Growth and poverty in Sri Lanka: Updates on nexus

A Colombo shanty dweller prepares a meagre meal for her family

ECONOMY IS PREDICTED TO GROW AT 2.2 PERCENT, 2.5 PERCENT AND 3.0 PERCENT IN 2024, 2025 AND 2026, RESPECTIVELY. THEREFORE, POVERTY INCIDENCE IS LIKELY TO REMAIN HIGH IN THE NEAR FUTURE

Sri Lanka had achieved a remarkable success in poverty reduction, before the country’s present economic crisis, which reversed it during the past few years. 

According to the official poverty line based on the 2002 data, the number of poor declined sharply from 22.7 percent in 2002 to 3.2 percent by 2019. Then, due to the COVID pandemic, followed by the debt and foreign exchange crises, the economy collapsed. 

While part of debt servicing was suspended since April 2022, people experienced unprecedented hardships, due to the shortage of electricity, fuel, food, medicine and other essential goods. The economy contracted in 2021-2022 and part of the wealth that had already been created in the past got wiped out.

Aftermath of economic crisis

As economic growth is fundamentally important for poverty reduction, lower or negative growth in the past few years has eroded Sri Lanka’s gains in poverty reduction. Supporting about one-third of the population, who live below the poverty line, by a bankrupt country is on the one hand, an enormous economic burden. On the other hand, failing to provide the basic needs to the impoverished population as such would be inhumane, while the socioeconomic and political fallout of ignoring the poor would be disastrous. 

The current economic environment demands for the need to get back to a path of higher economic growth, amongst many other things. As it is well known, there is no linear relationship between economic growth and poverty reduction. In this context, it is opportune to revisit the nexus between economic growth and poverty, to shed light on the prospect of poverty reduction in Sri Lanka in the post-economic recovery period.
Economic growth can contribute to poverty reduction but the effect of growth on poverty reduction varies from country to country and over time. Moreover, poverty and inequality are closely intertwined as inequality can contribute to the perpetuation of poverty through barriers to accessing education, healthcare, employment and other opportunities. 

Conversely, poverty can also contribute to increased inequality. Therefore, effective policies to address poverty and inequality in a crisis-ridden economy require a holistic approach that considers the underlying social, political and economic factors shaping the dynamics of growth and poverty.

Towards pro-poor growth

Older economic literature published in and around the mid-20th century portrayed how economic growth leads to poverty reduction through the ‘trickle-down effects’ of growth. During the latter part of the 20th century, the focus was shifted from the trickle-down theories to ‘growth plus redistribution’ theories; they assert that growth and redistribution are not conflicting policy goals, so that the policies could be designed to promote both higher economic growth and a fairer distribution of income, leading to poverty reduction. 

The research findings of development studies doubted the trickle-down effect and confirmed the growth plus redistribution episode had a significant influence on the development policies. In fact, major international donor agencies like the World Bank and Asian Development Bank (ADB) also shifted their emphasis from economic growth to targeted poverty reduction measures. Many development financing agencies declared poverty reduction as one of the development goals along with economic growth.

The availability of data in the developing countries enable economists to quantify the effect of growth on poverty around the dawn of the 21st century. A number of cross-country studies estimated growth elasticity of poverty (percentage reduction in poverty as a result of one percent economic growth) resulted in another notable distinction in poverty reduction with the notion that ‘growth can be pro-poor’. These studies, which advocated for ‘pro-poor’ growth strategies, asserted that growth-enhancing policies of good rule of law, fiscal discipline and openness to international trade should be at the centre of successful poverty reduction strategies. International development agencies reduced the emphasis on targeted poverty reduction and refocused on growth-enhancing policies and projects.

Poverty reduction from growth

Growth improves income levels, contributing directly to reduce poverty with financial resources needed to meet the basic needs. A more complex form of growth contribution to poverty reduction comes from not only through income generation and job creation but also through increased government revenue, human capital development, entrepreneurship and innovation and access to infrastructure and services.

The notion that growth reduces poverty is not as straightforward as it is assumed to be. Studies confirm that the impact of growth on poverty reduction is smaller than what was presumed earlier. Further, it was realised that inequality dampens the effect of growth on poverty. 

Moreover, there is also evidence to support the notion that growth is not always favourable for the poor. However, despite the varying degrees of its effect, poverty can’t be reduced without economic growth. It is true that poverty reduction strategies become more effective with growth that generate employment and unveil opportunities.

New lessons

The economic recovery programme of Sri Lanka with the assistance of the International Monetary Fund is aimed primarily at restoring macroeconomic stability, strengthening public finances and promoting inclusive growth. The programme has helped stabilising the economy, reducing inflation and improving investor confidence. Along with that the government’s major social protection programme Aswasuma was also implemented, in spite of its exclusion and inclusion errors.

One of the notable findings is the difference between pre-crisis and post-crisis growth elasticity of poverty in Sri Lanka. Before the crisis, impact of economic growth on poverty reduction is marginal, as low as minus 0.2 percent or lower. This indicates that the lower the poverty levels, the greater the structural factors underlying poverty towards its bottom, which may be difficult to correct with economic growth. 

In contrast, the higher the poverty levels, the greater would be the growth impact on poverty reduction. This is confirmed by the higher growth elasticity of poverty that was as high as over minus 1.0 percent for the post-crisis period. This means that in the crisis-ridden economy, economic growth will have a greater impact on poverty reduction. Particularly, with a 5 percent annual rate of economic growth, it would be likely to take about 10 years to reduce poverty from 31 percent to 18 percent. 

As per the World Bank economic update (February 2024), the economy will have a very slow recovery; the economy is predicted to grow at 2.2 percent, 2.5 percent and 3.0 percent in 2024, 2025 and 2026, respectively. Therefore, poverty incidence is likely to remain high in the near future. 

Apparently, getting back to a high growth path is the key to reverse the current poverty trends and reduce the impact of the economic crisis on the vulnerable population. The impact of the social protection programme is secondary to a reform process that is aimed at achieving higher economic growth.

(Dr. Herath Gunatilake, Executive Director of the Centre for Poverty Analysis (CEPA), previously worked at the ADB for 15 years, holding different positions, including Director Environment and Safeguards. Prior to his ADB work, he was a Professor at the University of Peradeniya.)