The Presidential address at the 2007 Annual Sessions of the Sri Lanka Economic Association:

Inequity, poverty and development

Prof. A. D. V. de S. Indraratna

The theme of this year’s Annual Sessions is Inequity, Poverty and Development. In my Presidential Address, I wish to share with you some of my thoughts on this theme within the limited time allocated to me.

There is a close relationship between inequity and poverty and between poverty and development.It is usually equity, and not inequity, that is combined with development. SLEA advisedly decided to combine development with inequity because inequity has a direct relevance to, or impact on, poverty.

Very often this nexus between inequity, poverty and development is either ignored or forgotten by many of us. If that were the case, the whole purpose or objective of development would be misconceived. In order to clarify this, let me begin by explaining to you first what I specifically mean by these concepts.

Defining equity

Inequity is the opposite of equity. Equity is not equality, as it is very often misunderstood. For equality is neither feasible or practicable nor even desirable. Why? because it ignores or disregards productivity and kills incentive, both of which are stimuli for economic growth.

The Concise Oxford Dictionary defines equity as fairness and inequity as unfairness respectively. Fairness in economics is more specific and wider in scope. For it is fairness in providing equal opportunities for employment and services such as education and health and non deprivation of access to them.

The World Bank defines equity as equality of opportunities and avoidance of absolute deprivation. In further elaborates this (WDR, 2006, p.2) “that individuals, in a society or nation (sic), should have equal opportunities to pursue a life of their choosing and be spared from extreme deprivation in outcomes.

The main message is that equity is complementary, in some fundamental respects, to the pursuit of long-term prosperity. Institutions and policies that promote a level playing field - where all members of society have similar chances to become socially active, politically influential, and economically productive-contribute to sustainable growth and development.

Greater equity is thus doubly good for poverty reduction through potential beneficial effects on aggregate long-run development and through greater opportunities for poorer groups within any society” (WDR, 2006, p 2).... “Greater equity can, over the long term, underpin faster growth” (ibid., p.17)

With equity thus spelt out, one immediately sees the connection between inequity and poverty. Poverty, after all, is nothing other than the status or position of individuals of a society not being able to meet their basic needs of living, such as food, clothing and shelter and primary education and health care, due to the lack of equal opportunities, and deprivation of access to them even when opportunities are open.

There are various levels, and various measures or indexes, of poverty. We need not go into or elaborate them here. Suffice to say that from the definitions of inequity and poverty we have given here, we immediately see the need for development with equity.

What is development after all? In my presentation I use it synonymously with economic development or economic growth? It means the rate of growth of the Gross Domestic Product, which is simply the total net value of goods and services produced within a country or by a nation in a given period of time, usually one year.

Why or for whom are these goods and services produced. We need it for enhancing the quality of life of a country’s entire people or citizens, not for the benefit of only the elitist or economically, or politically, powerful few.

If the benefits of development are not shared equitably by all but confined to a small fraction of a people is that development worth - while? Will such development be sustained? No, Development with inequity gives rise to mass poverty which boomerangs on development itself. On the other hand, can equity be sustained without growth. No. That is not possible either.

Inequity is manifest in relatively high unemployment, and low income, among lower segments of the people and in some regions or sectors. This, in effect, means that the development potential of the human and natural resources of those sections and sectors has not been fully mobilized or utilized, resulting in sub-optimal growth, which, in turn has aggravated poverty.

Many of us, economists forget or ignore this nexus between inequity, poverty and development when we speak of economic growth. It is not growth per se that a country needs but growth with equity. Let me look at Sri Lanka’s experience in this regard? I shall give only a brief account of this within the scope my presentation.

Sri Lanka’s experience

Sri Lanka, then Ceylon had a prosperous economy during the first 8 years of its Independence, being much ahead of her Asian neighbours. Since then, Sri Lanka began to lag behind them.

The last five decades from 1956 to 2006, she has been ruled alternately by centre-left and centre-right Governments almost on a thattumaru basis. They were vying with each other to gain, or remain in, power by increasing welfarism at the expense of growth. Equity in income distribution improved as a result.

The income share of the top 20% of the income receivers fell from 56.7% in 1953 to 45.9% in 1973 (CB, Socio-Economic Surveys) with the Gini Coefficient (overall measure of income distribution) of both spending units and income receivers declining respectively from 0.46 and 0.50 to 0.35 and 0.41 during the same period (ibid).

However, the average annual rate of economic growth of 4.3% in 1951-1955 had decreased to 2.7% in 1971-1976, with the rate of unemployment reaching an unprecedented record level of 20% at the end of the period.

The centre-right government which came into power in November 1977 found it no longer possible to retain the welfare subsidies in a regulated economy, and therefore opened it, removing all subsidies along with restrictions.

The economy began to grow once again but with less equity. The income share of the top 20% had increased from 45.9% in 1973 to around 55%, with Gini-coefficient (of income receivers) rising to 0.50 again, by the time the new centre-left Government of Chandrika Kumaratunga came into power.

While deciding to continue with the open economy policy of the previous Government , she wanted to distinguish her policy from the previous government by announcing that her vision was directed at growth with a “human face” (i.e. the benefits of the open ecomony equitably reaching the lower income groups).

Although she thought she could do it with the Samurdhi replacing the Janasaviya of the previous Government, hers too was a miserable failure in this regard, due to the irregularities and the corruption that accompanied Samurdhi, resulting in the income shares and the Gini-coefficient remaining at the same sort of values as before she took over.

Economy was growing

In this last five decade history, the economy was growing much faster in the last three decades than in the preceding two. Even including the abnormal year of 2001 with a negative growth of 1.5%, the economy had grown at an annual average of 5.0%.

With a population growth rate of less than 2.0%, the annual growth in per capita real income had been substantial. Nevertheless, the inequity in income distribution remained more or less the same as judged by the 2003/2004 Consumer Finance and Socio-Economic Survey (CFS) of the Central Bank.

Even though the per capita GDP (at market prices) is US$ 1355 (2006), nearly half of the population live below the poverty line of US$2.00 per day, that is less than US$ 730 per capita per annum, which is around half of the national average.

Even more alarming is the fact that the bottom 20% of the income receivers get less than 4% of the total income, which on a very rough and ready reckoning means that their per capita income would be closer to one quarter or one fifth of the national total (I had no time to make more accurate estimates).

This inequity and resulting poverty, with one fourth of the population considered poor and a similar proportion malnourished) is manifest in the deprivation of the poor in regard to facilities such as housing, electricity, sanitation and household equipment.

Even after a nearly six decades of so called development since Independence, 12.5% of our people live in wattle and daub houses; 25% or a quarter of the population lacks electricity; 4.4% use common toilets while 5.6% without any toilet; Though the richer families (segments) in the population have several cars, several telephones and several television sets each, one fifth of the population has not got even a radio.

Inequity and Cost of Living

It is these poorer sections of the people with inequity in incomes who are also worse affected by the rising prices or inflation. I mentioned earlier that the ecomony had grown annually by 5.00%. With population increase being less than 2.00%, the average per capita real income has been growing by more than 3.00%.

This means that the average money incomes have been rising faster than the rate of increase of prices of goods and services. Then why are the people complaining? It is not the richer who complain, but these poorer segments, and they do so rightly.

Although, on the average, money incomes have been rising faster than inflation, the poorer sections have not benefited from this increase, because, as I mentioned earlier, the increase has been concentrated among the upper segments of society.

Their money incomes have been rising many times faster than the national average and they have been, in other words, amply compensated for the rising cost of living. The money incomes of the poorer, on the other hand, have been lagging behind inflation.

Is it then surprising why the former have been telling our policy makers that while “you are trumpeting so much of a 6-7% growth rate, we are suffering from the sky-rocketing prices”?.

A little inflation may be inevitable with growth, but one effective way to cushion its impact on the cost of living is raising every body’s money income faster, not only of a few (I am ignoring the supply side here).

This requires speedy measures for removing the causes for inequity. In many of our frequent discussions on the cost of living or inflation, scant attention has been paid to this aspect.

It may not be considered an immediate solution. Nevertheless it is fully worth to take it up. This brings us straightaway to the causes of inequity and poverty in our societies which need remedial action.

There are several causes of inequity. The most important among them are:

* Regressive taxation

* Absence of direct income redistributive measures or social welfare benefits or safety nets

* Regional Disparities

* Imperfect markets

* Impaired institutions

* Bad governance

* Corruption.

Let me briefly discuss them one by one.

Regressive

Taxation

Sri Lanka’s tax system has been becoming more and more regressive since the opening of the economy at the end of 1977. Even though the tax revenue comprises 9/10 of the total Government revenue, the bulk of it comes from indirect taxation, mainly taxes on goods and services which are regressive.

Despite the lowering of rates, income tax revenue as a percentage of GDP has been falling. Even though it has taken a reverse turn during the last year or so, it is still only 1.8% of the GDP (not taking into account the Withdrawing Tax which is in any case deducted from the total tax liability).

Leave aside developed countries, compared even with our neighbouring Asian countries this seems far too low. The top 20% or 1/5 of income receivers get more than half (55.1% according to the CFS 2003/4 of CB) of the total income. Their average income is several times the national average per capita income of US$ 1355.

There are around 1.5 million income receivers in this group or category (C.B.). But the Inland Revenue department has only 400,000 tax files, most of whom are also not paying tax. Thus, there seems to be a staggering number who are evading tax now, and who need to be brought under the tax net.

Some proposals were made in the 2007 Budget to double the contribution of income tax to 3.5 of GDP. These may not be enough to achieve this target.

Some revolutionary measures such as prescriptive taxation (as in India), and a poll tax on professionals (as was the case in the Felix Dias Regime) with provision to set off against tax liability on submission of returns, would be required.

If direct taxation were raised to at least half of the total tax revenue, without further increase in taxes on goods and services, regressiveness of taxation would be significantly reduced.

Direct transfer incomes in the form of food and other consumer subsidies would also reduce inequity in incomes. But to have their desired effect they must be properly administered, corruption-free and reach only the intended, targeted groups. Despite the shortcomings in their implementation, we have seen how income distribution became less skewed when they were in operation.

Regional Disparities

Regional disparities are quite marked in the development that has taken place in Sri Lanka. It has been concentrated mainly in the Western Province out of her nine provinces.

A few statistical data, as contained in Table 1, would amply demonstrate this highly skewed development which had resulted in rural poverty and overall inequity, to which we have already referred.

There are wide provincial disparities in the income and consumption expenditure levels as well as access to services such as primary education, availability of electricity, water supply and sanitation. Its per capita GDP is more than twice that of any other province and is 176% of the national average (2006). 29% of the total employment and the bulk of the industrial capital are concentrated also in the Western province.

These disparities could be removed with development moving into provinces other than the Western. Resources are widely spread throughout the country and in the seas right round it with its maritime boundaries, in fact, covering an area four times as large as its land area. The balanced regional development is therefore quite feasible.

Market Imperfections

With imperfect markets, inequalities in power and wealth translate into unequal opportunities, leading to wasted productive potential and inefficient allocation of resources.

Imperfect, are the capital markets with differentiated interest rates for different social groups, or land markets with landownership and land titling problems for the poor, or human capital markets with different parent abilities for children’s education and ethnic or tribal/caste discrimination or job allocation based on personal contacts or relationship.

This does not enable the full potential of those in the poorer segments to be developed, and the inequity perpetuates. Reforms in our policies and legislation relevant to these areas are imminently necessary to alleviate the situation.

Impaired institutions exist, when there are inequalities in the political system and social realm, and there is poor governance, a cause for inequity in itself, which I shall discuss next. Particularly when institutions, that define and enforce property rights and contracts such as courts, are not independent, equality of treatment is denied and inequity prevails.

“Poor institutions emerge and persist in societies when power is concentrated in the hands of a narrow group or an elite” and political inequality emerges, which is often underpinned by economic inequality. When there is poor governance there is no incentive for proper institutions. However, without unimpaired institutions such as security of property rights and equality before the law, prosperity cannot be sustained.

Bad/Poor Governance

Good governance in layman’s terms signifies the proper management of a country’s resources for the equitable benefit of all, and not of a few. Transparency, accountability and equal treatment of all its citizens are the hallmark of good governance.

Poor governance, as I said before, is associated with inequity and poverty.

It also helps corruption which is my last cause of inequity and poverty.

Corruption

Corruption, which I have kept to the last, is by no means, the least important. I have deliberately taken it up last because I want to emphasise it and devote a little bit more time to its discussion, as public officials and our politicians fight shy of even mentioning it as a cause of our poverty, and even among us, economists only a very few, and that too very recently, have shown interest in the study of this nexus between corruption and inequity and poverty.

Corruption can impact on poverty if it affects either the available investible resources (GDP available for investment) and our productivity. Very often, a large amount of revenue is foregone when corruption takes place. The VAT scam reported by the former Auditor-General, amounting to some Rs. 3.2 billion is one good example of this.

There are many other similar cases of corruption of various magnitudes as reported by the COPE Chairman, as well as others not reported or gone undetected. If these revenues were not lost they could have either augmented the gross investment of the public sector or helped to reduce the burgeoning budget deficit.

The level of infrastructure as well as productivity of infrastructure are affected both at central government and provincial government level, as well as at the level of line-ministries, due to rampant corruption in infrastructure projects such as building of new roads and bridges and maintenance of existing ones, and projects relating to irrigation, water and power supply.

This is owing to contractors getting away with substandard work or pilfering inputs or not using specified materials, by giving commissions or kickbacks to officials or elected representatives who are overlooking such projects. These are examples from the supply side.

On the demand side also, corruption increases inequity and poverty by reducing the access of those to goods and services or increasing their deprivation due to their having to give bribes to get things done by public officers.

Corruption also affects the poor directly when they are unable to pay the bribes demanded of them, and thereby are denied basic justice, for example in the hands of the Police and local officials. Similarly, the corruption in respect of procurement and supply of equipment in both foreign and local funded projects directly reduces the benefits intended for the target groups.

It affects the poor relatively more. Even in regard to the supply of material inputs, such as fertilizer, seed paddy and water, corruption worsens the poverty of the rural farmer. Any corruption in the Samurdhi Scheme affects the poor directly as Samurhdi is entirely targeted at them.

I can go on citing various examples of corruption both on the supply and the demand side which contribute to poverty and inequity and slow growth. But I have no time to do this. Also, this aspect of impact of corruption on poverty and growth has also been discussed at length in a Report prepared by me and three others.

Suffice to conclude this section on corruption by extracting a few conclusions from that Report: If funds lost as a result of corruption in 26 public enterprises as reported by the COPE Chairman of around Rs. 100 billion and the loss due to identified corruption elsewhere, the total annual loss would be around 9-10% of our GDP.

If these funds had been saved and invested, Sri Lanka’s growth rate would have been raised by a further 2 percentage points, without any further increase in the present rate of gross investment or productivity.

We always speak about the loss in growth due to the terrorist war but we hardly talk of the loss due to this other terrorism, corruption. To quote from our Report again, “The costs of corruption are very high. It slows down growth and reduces what is available for distribution.

It reduces the disposable income available in the hands of individuals. It aggravates inequity. In all these, the burden falls relatively heavily on the poor, because eventually, the marginal utility of money is relatively high for the poor, on the one hand, and corruption acts as a regressive tax on them, on the other.

Conclusion

The improvement of quality of life of our entire nation, not of one segment or a small percentage of it, should be the ultimate goal of economic growth and development. In fact, this is what Sri Lankan development should be all about. To this end, irrespective of the Government in power, there must be continuous or sustained national policies regarding the development of various sectors, and regions, of the economy.

With nearly six decades of “development”, after attaining Independence from foreign rule, Sri Lanka has not been able to eradicate poverty and unemployment. Development policies have been changing with alternating political regimes without any economic rationale.

National policies with respect to any major sectors of the economy have been sadly lacking. Good governance has been markedly missing. Whatever development that has occurred has been highly skewed.

Sri Lanka is blessed with a rich endowment of natural resources spread throughout the country as well as right round it. These natural resources are accompanied with a large human resource. It has a great agricultural and industrial potential.

All its three main cash crops as well as some of its subsidiary food crops such as fruits, have much scope for processing and value addition for export. It has a rich endowment of marine and a large variety of mineral resources and gem stone, much of which is not exploited at present, and even the little that is exported leave our shores mainly in raw form.

Since these resources are widely spread throughout the country and in the seas right round the Island, industrial enterprises can be established in the regions outside the relatively well developed Western Province, in order to reduce the regional disparities.

Without confrontational politics, but with good governance bereft of corruption, and proper national policies in place, Sri Lanka should be able to take into sustained balanced development with a high growth rate. This will enable her to bring down unemployment and poverty within tolerable limits, eliminating inequity significantly, at the same time.