Do public and internal debt cause income inequality? Evidence from Kenya.
| Autor | Obiero, Wilkista Lore |
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Introduction
The question of how income should be distributed, and what level of inequality is acceptable in society has been pondered upon by many economists. Some argue that income ought to be distributed according to the contribution provided by the income earner so that more productive people earn higher than less productive ones (Byrns and Stone, 1989, p. 591). Another argument that is put forward by Karl Marx (1818-1883) is that distribution should be done according to people's needs although this view has received sharp criticism for its tendency to encourage laziness. Others yet believe that income should be distributed equally among all individuals, and this too has been criticized as being likely to reduce productivity in the society (Conrad, 2016). The Greek philosopher Plato argues that income distribution should ensure that the income of the richest person should not exceed four times the income of the poorest person in society (Byrns and Stone, 1989). This is however not the case with our societies today where some people are extremely wealthy while others cannot even afford the necessities of life like proper food and shelter.
Some form of inequality, whether in income or labour, exists in every economy. This may result from the ability of some people to perform some tasks better than others, work longer, take risks, warranting higher payments (Schmidt et al., 2015 and Checchi et al., 2017). Differences in education and skills also qualify people into different job groups (van Damme, 2014), in addition, some people inherit wealth while others do not (Elinder et al., 2018). Economists have different views on how this existing inequality level should be handled [1].
According to theoretical views, one of the macroeconomic variables that explain income inequality is debt. This relationship, however, is not straightforward. Productive use of debt could lead to a reduction in inequality levels (You and Duttf, 1996) while high debt values could lead to volatility of income and as a result increase inequality (Azzimonti et al., 2014). The direction and impact of this relationship, therefore, varies from country to country depending on their macroeconomic policies (Anselmann and Kramer, 2016).
The redistributive theory states that an increase in internal debt will lead to an increase in inequality levels in an economy. Internal debts are held in the form of government securities, coupled with the fact that the government securities have relatively high prices, it is only the rich who can purchase the bonds. Consequently, when debt is serviced, it is the rich class of bondholders who again receive interest from the debt amounts. Being that debt servicing is achieved through taxation, resources end up being transferred from the poor to the rich bondholder class. The redistributive theory forms the main motivation of this study since there is little attention given to analysing the effect of debt on income inequality, a gap which this study seeks to fill. The main hypothesis of this study is to ascertain the impact of high values of debt on income inequality level as stated in the debt redistribution theory.
There are limited studies on this topic, but to the best of our knowledge, none of them examine the Kenyan economy. Debt-inequality nexus is a peculiar phenomenon for every country and the current study will be specific to Kenya. In this study, the effect of internal and public debt on income inequality is examined by using ARDL Method for the 1970-2018 period in Kenya. After determining the long-term relationships between variables, Toda Yamamoto Causality tests are also conducted to ascertain the existence of causality relationships between debt and inequality. The rest of the study will be divided as follows: the next section will provide theoretical and empirical background on the study, followed by the methodology and data section while the last section is where the results, conclusion and policy recommendations will be provided.
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Literature review
2.1 Theoretical background
In a bid to finance expenditures, the government may resort to one or both of two options debt financing and/or an increase in taxes. The impacts of these forms of financing, most especially debt financing on the economy have been analysed by various economists. David Ricardo argues that there is no change in the national output of the overall economy when either form of financing is adopted, commonly known as Ricardian equivalence. This term was formally used by Barro (1989). The term has since been argued by economists as one of the theoretical views on public debt and inequality relationship. A decline in government budget deficit is offset by an increase in private savings implying no change in the national savings amount (Ricardo, 1817). This is because if there is an increase in government debt currently, the forward-looking consumer increases their savings as opposed to increasing their consumption to cater for possible future increases in taxes. The increase in savings can then be spent in the bonds market further increasing government debt. It is the rich in the society who often save as compared to the poor who are likely to channel the increase in disposable income to consumption. The implication is that government borrows from the rich but taxes both rich and poor to pay those debts. Therefore, government financing decisions may impact inequality position even though it may not impact output as postulated by Ricardo.
Another explanation for the theoretical relationships between domestic debt and inequality is that domestic debt causes income redistribution. According to this theory, internal debt causes income redistribution in the economy since the people who purchase government bonds and treasury bills are the rich while during repayment, the burden of repayment lies on the entire tax base. This implies that during the debt repayment process, although rich people also pay tax, they receive interest rates from their treasury bills and bonds thus gaining more income. Through this process, the rich lenders become richer while the poor become poorer thereby increasing the inequality gap (Alesina and Tabellini, 1987; Elmendorf and Mankiw, 1998, p. 8; Mishkin, 2014, p. 438; Salti, 2015; Bohoslavsky, 2016, p. 189). This effect, however, may not be experienced in the short run because most rich people are highly dependent on capital income while the poor rely mostly on income from labour. When a debt crisis occurs due to a high amount of debt in the economy, a decline in output is likely to be experienced implying a reduction in both capital and labour incomes. In the long run, however, the capital income owners receive compensation for their capital making them richer while the poor are not compensated and tend to become poorer.
The direction of the relationship between debt and income inequality can also be from inequality to debt (Kumhof, 2015; Bohoslavsky, 2016, p. 183). With inequality, there is an existing possibility of reduced future consumption and so private investors seeking to maintain their present consumption into the future will purchase government securities when they are issued. The demand for government bonds thus increases. Through elections and exercising of democratic rights, the government is forced to issue more bonds implying higher public debts. Inequality thus triggers both the demand and supply of bonds. The rich vote for the bonds and treasury bills because it is a safe way of keeping money and ensuring continued consumption. The poor keep voting because of reduced international interest rates which are attractive to them.
2.2 Empirical literature review
Much of the current literature on inequality pays particular attention to the relationship between inequality and economic growth. Similarly, a considerable number of empirical studies on debt and economic growth have been conducted. However, the studies on the relationship between debt, both public and internal, and income inequality are quite limited. These studies are summarized in Table 1.
Sakkas and Varthalitis (2019) and Tung (2020) ascertain that public debt harms inequality for countries in the Euro Area and Asia -- pacific region respectively. These studies taken together suggest that governments may use public debt as a means of reducing inequality. However, Akram and Hamid (2016) analyse the impact of internal debt and external debt separately. The study concludes that only internal debt reduces inequality, whereas external debt has no impact on inequality. The study finds no statistically significant difference in the impact of external debt on the rich and the poor in South Asian economies.
Country-specific studies include Akram (2013) and Farid et al. (2016) who provide an analysis on how external debt impacts inequality levels in Pakistan. The former study uses the OLS method while the latter uses the ARDL method of analysis. Both studies find that external debt is not pro-poor as they prove the existence of a positive relationship between external debt and income inequality in Pakistan. Sayed (2020) and Topuz (2021) find a positive impact of domestic debt on income inequality in Lebanon and Turkey respectively. In a study conducted for Turkey, Arslan (2019) proves the applicability of the redistribution effect in Turkey. The results from this study indicate that there is an improvement in income inequality levels in the country when public borrowing reduces.
Some of the panel studies that have considered the inequality and debt relationship for both developing and developed economies belong to Prechel (1985), Arawatari and Ono (2015), Salti (2015), Tibi (2015), Detzer (2016) and Sezgenc (2019). Detzer (2016) uses financialization to explain the differences in debt and inequality for developed and developing economies while Prechel (1985) explains that the insignificant debt and inequality relationship in...
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