High corruption leads to high GDP growth - By Prof. S. S. Colombage

http://www.sundaytimes.lk/150104/business-times/high-corruption-leads-to-high-gdp-growth-129244.html
The Sunday Times
04 Jan 2015

Official reports claim that poverty levels have come down dramatically during the last decade owning to the development strategies adopted by the government. The poverty headcount ratio (proportion of the population living below the ‘poverty line’) is down from 22.7 per cent in 2006/07 to 8.9 per cent in 2009/10 and to 6.5 per cent in 2012/13, according to the Household Income and Expenditure Surveys (HIES) of the Department of Census and Statistics (DCS). The rapid decline in poverty within such a short period, of course, appears impressive.

Work on the Katunayake Expressway before completion.

However, it is questionable whether these poverty figures accurately reflect the actual poverty situation in the country. The poverty headcount ratio is based on the Official Poverty Line (OPL), which is an absolute poverty line constructed by the DCS using the cost of a basket of basic needs. The basket consists of food items that are required to meet the minimum nutritional intake (2,030 kilocalories) and other non-food basic needs. This translated into a poverty line of Rs. 3,781 per person per month at the end of 2013, and accordingly, the persons whose expenditure fell below this level are considered as poor.

Poverty measurements inadequate

Poverty is multi-dimensional, and therefore, reliance on a single point indicator such as the OPL to measure the country’s poverty level may lead to misleading conclusions. The monthly income threshold of Rs. 3,781 (which is around a daily expenditure level of Rs. 126 or one dollar) may not be sufficient to meet the basic requirements. In broader terms, access to health, education and transport facilities also have a bearing on the incidence of poverty. Poor people living in rural areas have less access to such facilities. Therefore, the poverty profiles based on the narrowly defined poverty lines should be interpreted with much caution.

The most frequently used headline indicators to elaborate economic progress and poverty reduction are the rate of growth of Gross Domestic Product (GDP) and the level of per capita GDP. They too have many weaknesses as indicators of quality of life though they are quoted very often in policy documents and public debates.

Poverty levels underestimated

A closer analysis of HIES data reveals disturbing trends with regard to the gap between the rich and the poor. The average monthly per capita income of the poorest 10 per cent of the population was only about US$192 in 2012 according to the HIES, representing less than one fifth of the country’s per capita GDP stood at $2,922. Accordingly, their average daily per capita income amounted to only $0.53 which is much lower than the globally accepted poverty threshold of $1.25 a day. Even the next upper decile group’s average per capita income was only $ 0.98 indicating at least 20 per cent of the population lives below the global poverty line.

At the other extreme, the richest 10 per cent of the population received a much higher average per capita income of $4,283, giving rise to a daily per capita income of nearly $12. The extent of the income disparity can be understood by the fact that the poorest 20 per cent of the population receive only 4.9 per cent of the total income while the richest 20 per cent enjoy an exorbitant income share of 53.2 per cent.

Raising per capita income as a key goal Per capita GDP is frequently used in official documents in synonymous with social well-being and poverty reduction. The Central Bank in its annual Road Map claims that the rise in the country’s per capita income to $3,280 in 2013 is a major achievement of the government, and the Bank warns us to “prepare for $4k ahead!” That is the kind of sensational feeling attached to per capita GDP.

Meanwhile, doubling the per capita income between 2011 and 2016, and achieving a per capita income level of $7,000 by 2020 are envisaged as the key goals of the government, according to the Ministry of Finance and the Central Bank. For this purpose, an annual GDP growth rate over 8 per cent is targeted for 2015 and beyond.

Only a portion of GDP goes to households. According to the UN System of National Accounts, GDP is distributed among five sectors in an economy: non-financial corporations, financial corporations, government units, non-profit institutions and households.Thus, the entire GDP does not go to the household sector contrary to the popular belief.

In 2012, the gross income shared by households out of GDP by way of wages, rent, interest, dividends and subsidies amounted to Rs. 4,743 billion. Of that amount, a sum of Rs. 518 billion was absorbed by the government through indirect taxes. Also, a sum of Rs. 155 billion had to be given to foreigners as profits and dividends, and a further sum of Rs. 2.5 billion was paid to foreigners as their salaries. Leaving aside these negative components, the net income received by households out of GDP was Rs. 4,070 billion.

In GDP computations, however, factor incomes paid to foreigners are included, and therefore, per capita GDP is an overestimation as that part of income does not go to locals. This was rectified by the previously popular measurement of Gross National Product (GNP) by excluding such incomes going out of the country.

Based on these estimates, per capita income in 2012 was only $1,569 in contrast to a much higher per capita GDP figure of $2,922 for the same year.

Thus, the amount of household income accounts for only about one half of GDP. This shows the inaccuracy in using per capita GDP as an indicator of quality of life and poverty reduction.

The picture is even worse when comparing per capita GDP as against per capita income derived from the household surveys. Per capita income derived from HIES for 2012 is only $1,122 representing only 38 per cent of per capita GDP at $2,922. This ratio continuously fell from 47 per cent in 2005 to 44 per cent in 2007 and to 40 per cent in 2009 reflecting a declining trend in the share of household income.

Per capita GDP – an imperfect indicator of social well-being Per capita GDP suffers from many shortcomings as an indicator of people’s quality of life, though it is widely used in professional circles as well as in political platforms to show the economic progress of the country. Quality of life could be defined as the degree to which the objective needs of an individual are met in relation to the subjective perception of well-being.

What is wrong with GDP as an indicator of quality of life? The root cause of the problem is the use, or rather misuse, of GDP as an indicator of quality of life, more than any fault of GDP itself. In fact, GDP was never intended to be a measure of qualiy of life. Simon Kuznets invented the measure of GDP at the request of the US government in the early 1930s to track economic activity which was badly hit by the Great Depression. Even Kuznets warned that the welfare of a nation can scarcely be inferred from a measurement of national income.

GDP adds up ‘ goods’ and “bads” together. Bads including things such as cigarette smoking and tree felling contribute to GDP. Also, GDP does not make any distinction between productive investment and wasteful expenditure incurred by the government. As a result, construction of an irrigation tank in a drought-stricken area or constructing a monumental tall tower in the middle of the city with very little or zero returns get identical treatment in GDP calculations. Both activities raise GDP, though the irrigation tank would make a significant contribution to improve the quality of life of people living in the drought-hit area. But the monumental tower may not have any positive impact on an ordinary man in the street. Nevertheless, GDP counts both activities in equal terms.

The problem is compounded if wasteful government expenditure is met by borrowed money thus, sacrificing the quality of life of future generations.

Cost escalations resulting from commissions and bribes that might be included in government investments lead to further raise GDP. Apparently, the higher the corruption, the higher the GDP growth.

Hence, a rise in per capita GDP does not necessarily imply an improvement in social wellbeing or a reduction in poverty.

Wrap-up

Poverty is currently measured by using the official poverty line which is a single point indicator. It shows a declining trend in poverty in recent years. However, alternative measurements based on income distribution reflect much higher poverty levels. Given the multi-dimensional nature of poverty, broader indicators are needed to compute the poverty ratios.

Evidently, the entire GDP does not pass on to the household sector, and therefore it is incorrect to assume that a rise in per capita GDP leads to an automatic improvement in the living conditions and poverty reduction.

Obviously, GDP growth is an essential prerequisite to raise household incomes and thereby to attain better living conditions. However, a mere growth in GDP does not necessarily reflect an improvement in social wellbeing and poverty reduction.

While recognising the vitality of economic growth in the country’s socioeconomic progress, it is important to assure that the benefits of growth are passed on to ordinary households. This is called pro-poor or inclusive growth. Otherwise, economic growth would not lead to upgrade the living conditions or to reduce poverty as in the present case.

(The writer is a former central bank official and university academic)