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Slide 2 Emerging Income Inequality and Widening Economic Divide: the Case of Sri Lanka IDEAs Conference on Policy Perspectives on Growth, Economic Structures and Poverty Reduction:7-9, June, 2007 Tsinghua University, Beijing, China Upali Vidanapathirana Slide 3 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 58.179.1122.071.5 $ 826-3255 69.82429.393.1$101074131592 Slide 4 Introduction Liberalization orthodoxy claims that openness produces faster GDP growth rate on a sustainable basis Liberalization orthodoxy claims that openness produces faster GDP growth rate on a sustainable basis Such growth engenders income equality Such growth engenders income equality Sri Lankas liberalization experience of about 30 years is adequate to test this claim using context specific empirical data Sri Lankas liberalization experience of about 30 years is adequate to test this claim using context specific empirical data Slide 5 Theoretical base of inequality and openness Inequality in open economies is explained in terms of archetypical Kuznet hypothesis where initial spurt in GDP growth increases inequality (Kuznet, 1955) 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) 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. HOSS theorem claims that openness increase scope for jobs and increases real wage rates of unskilled workers to cause equality. Kuznets claims are not archetypical; inequality is harmful to growth (Rodrik, 1996; Thorebecke, 2002) Kuznets claims are not archetypical; inequality is harmful to growth (Rodrik, 1996; Thorebecke, 2002) Openness is not distribution neutral (Wood, 1999; Anderson, 2005) 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) HOSS fails in many countries to give jobs to unskilled labour (Carter and Barham, 1996; Lipton, 1985 nd 2007) Slide 6 Proximate determinants of inequality 1 Economic growth is the most potent determinant of income distribution; its distributive implication depends on whether the growth was pro-poor or pro-rich. 2 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. 3 Employment generation is the third variable. If free trade serves unskilled labour better, naturally that should be pro-poor. 4 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. 5 5 Arising from 4 above, the status of infrastructure including roads, markets, storage, irrigation canals, extension services etc undermines the distribution of economic opportunities. 6Education is considered an equalizer of income distribution; This depends on considerations of access and equity. So does health! Slide 7 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). 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! 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). 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). Slide 8 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, 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 specific factors have engendered and/ or hindered such outcomes, What are the lessons of experience Sri Lanka provide to other developing countries What are the lessons of experience Sri Lanka provide to other developing countries Slide 9 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 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 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 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. 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. Slide 10 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. 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. Conversely the top most deciles gained persistently. The income share of the 1 st decile fell from 2.79 in 1973 to 1.86 in 2004. The dividends of reforms have by passed the poor. The income share of the 1 st 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 10 th decile swelled from 28.03 in 1973 to 36.45 in 2004. The rich amassed the benefits of reforms The share of the 10 th decile swelled from 28.03 in 1973 to 36.45 in 2004. The rich amassed the benefits of reforms Slide 11 Income inequality trends (income data) Quintiles19731978/791981/821986/871996/972003/04 Bottom7.25.75.75.05.75.1 2 nd 12.110.39.59.110.09.1 3rd16.214.313.313.514.113.4 4th21.619.819.520.120.820.5 Top42.949.952.052.349.452.0 Slide 12 Quintile distribution (1973-2004) The gains to the top 40 percent have increased from 64 percent in 1973 to 72 percent in 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). 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. 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. Slide 13 Figure 1- Lorenz Curves for years 1973, 1981 and 1996. Source: Central Bank of Sri Lanka Slide 14 How Gini ratio changed over the period 1963-2004 Slide 15 Other indices of income inequality Description19731978/791981/821986/871996/972003/4 Gini ratios Spending units Income receivers Quintile Ratios (Q1+Q2)/Q5Q5/Q1 Theil Index 0.350.410.455.90.280.430.500.328.70.350.450.520.299.10.390.460.520.2710.40.390.430.480.328.60.330.460.500.2710.10.38 Slide 16 Discussion Indicators are unanimous that income inequality has worsen. 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. 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 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 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 Slide 17 Consumption data Consumption data are generally supposed to be better than the income 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. 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 DCS data series became comparable since 1990/91 Slide 18 Consumption Data Quintiles1980/811990/912002 Bottom 2 nd 3 rd 4 th Top8.912.916.521.340.48.812.916.521.540.27.711.515.421.543.7 Slide 19 Consumption data-Changing pattern of Gini ratios 1980-2002 Slide 20 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). 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). 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). Slide 21 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. 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. 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. Regional, sectoral and gender biases in terms of income, health, educational and employment opportunities cover another major problem area. Slide 22 Filters-GDP Growth Growth rates falling and becoming volatile Growth rates falling and becoming volatile In booms the top deciles gain but in busts the bottom loses disproportionately. In booms the top deciles gain but in busts the bottom loses disproportionately. Was the growth pro-poor? Who gain and where? Was the growth pro-poor? Who gain and where? Slide 23 Table 1.1-Economic growth as a filter Indicator/year 1970-19781978-19881989-20041970- 2004 Average growth rate Average rate of growth of agricultural sector Gini ratio Reduction of income inequality (%) [1] [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 ( Slide 24 Growth trends compared Slide 25 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 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 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 Industrialization has centralized to the Western province (which is the top gainer of reform dividends); so does the booming services sector Slide 26 Table 1.2- Priority sectors (industrialization strategy) Indicators / Period 1970-771978-881989- 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 Slide 27 Spatial distribution of industrial units Slide 28 Are food grains unproductive? Slide 29 Falling real prices of food grains Slide 30 Filters-Fiscal compression Investments on physical and institutional infrastructural have fallen Investments on physical and institutional infrastructural have fallen Soft targets like education and health sectors suffered the most Soft targets like education and health sectors suffered the most Subsidies including food, fertilizer, credit, are immediate casualties Subsidies including food, fertilizer, credit, are immediate casualties Slide 31 Falling public expenditure on agriculture Slide 32 Reemergence of Malaria in the second wave Slide 33 Impact of Financial reforms Slide 34 Employment filter Jobless growth falling employment elasticity of growth leaving many un- or under employed. Jobless growth falling employment elasticity of growth leaving many un- or under employed. Changes in the structure of employment favouring unorganized/ informal/ casual sectors. Changes in the structure of employment favouring unorganized/ informal/ casual sectors. Privatization leading to lay-offs and casualization of work Privatization leading to lay-offs and casualization of work Wage levels falling in real terms Wage levels falling in real terms Conditions of work deteriorating Conditions of work deteriorating Slide 35 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* 197122936494.091.08 1979321464740.127.34 1.77(0.22) 0.68 (0.08) 1987462527143.9213.43 0.09(0.008) 0.30(0.03) 2003929694710131.79 -0.16 (-0.01) 0.31 (0.02) Slide 36 1.4-Percentage employed by status of Employment Category of employment 19731978/791981/821986/971996/972003/04 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 Slide 37 1.5-Dichotomies in weekly earnings by organized and the unorganized sectors Slide 38 Inflation filter Exchange rate-inflation link. Exchange rate-inflation link. Inflation is specially bad for workers in the agricultural and other unorganized sectors (whose wage rates are not indexed). 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. 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. Slide 39 Exchange rate-inflation nexus Slide 40 Real wages falling for plantation workers in the second wave Slide 41 Overall welfare Sri Lankas initial welfare gains are lost; she has failed to increase the lead or even to maintain the lead. 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 Other conditions of socio-political gains also are fast disappearing Suicides in the agricultural belts portray this calamity. Suicides in the agricultural belts portray this calamity. Slide 42 Suicides in Sri Lanka Slide 43 Slide 44 Slide 45 Slide 46 Slide 47 Slide 48 The lessons Findings show that there is a marked divergence between the theory and practice of liberalization orthodoxy. 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. 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. 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. 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. 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. 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.