distribution neutral (Kraay, 2000)
• HOSS theorem claims that openness increase
  scope for jobs and increases real wage rates of
  unskilled workers to cause equality.

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Proximate determinants of inequality

• Economic growth is the most potent determinant of
  income distribution its distributive implication
  depends on whether the growth was pro-poor or
  pro-rich.
• Growth performance of priority sectors become the
  second most potent determinant. It tells us
  where the growth occur and whether it excludes
  some sectors and communities. In the case of Sri
  Lanka the rural sector estates house about 77
  percent of the population.
• Employment generation is the third variable. If
  free trade serves unskilled labour better,
  naturally that should be pro-poor.
• The tenor of public policy is another crucial
  determinant Fiscal contraction, for instance,
  aggravate conditions of inequality. This
  includes pruning financial flows to social
  welfare, physical and institutional
  infrastructure, and human development.
• Arising from 4 above, the status of
  infrastructure including roads, markets, storage,
  irrigation canals, extension services etc
  undermines the distribution of economic
  opportunities.
• 6 Education is considered an equalizer of income
  distribution This depends on considerations of
  access and equity. So does health!

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Why reforms in Sri Lanka in 1977?

• Reforms in SL was conveniently referred to as
  crisis driven although in practice it was more
  of crisis creating (The reasons for reforms in
  Sri Lanka in 1977 much before its SA
  counterparts include ostensibly to address
  problems of low GDP growth, unemployment, poverty
  and inequality and also to correct problems
  arising from worsening economic fundamentals).
• But in reality it was a political project of a
  rightist government!
• Has reforms in Sri Lanka result in crisis? Many
  see a link between reforms and crisis in Sri
  Lanka(Lakshman, 1996 GOSL, 1990 Jayasuriya,
  2004).

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Objectives of the paper

• To evaluate the Sri Lankan case of economic
  reforms (1977-2006) to ascertain whether the
  reforms have produced desirable outcomes in terms
  of equity and inclusiveness,
• What specific factors have engendered and/ or
  hindered such outcomes,
• What are the lessons of experience Sri Lanka
  provide to other developing countries

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Methodological issues

• The post-liberalization era is divided into two
  phases i.e., the first wave-1978-1988) and the
  second wave (1989-2006)
• The liberalization experience is compared with
  the pre-reform era (1970-1977) to contrast the
  development trajectories
• Focuses on both income inequality and the
  broader space of economic divide and to identify
  some of the proximate determinants
• Data sources include CFS (CBSL) and HIES (DCS)
  series here, one faces a huge challenge as data
  are not consistent for a variety of reasons. The
  paper uses other eclectic sources of data too .

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Income distribution by deciles (1973-2003/04)

• Decile distribution data are rather congested
  Yet, they show that income shares of the first
  two quintiles declined relentlessly since
  1978/79.
• Conversely the top most deciles gained
  persistently.
• The income share of the 1st decile fell from 2.79
  in 1973 to 1.86 in 2004. The dividends of
  reforms have by passed the poor.
• The share of the 10th decile swelled from 28.03
  in 1973 to 36.45 in 2004. The rich amassed the
  benefits of reforms

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Income inequality trends (income data)
Quintiles 1973 1978/79 1981/82 1986/87 1996/97 2003/04
Bottom 7.2 5.7 5.7 5.0 5.7 5.1
2nd 12.1 10.3 9.5 9.1 10.0 9.1
3rd 16.2 14.3 13.3 13.5 14.1 13.4
4th 21.6 19.8 19.5 20.1 20.8 20.5
Top 42.9 49.9 52.0 52.3 49.4 52.0
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Quintile distribution (1973-2004)

• The gains to the top 40 percent have increased
  from 64 percent in 1973 to 72 percent in 2004.
• However, what is more important perhaps is the
  changes in the income share of the top 1 percent
  which represent the ultra rich (For which we do
  not have data).
• Using the Mishras classification income share of
  19.3 for the first 40 in 1973 was permissible
  but this condition deteriorated sharply during
  the post reform period.

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Figure 1- Lorenz Curves for years 1973, 1981 and
1996. Source Central Bank of Sri
Lanka
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How Gini ratio changed over the period 1963-2004
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Other indices of income inequality
Description 1973 1978/79 1981/82 1986/87 1996/97 2003/4
Gini ratios Spending units Income receivers Quintile Ratios (Q1Q2)/Q5 Q5/Q1 Theil Index 0.35 0.41 0.45 5.9 0.28 0.43 0.50 0.32 8.7 0.35 0.45 0.52 0.29 9.1 0.39 0.46 0.52 0.27 10.4 0.39 0.43 0.48 0.32 8.6 0.33 0.46 0.50 0.27 10.1 0.38
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Discussion

• Indicators are unanimous that income inequality
  has worsen.
• Inequality level was lowest in 1973 worst in
  1986/87 (towards the end of the first wave).
  Second wave marks signs of leveling off but this
  trend was reversed again in 2004.
• The figures quoted are comparatively worse and
  here most of the SA countries perform much
  better. For instance, Gini ratio is around
  0.3-0.4 for all the SA.
• The quintile ratio of 10 plus (meaning, the share
  of the top income decile is about 10 times the
  bottom income decile) compares with about 6 in
  India and Pakistan

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Consumption data

• Consumption data are generally supposed to be
  better than the income data.
• However, Sri Lankas consumption data series is
  not as consistent as the income data series of
  the DCS.
• DCS data series became comparable since 1990/91

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Consumption Data
Quintiles 1980/81 1990/91 2002
Bottom 2nd 3rd 4th Top 8.9 12.9 16.5 21.3 40.4 8.8 12.9 16.5 21.5 40.2 7.7 11.5 15.4 21.5 43.7
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Consumption data-Changing pattern of Gini ratios
1980-2002
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Discussion of Income/expenditure distribution
trends

• In the mid 1970s, poor gained both absolute and
  relative terms (Fields, 1980). These changes
  were directly policy driven. The changes had far
  reaching consequences (Land Reforms, 1972
  Nationalization of Plantation Companies, 1975
  Ceiling on Housing property, 1973 Compulsory
  savings for rich, 1994 and so on).
• 1977 reforms reversed this process (Tax
  concessions, amnesties, stipulations to increase
  land rent for share tenancy, privatization
  programme, removal of the universal food subsidy,
  reduction of social welfare expenses, removal of
  fertilizer subsidy, closure of PMB, closure of
  seed farms, elimination of state monopolies,
  reduction of expenditure on irrigation and road
  infrastructure and so on).

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Widening the divide

• Specific situations of reforms affecting
  nutritional levels of adults in the first wave
  and children under 5 in the second wave are
  identified.
• Drop-outs in education and the gaps in
  educational quality by regions form another
  divide.
• Regional, sectoral and gender biases in terms of
  income, health, educational and employment
  opportunities cover another major problem area.

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Filters-GDP Growth

• Growth rates falling and becoming volatile
• In booms the top deciles gain but in busts the
  bottom loses disproportionately .
• Was the growth pro-poor? Who gain and where?

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Table 1.1-Economic growth as a filter
Indicator/year 1970-1978 1978-1988 1989-2004 1970-2004
Average growth rate Average rate of growth of agricultural sector Gini ratio Reduction of income inequality ()1 3.07 1.41 0.35 (1973) -22 4.98 2.95 0.46 (1987) 31 4.83 1.48 0.46(2004) 0 4.48 1.93 0.35-0.46 31
Source Computed using data from the annual
report of the Central Bank of Sri Lanka-2004 and
W D Lakshman, (1997). Negative figures indicate
reduction of poverty (
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Growth trends compared
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Priority sectors and growth

• In terms of distribution of income rural estate
  sectors matter a lot 77 of the population and
  more than 90 of the poor dwell here
• Agricultural income has fallen minimum
  procurement prices have fallen credit to the
  sector has fallen irrigation investments have
  fallen
• Industrialization has centralized to the Western
  province (which is the top gainer of reform
  dividends) so does the booming services sector

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Table 1.2- Priority sectors (industrialization
strategy)
Indicators / Period 1970-77 1978-88 1989-2004
Annual growth rate of Industrial GDP (deflated using GDP deflator). Annual growth rate of exports (in US ) Annual growth rate of GDP 6 14.4 3.06 8.8 6.1 4.98 12.4 16.7 4.45
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Spatial distribution of industrial units
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Are food grains unproductive?
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Falling real prices of food grains
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Filters-Fiscal compression

• Investments on physical and institutional
  infrastructural have fallen
• Soft targets like education and health sectors
  suffered the most
• Subsidies including food , fertilizer, credit,
  are immediate casualties

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Falling public expenditure on agriculture
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Reemergence of Malaria in the second wave
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Impact of Financial reforms
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Employment filter

• Jobless growth falling employment elasticity
  of growth leaving many un- or under employed.
• Changes in the structure of employment favouring
  unorganized/ informal/ casual sectors.
• Privatization leading to lay-offs and
  casualization of work
• Wage levels falling in real terms
• Conditions of work deteriorating

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Employment as a Filter Table 1.3 Data on the
elasticity of employment
Year GDP (1996 factor cost price) Total Employment Change of GDP Change of employment Employment elasticity of agricultural GDP Employment elasticity of GDP
1971 229 3649 4.09 1.08
1979 321 4647 40.1 27.34 1.77(0.22) 0.68 (0.08)
1987 462 5271 43.92 13.43 0.09(0.008) 0.30(0.03)
2003 929 6947 101 31.79 -0.16 (-0.01) 0.31 (0.02)
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1.4-Percentage employed by status of Employment
Category of employment 1973 1978/79 1981/82 1986/97 1996/97 2003/04
Regular Casual Employers Self employed Unpaid family workers 60.9 -- 1.4 30.9 6.7 36.5 25.6 1.5 23.0 13.5 30.4 36.2 2.2 22.8 8.5 29.7 28.6 1.6 30.0 10.2 22.8 35.3 1.3 30.0 10.6 20.9 35.8 1.7 32.9 8.7
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1.5-Dichotomies in weekly earnings by organized
and the unorganized sectors
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Inflation filter

• Exchange rate-inflation link.
• Inflation is specially bad for workers in the
  agricultural and other unorganized sectors
  (whose wage rates are not indexed).
• It is also bad for producers whose bargaining
  power is limited it lowers internal terms of
  trade for farmers when input costs rise at a
  faster rate than output prices.

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Exchange rate-inflation nexus
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Real wages falling for plantation workers in the
second wave
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Overall welfare

• Sri Lankas initial welfare gains are lost she
  has failed to increase the lead or even to
  maintain the lead.
• Other conditions of socio-political gains also
  are fast disappearing
• Suicides in the agricultural belts portray this
  calamity.

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Suicides in Sri Lanka
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The lessons

• Findings show that there is a marked divergence
  between the theory and practice of liberalization
  orthodoxy.
• In the case of Sri Lanka the dividends of reforms
  were short-lived but the social costs were
  deep, pervasive, long-drawn.
• Income inequality has undoubtedly increased
  there is ample evidence to show that the other
  forms of divides are widening.
• These trends are directly linked to the reforms
  and various filters of inequality also are
  identified.
• Context specific data shows that reforms thus far
  have failed to produce the promised results.
• The dangers are not over. Pressure for market
  driven reforms in the land, water,
  infrastructure, health and education markets are
  building they will remove the remaining
  safeguards and with that inclusiveness will
  disappear from the skies of Sri Lanka forever.