Why Is Poverty Declining So Slowly in India?

Ashok Kotwal and Arka Roy ChaudhuriPrepared for IGIDR Conference Dec 1-

3, 2012.

We draw on the following

Outline• Motivating Question: Why is the poverty decline slow

(compared to other Asian countries) despite fast growth?• Possible factors driving the process of poverty decline.• Are the sectors driving growth the same as the sectors

driving poverty decline?• Changing employment picture from 1983-2009.• The role of consumption demand in the process of

poverty decline.• Reflections on development policy.

Poverty Decline in India

Poverty Elasticity of Growth

Compare India to China and Indonesia

• Greater poverty decline in China and Indonesia during the relevant 17 years period.

• Note that China’s steepest drop in poverty is during the initial phase 1980-86 when it had not yet become a manufacturing giant; it was due to agricultural productivity growth.

• Unlike India, both China and Indonesia have periods when the agricultural labor force declined significantly.

Questions to Explore?

• What drove India’s fast growth?• Why was this growth accompanied by a slow

trickle down?• Why is the process of labor movement out of

agriculture slow in India?

Structure of Indian Economy

• Most of India makes its living in the informal (unorganized) sector. In 2004-05, total employment was 457 million. Only 7% in the organized or formal sector.

• If we exclude agriculture, 83% of all non-farm employment is in the informal sector.

• Informal sector produces 58% of NDP.• Informal sector is characterized by low level of:

technology, skills, scale.• Most of the poor work in the informal sector.

Agricultural wages are inversely correlated with poverty.

Possible Sources of Poverty Decline• TFP increases in the informal sector. • Expansion (either due to an increase in TFP or due to derived

demand) of the non-farm sector (formal as well as informal) that draws labor out of agriculture increasing wages of labor remaining in agriculture.

• Income increases in any sector create demand increases inducing the resources to move to those sectors. Do these sectors employ unskilled labor?

• Education system transforms unskilled labor into skilled labor who find employment at higher wages.

TFP Increase in the Informal Sector

• Greater possibilities in agriculture: irrigation, seed improvements, diversification to dairy, poultry, horticulture etc.

• More difficult in non-farm informal: unlike the formal sector, available technology is not easy to transfer. Some exceptions such as cell phones.

• Skill accumulation, infrastructure, access to credit are crucial for productivity improvements but they depend on institutional improvements.

Formal Sector Growth and Poverty Decline

• Fruitful to examine the following conduit: Technology transfer brings about TFP increase in the formal sector that increases demand for both skilled and unskilled labor.

• We will first look at the empirical picture to understand the development process at work and then see if we can capture it in a simple model.

Growth Drivers & Employment: 1983 – 93.

Growth Drivers & Employment: 1993 – 2004.

What do we infer from the previous two slides?

• The fastest growing sectors did not create employment for the unskilled. Business Services was the fastest growing sector.

• The fastest growing sectors are typically export oriented sectors.

• Transport (13th fastest growing sector), Construction and Trade (25th and 26th fastest growing sectors) were the only sectors in 1983 that created any substantial employment for the unskilled.

• Similarly, Trade (12th) and Transport (21st) and Construction (22nd) were the creators of the unskilled labor in 1993.

Labor Movement out of Agriculture 1983-2004

Labor Movement out of Agriculture 2004-09

Changes in the labor to land ratio

Observations on Labor Movement Out of Agriculture.

• From 1983 to 2004, labor to land ratio has in fact increased in all but 4 states.

• From 2004 to 09, it decreased in most states but not enough to overcome the increase since 1983. In fact, it is a lot higher in 2009 than in 1983.

• This suggests that if there had not been TFP growth in agriculture, the wages would have in fact declined (i.e., poverty would have increased).

Elasticity of the Inverse Labor Demand Function

• 2004-09 period is encouraging but how much impact did the reduction in labor to land ratio have on wages?

• The maximum reduction in labor to land ratio took place in Bihar (12%).

• Kanika Mahajan’s estimation of the elasticity of inverse labor demand function based on NSS data is -0.3.

• The maximum increase in agricultural wages from 2004 to 2009, by this estimate, would be 4% out of the actual increase of 25% in average real wages.

What then is non-farm sector’s contribution?

• If non-farm sector had not created additional jobs, the labor to land ratio in agriculture would have been worse and the wages would have been lower.

• A counter factual would help us to gauge the relative contribution of non-farm in shoring up the wages and hence in reducing poverty.

• See the next figure.

Agricultural Sector Development

• Indeed, the yields have gone up between 2004 and 2009.

• Partly, it may be due to an increase in irrigated land.

• Yield increases have also played a significant role in the increase in agricultural wage.

Employment Share of Different Sectors1983 to 2009

Model

Results

Qualifications

• Indian economy is not exactly a small open economy.

• Domestic demand composition matters• Non-traded goods and services form a large part

of the economy.• Is it possible that those whose incomes are

growing fast have low income elasticities for the sort of goods and services that the poor (unskilled) can produce?

Consumption Pattern across Income Groups

Consumption of Food grains & Other Unprocessed Foods

Expenditure on Informal and Formal Sector Output

Income Elasticities

• The income elasticities in the descending order of magnitude are: Formal sector output, Group#2 (dairy, horticulture, poultry etc), Informal sector output (excluding agriculture), and then Group#1 (food grains and pulses).

• Group#2 shows most potential for trickle down.

Educational Premia

• Q: Is there continuing excess demand for skilled workers?

• For the 34-42 cohort, the educational premia for those with middle school education and graduates over those with no education were Rs. 96 and Rs. 224 in 1983. These premia had risen to Rs. 197 and Rs. 696 in 2004. (Eswaran et al (2009)).

• We have yet to carry out this exercise for 2004 to 2009.

Defining skilled?

• Of course, years of education is an imperfect indicator of the level of skills.

• ASER (Annual Status of Education Report, 2010) reports that 47% of class 5 children could not read a simple Class 2 level text. Even in Class 8, 17% of children could not read a class 2 level text.

Conclusions

• Too small a part of the labor force is truly skilled. (Educational premium increasing)

• Growth spearheaded by skill intensive sectors.• Any possibility for TFP increase in the informal

sector is dependent on local institutions whose transformation will take a long time.

• TFP growth in dairy, horticulture, poultry etc will have a direct positive impact on the poor.