Podcast
The human dimension to Sri Lanka’s economic crisis
On rising poverty, income inequality, and potential solutions.
Discussions around Sri Lanka's economic crisis have often focused either on the continuing citizen protests or on economic policy and the details of ongoing IMF staff negotiations. In these discussions, the human cost of living through an economic crisis is often discussed in statistical terms or in one-off narratives that fail to capture the nuanced impacts of increasing poverty, high inflation and widening income inequality. In order to capture some of this, Himal Southasian interviewed economist and author Sonali Deraniyagala.
The following text is an edited excerpt from a combined audio and email interview. Please listen to the audio before quoting directly from it.
Raisa Wickrematunge: Hi everyone, and welcome to Himal Interviews. I'm Raisa Wickrematunge, Acting Editor, and I'm here with Sonali Deraniyagala, who is a lecturer in Economics at the SOAS South Asia Institute. We're going to be talking about an aspect that is still missing in discourse around Sri Lanka's economic crisis, which is what the impact is in human terms, particularly for those from marginalised communities.
Thank you for joining us, Sonali.
Sonali Deraniyagala: Thank you, Raisa. My pleasure.
RW: A lot of the discussions around the economic crisis fixate on statistics and the minutiae of IMF negotiations. What are some of the impacts on human lives that we're seeing beyond the immediate crisis of hunger that is being reported?
SD: I think there's a lot of discussion on the macroeconomics of the crisis, but the macroeconomics is intimately related to the human dimensions, as you say. And in terms of human aspects, we talk a lot about hunger and malnutrition, for good reason, because this crisis in Sri Lanka has meant that there's a devastating fall in people's money incomes. About 8 out of 10 households say they earn less than they did before the crisis. And about 7 out of 10 households have cut back on food they say – so in this way, Sri Lanka has really descended into a new, very dark reality and it's not the reality of the middle-income country that we used to be. So we talk about hunger and these issues a lot because hunger is the most immediate, most viscerally felt human cost. There was an article recently in Reuters about this man in the north in Mullaitivu, who has now become a peanut farmer because he had lost both his legs in the war and he used to work on fishing boats. And the crisis meant that avenue of income was lost to him, and now he was forced to perform a much more difficult job and his children were going hungry. These are devastating stories and this is only one such story. And the question we must ask really is what are the long-term prospects for families like this? When you talk about numbers, they say 700,000 additional people are going to be thrown into poverty. And the question we have to ask is why exactly are they becoming poor? What have they lost? Is it a job? Is it an asset? And what can we do about it? So these are some of the key questions that we have to ask. There is the notion that people fall into a poverty trap – a hypothesis that households need to have a minimum level of assets if they can escape poverty and improve over time. An asset could be a job. It could be a fishing boat or a piece of land. They could also be skills and knowledge and things that make you more productive in the workplace. So what can happen in the context of Sri Lanka's crisis is that people can lose these assets. We see that in the case of this man who's now peanut farming – he lost his job, and when you lose your asset, then the question is – is this transitory because of the crisis? And there's a lot of evidence to show that for a significant section of the population, this effect lasts over time and even inter-generationally. Some people might sell, say, a fishing boat, because they need to smooth consumption. They need to feed their families so they have to give preference to consumption over what they own. So that might cause them to lose that asset and interest rates have gone up, and you never have the capital to buy a boat again. And another very important way is through under-nutrition and malnutrition. And that is another area of this poverty trap hypothesis that is very relevant to Sri Lanka and to children in particular. Because what you find is that in crises like this, there is new evidence in Sri Lanka too that there's increased wasting, and there's increased stunting among children – these are the first signs – due to the lack of nutrition. There are some studies that look at more than a million children and they find that when economic growth falls by about 10 percent, wasting increases by 17 to 18 percent. That's a very big increase. And Sri Lanka's economy is going to shrink by 8 percent or more. This is bad in the immediate sense, but it's also bad because that feeds into cognitive development, educational attainment falls as well as their own productivity and earning capacity in the future. So what this means is that there could be inter-generational poverty.
When people are feeling multiple stressors like they are in Sri Lanka, where food prices are rising, there's shortages, people are losing jobs, incomes are falling – people's cognitive ability to cope with crises and to escape poverty is severely constrained.
RW: Sri Lanka's poverty line was declining before COVID-19 and the economic crisis. I believe it was around SLR 7913 last year and it was recently reported that it has now increased to SLR 13,138. Do you think the indicators used to measure poverty provide an accurate capture of the situation?
SD: As we know, the poverty line is used to measure absolute poverty. So when you say 30 percent or 10 percent of the population lives in poverty, their income or expenditure on essentials fall below this line. In Sri Lanka, the poverty line measures minimum expenditure per person per month that is necessary to meet basic needs. The reason it went up is because of inflation. It has to reflect this very sharp rise in inflation. Statistically, you have to raise the poverty line. But in reality, there are other calculations that show that in the present context in Sri Lanka – for a household which is around 3.7 or 4 people, to meet a WHO [World Health Organisation] recommended diet, you need way more than that – you need 100,000 to 150,000 rupees per month. But if you take 2019 data you see that 40 percent of the population's household earnings were less than 30,000 rupees a month. So yes, the poverty line, it was necessary to raise it but it doesn't capture poverty fully and it never does – especially in a country like Sri Lanka, where our wages are fairly static but inflation is rising very rapidly, so it's hard to keep a grasp of this all the time. And we can also go beyond this simple poverty line measure and look at broader indicators of poverty. There's an indicator called the Multidimensional Poverty Index, which has been computed for Sri Lanka, again only in 2020, so the data is older, and that looks not only at income but other aspects of poverty; so it looks at health, education and many, many indicators of the standard of living like sanitation, access to fuel, transport and so on. So the broader the indicator, in a way, the better – the poverty line is a very important indicator but we must complement it with other indicators. For instance, with the current change in electricity pricing in Sri Lanka – the sharp hike in prices is very likely to have a regressive effect on the urban poor. If you use the multidimensional poverty indicator, you'd see quite a large increase in poverty on the urban poor using that indicator, because it captures all those factors as well.
They say 700,000 additional people are going to be thrown into poverty. And the question we have to ask is why exactly are they becoming poor? What have they lost?
RW: People have been talking about the mental health impact of having to navigate multiple crises at the same time, even if they have access to financial resources and support. Is there any research on the impact of living through a crisis on mental health and what can be done to address this issue?
SD: After the 2009 crisis and with austerity and the economic collapse in Greece, quite a lot of research was done on young people and suicide and the drastic effects on mental health in an economic crisis. Interestingly from an economics point of view, there's a lot of research coming out from the behavioural school of economics that looks at how people's mental health affects their economic behaviour and that again relates to economic hardship and poverty. When people are feeling multiple stressors like they are in Sri Lanka, where food prices are rising, there's shortages, people are losing jobs, incomes are falling – you have these multiple crises happening – and people's cognitive ability to cope with crises and to escape poverty is severely constrained. Not that it's any fault of theirs, but all you can do is focus on the day-to-day. How are you going to get the next meal for your children? How are you going to get a canister of gas? Your focus is very immediate, so you can't think of longer-term issues like, how do I find my child a better tutor? And so you can't think of issues that would pay off in the longer-term. Some call it the economics of depression, the economics of hope. Economists will talk about equilibriums a lot, and this is an equilibrium situation so it needs something to move it – in the sense that people are optimising their behaviour in this way, and poverty and crisis lead to this. Economic shocks create a huge cognitive and mental burden on families. One of the analogies used is that of an air traffic controller who's trying to avert a crash, they're trying to stop two planes from colliding, and you can only focus on the two planes, you can't look at anything else up there like a cloud, or lightning.
We talk about hunger and these issues a lot because hunger is the most immediate, most viscerally felt human cost.
RW: There's been a lot of emphasis from the IMF and policymakers on cash transfers. What are your thoughts on cash transfers as a measure to address deprivation? Are there other measures that could be implemented instead?
SD: During this phase of a crisis, cash transfers are of course important, but in the Sri Lankan context one really has to work out the coverage, and it would have to be very extensive given the huge percentages of the population – 40, 50, 60 percent – who are facing hardship. That is a big issue that needs to be worked out. Apart from cash transfers, we need to look at this question very analytically and think, what is this crisis doing to households? In what way are they facing income shocks? How are these income shocks coming about? Is it because they're losing jobs? Is it because as this poverty trap model suggests, they're giving up assets or selling assets and smoothing consumption? Is it because of all these psychological factors of not being able to cope? And so in some cases, it could be asset transfers, it could be subsidised credit to particular groups, to women, and so on. As you said at the beginning, our Sri Lankan experience is so new and so shocking, we are full of narrative. And this is probably the time to do some research, using sound methodologies, randomised trials and so on to see what kind of mechanisms and interventions will work best. There's a lot of evidence from around the world. In countries like Bangladesh, there was a big randomised study which shows that in some contexts, asset transfers worked better than cash transfers. In some countries, direct interventions for children were very effective, as in Mexico and so on. We really need to do the work on that to see which groups need which kind of intervention.
RW: Unfortunately, it seems that we wait for a crisis to hit before we think of strategising!
SD: I know, and even during a crisis, this is the time to do the work rather than winging it. There is still time to do pilot studies and randomised trials and so on.
RW: What might be some of the impacts of increased income inequality that Sri Lankans might not expect, and how should this be addressed?
SD: Sri Lanka is a country with fairly high income inequality, I think we are in the top one-third of the most unequal countries in the world, and wealth inequality is also very high. For instance, the top 1 percent of Sri Lankans, own 31 percent of total personal wealth in the country, whereas the bottom 50 percent own less than 4 percent of total wealth, so that gives you a snapshot of how unequal the country is, and even though historically since 2005, we've had a fall in poverty, income inequality has remained high. So this is going to be a problem, and in any crisis, financial and economic crises typically lead to an increase in income inequality. So what we can expect in Sri Lanka is a further increase in inequality. We talked about the loss of income for the majority of the people, there'll be small groups who earn in dollars who have their wages and salaries indexed to inflation in some way, so this gap between the rich and the poor is most likely going to increase in the Sri Lankan context. And that's not a good thing for economic growth and it's not a good thing for economic development. There used to be the idea that the rich will save more and invest, and that is good for economic growth, but that's an old notion and has been empirically shown to be totally wrong. What you need is demand in an economy to increase investment and so on. With high levels of inequality, it also increases the chances of political capture – small groups capturing political power in the country, and of course in Sri Lanka we have that in spades as well. Worsening inequality is a bad thing, and it's a bad thing for policymaking, because when small groups capture political power or have a huge influence on political power you might have the wrong types of economic policies put into place. We need an export-led policy in Sri Lanka at the moment, but the emphasis at the moment is still very much on inward-looking interventions. So all of this income inequality is not a good thing for public services. It's something that we really need to be cognisant of and take seriously. And there are policies, of course. Taxation is one way of dealing with it – increasing the base of taxation and making it more progressive. So it has to be at the forefront of policy going forward, I think. There can be wealth taxes, there can be increased corporate tax, there can be progressive income tax and so on.
The top 1 percent of Sri Lankans, own 31 percent of total personal wealth in the country, whereas the bottom 50 percent own less than 4 percent of total wealth, so that gives you a snapshot of how unequal the country is.
RW: Sri Lanka has an ageing population, and this was something you could see before the pandemic and the economic crisis. Do you think we are adequately prepared to deal with the issues this might raise in the future?
SD: The ageing population will become a problem very soon, purely in terms of our demographic dividend. You know when you have a population which is more working age then there is potential for these people to work and improve productivity and increase economic growth and so on. So the ageing population then takes that away. People are out of the labour force. So you have a higher dependent ratio and then you need to increase the welfare net for an ageing population – so that's a challenge. The IMF argues that our social security figures, our spending on social safety nets, which is only around 0.4 percent of GDP, is very low and needs to be increased – so an ageing population would mean, the 0.4 percent needs to increase quite significantly. The question is that what we need going forward is a system which has a way to earn revenue – through higher taxation for example, and then increase expenditure on health, education and social safety nets. Sri Lanka is both a very low tax economy and a very low spend economy.
RW: Speaking of fiscal consolidation, right now people are talking about the possibility of a wealth tax. And people are saying that it's not feasible because there are administrative difficulties in implementing that. What's your response to those arguments that are being made?
SD: I think we can't dismiss it without really investigating it. I've seen some of the arguments made against it, and they're not really solid in the economic sense. I think the administrative burden is one thing, and then of course there's a lot of changes and improvements we can make in that area – on how to administer the tax – there's a lot of expertise in the world that we can draw on for that. So that is one issue. The one issue is the argument that wealth tax is anti-growth. Most economists know that it isn't a deterrent to growth, and in these situations, it's often very necessary. The other is of course, to increase the base or the scope of tax in Sri Lanka, given how few people even pay income tax, and then to increase progressivity of tax, and then look at corporate tax as well – when are you stopping corporate tax incentives and so on. I think the wealth tax definitely needs to be looked at carefully to see how much of it is going to be bringing in, and how it is going to be administered – look at it in a normative way rather than be afraid of it – and I think that's very important going forward. It must be taken seriously.
One issue is the argument that wealth tax is anti-growth. Most economists know that it isn't a deterrent to growth, and in these situations, it's often very necessary.
RW: This was arguably a foreseeable crisis. With the benefit of hindsight, what steps could we have taken to prevent this from happening – also, in order to break the cycle not just for Sri Lanka but for other countries in the region, like Pakistan who are facing similar issues, continually having to return to the IMF for aid?
SD: Of course, this was an avoidable crisis. There were policymakers who had the foresight, there were some who knew and there were others who completely ignored it and weren't following economics but rather voodoo economics! So we need to have separation between the technocrats who run the Finance Ministry and the Central Bank, and politics. When you don't have separation, there's capture. And that's what happened in the immediate sense. In the long term – one of the bigger problems and fundamental deficits is the balance of payments. And coming back to that, we need to move the economy into being an export-led economy which is able to export high-value-added products. We need to participate in global supply chains in the correct way. There are two ways to become an export-led economy. You can take the low road, which is cheap labour, using low technology, or you can take the high road, and I think we really need to take the high road where there is still space for that. And it's quite alarming that even now, without an export economy, we're really taking a low road to development in terms of encouraging migrant labour to leave the country. Now, of course, it's for those people themselves and in an immediate sense, they need relief, they need a job, they need money. But the alarming exodus of skills in the country is going to be a huge deterrent to development – especially in terms of an export-led strategy. There's a lot of discussion amongst economists about whether the world has entered into a new phase of globalisation. It's not the old world where there was a lot of supply chain activity in trade, with some components being manufactured in various countries. Trade as a percentage of world GDP is falling globally. Countries like China are not going to dominate these supply chains anymore. But that also means that there's space for countries like Sri Lanka and Vietnam. Some countries like Indonesia, Vietnam and Bangladesh have successfully occupied some of this space and are manufacturing for these global supply chains. And another area, of course, is services, which is also why I think it's very dangerous that we have this exodus of skilled labour. There's a lot of scope to join the global supply chain in services like IT, accounting, and all of that. And that is high skill, so the value added to the country is relatively high. So we need a big fundamental shift in the way we think, and at the moment, there's very few signs of that.
RW: On that note, thank you so much for joining us, Sonali.
SD: Thanks, Raisa.
***