Impact of Economic Growth on Income inequality: A Case Study of Sri Lanka

Abstract

Introduction : Economic growth and distribution of income can be recognized as two important issues, which are concerned with economic development. Although the poverty rate of Sri Lanka is a single digit value, the GINI coefficient value reflects relatively high income inequality. At the same time, even though Sri Lanka belongs to the middle income category2, the overall economic growth rate is unstable and not sustained. In addition, regional and provincial poverty levels depict disparities of income distribution at a micro scale. Therefore it is important to understand the growth-income inequality nexus.

Income inequality in economics is the significant disparity in the distribution of income between individuals, groups, populations, social classes, or countries. This territory is staked out by founding scholars. The seminal work of Kuznets (1955) is both important and controversial. He asserted that inequality was a consequence – though only temporary – of economic growth. In this respect, inequality was seen as increasing in the early stage of the economic development process before decreasing with further development. The existing empirical studies found a positive (e.g., Rubin and Segal 2015; Wahiba and Weriemmi 2014; Lundberg and Squire 2003), a negative (e.g., Majumdarand Partridge 2009; Nissim 2007) and mixed (e.g., Huang et al. 2015; Chambers 2010) relationship between economic growth and income inequality.

So in most cases, the nature of the relationship between income inequality and growth is dubious at best. Especially for developing countries, rising per

2 Sri Lanka had been elevated to the status of an upper middle-income country in July 2019 and again down rated as lower middle income country in July 2020.

capita income induces more inequality, which retards growth in this range. By contrast, in developed countries, rising per capita income tends to reduce inequality, which lowers growth in this range (Barro, 1990). Moreover, the relationship may differ depending on the region or the size of an economy. Fallah and Partridge (2007) show that the impact of inequality on economic growth is opposite in rural and urban settings.

In considering the Sri Lankan literature an uncertain relationship is observed due to the policy changes in the country (Rathnayaka, 2014). Also, Sri Lanka has been experiencing different phrases of income inequality; 1963-1973 low income inequality with welfarism policies, 1973-1987 high income inequality and 1987-1997 low income inequality (Karunarathne, 2000). Related studies on other Asian countries prove that economic growth impacts on income inequality significantly and positively. Further, Kakwani (1988) highlights that economic development and income inequalities are positively related in Sri Lanka, with the turning point of the Kuznets inverted U shape hard to find, or occurring at the last stage of development. In sum, studies highlights that there is no consensus on the sign and strength of the relationship.