Sri Lanka’s Poverty and Subsidizing the Rich

slum, somewhere in Sri Lanka, image from JDS

The IMF’s Regional Economic Outlook talks a fair bit about the Sri Lankan economy and its growth prospects. The region as a whole has grown but inequality is still a problem. Inequality is not the same thing as poverty, which has decreased. Inequality is measured by the GINI coefficient, which is basically a measure of inequality in a statistical distribution, in this case income. The higher the coefficient the higher the inequality. The chart below shows the increase in the GINI coefficient for a series of countries in the region.

A reduction in poverty is good. Poverty is measured by an increase in per capita incomes, which is the GDP divided by the population. The flaw here is that per capita measurements completely disregard income distributions by taking the total of the country’s income and assuming everyone gets the same size of the pie. Which is obviously not the case. Growth with inequality, while still growth, is counterproductive to sustained growth. Japan and countries like South Korea, Taiwan, Singapore and Hong Kong all had growth with greater equality until the eighties which contributed to their superior economies today. Basically you can grow without equality, but you can’t grow much.

-in Sri Lanka, number people living under $2 a day reduced by 20 percent

Interestingly Sri Lanka’s GINI, at 49 points as at 2007, dropped to 47 points in 2009/10. Going by available data alone this paints an encouraging picture. Maybe subsequent government policies have actually contributed to a decrease in inequality. Or it could be a temporary blip caused by the peace dividend hitting previously poor populations of the North and East.

How to combat inequality?

It is all in the policy. inequality is not irreversible, but it doesn’t involve simply doling out money to the poor either, this being a fine way of exhausting a countries fiscal resources in record time. Countries like the Philipines have started Conditional Cash Transfer programs that make welfare programs conditional on the receiver’s actions. So instead of subsidizing university education in a broad free for all, tuition would be provided to those students who actually show results. Or on a more simple level, family grants can be conditional upon whether you actually use the money to send your kid to school, or take them to the doctor. 

The IMF also claims that carefully targeted social safety nets like unemployment benefits and pensions can combat inequality. This is especially so in spending on health.  In China, a one yuan increase in government health spending is associated with a two yuan increase in urban household consumption. We might think Sri Lanka has sufficient spending on public health, it being free and all. But there are several inefficiencies in the system. But we all know sanitation here isn’t the best, and a recent clinic held by the private medical college in Malabe drew several times the hundred or so people they were expecting to come, proving a large unsatisfied demand for convenient health services.

Subsidies

Subsidies, though ostensibly geared at helping the poor, rarely do. In Sri Lanka we have a regressive tax system. The amount of tax you pay as a portion of your income actually decreases as you become richer continuously expanding inequality. This is mainly due to regressive taxes such as VAT.

Subsidies like agricultural subsidies, if not exactly counterproductive, don’t really help. Farmers still get crushed by price fluctuations. The real problem is possibly investment in agriculture. Very little agriculture here is actually industrial. The technology and methods used still date back to the times of the ancients. Agriculture has become a dumping ground for labour, with it usually being considered a final option for people who can’t succeed in the industrial sector.

the IMF report carries an interesting chart on how oil subsidies during the time of the global crisis helped the rich more than the poor. It says that the benefit of one dollars worth of fuel subsidies to the poor generally costs about 14 dollars to the budget. This is because higher income households tend to consumer more fuel than lower income households.

Sri Lanka spent upto 80 percent of what it spends on education and health on fuel subsidies. Recent tax cuts for vehicle imports and export benefits etc also favor the rich. More because market policies and business environments discourage entrepreneurship among the poor.

Middle Class Hypocrisy

Swaminomics has an interesting take on poverty in India and how it is relative. For example, a recent report that draws India’s poverty line at Rs. 32 a day attracted middle class ire, but the middle class itself, while fighting against poverty on one side, refuses to pay its servants good wages and bargains down prices in shops.

Middle class folk don’t want to calculate the per capita daily spending of their servant’s family. They resent servants constantly wanting more pay, even if this falls short of the very level they find outrageous when specified by the Planning Commission.

This double standard is not restricted to paying servants. When middle class folk go to Dilli Haat to buy a sari, they will beat down the weavers to the lowest price possible. If told that the weaver earns only Rs 4,000 per month, will they change their attitude or agree that they have helped keep the weaver poor? No chance.

I think this draws interesting parallels with Sri Lanka, whose middle class is much the same. Will we also forego low fuel prices and higher taxes in order to reduce inequality between the rich and the poor? Interesting question.

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3 comments
  1. Chavie said:

    Is fuel still being subsidised? I thought it was being taxed. :|

    Sri Lanka just lacks a long term strategy on combating poverty. Handouts are wildly popular, but they don’t help in making a systematic change. But they do win votes, so…

    • Whacko said:

      Nah fuel subsidies were for the period near the global recession. And yeah, we do have a popular give-it-away scheme. what is needed in contrast is stronger incentives for people to prosper, bettor opportunities etc. I think the present government, by virtue of it having near autocratic power, might be able to reverse the vote getting trend you mentioned. But that is assuming they stay benevolent, intelligent and curb corruption.

  2. In the past Sri lanka used to cross subsidize diesel by taxing petrol. The primary motivation was to subsidise the cost of public transportation at the expense of private car owners who were considered rich enough to afford the higher price of petrol. That policy lead to some interesting side effects:

    – Increased imports in diesel cars which the govt. countered by taxing them higher than petrol cars.

    – People responded by importing vans. I think vans and commercial diesel vehicles weren’t subject to the higher taxes. So you had families using toyota hiace vans as their primary means of transportation!

    Is this cross subsidizing scheme still in effect? If yes then that would explain the high level of fuel subsidies and how the government is financing them.

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