Macroeconomic Determinants of Income Inequality in Sri Lanka

Abstract

Even though several different income redistribution plans have been put in place by succeeding governments, income disparity has persisted in Sri Lanka over the past 50 years. Using secondary data from 1978 to 2021, this study aims to pinpoint the macroeconomic factors that contribute to income inequality in Sri Lanka. The basic estimating method is the autoregressive distributed lag model (ARDL), a rarely used analytical tool in Sri Lanka. The results show that the primary macroeconomic predictors of income inequality in Sri Lanka among the selected variables are government spending, trade openness, average prices, the share of agriculture in the GDP, and per capita GDP. Additionally, the findings demonstrate that trade openness and government spending cause income inequality, supporting Barro's theory. Additionally, the average price level and the percentage of agriculture in the GDP have helped to lessen income disparity in the nation. Per capita GDP also shows a marginal significance, supporting Kuznets’ view, which stresses that increasing a country’s GDP increases inequality. However, financial deepening and secondary school enrolment ratios do not show significant impacts emphasizing that financial and education factors do not contribute to inequality in the Sri Lankan setting. The study suggested that policy priority should be given to developing the agricultural sector and catching the spillover effect of international trade to reduce income inequality. That would ultimately lead to lowering trade-induced inequality. Furthermore, a crucial policy choice to lower the expense of daily life for the poor is to maintain a constant overall price level. Government transfer programs should primarily target the poor and maintain a proper monitoring mechanism to capture the outcome of those transfers also important. Currently, such a follow-up system is not in place; therefore, the government’s targets of reducing inequality couldn’t be realized to the fullest.