Inequality of Income and Wealth Distribution in Nepal Presented by Sunil Narsingh Rajbhandari Submitted for the degree of Ph.D. in Economics at Faculty of Economics University of Lugano Lugano, Switzerland Mauro Baranzini, supervisor, University of Lugano, Switzerland Heinrich Bortis, University of Fribourg, Switzerland Pietro Balestra, University of Lugano, Switzerland Lugano, March 2005 To my family ABSTRACT This dissertation focuses on the economic inequality problem in Nepal, in particular, to integrate insights from other social aspects into the distribution problems of economic resources. It consists of five chapters on income and wealth distribution in Nepal. The first Chapter presents an overview of Nepal’s history, geography, economic development, policies and problems. The aim of Chapter Two is to provide an understanding of the inequality of income for 1984 and 1996 in Nepal and to describe how income/expenditure inequality in Nepal has changed during the period 1984 and 1996. In Chapter Three we examine the inequality of wealth distribution for 1995 and 1996 in Nepal. The Chapter four continues to investigate income and wealth inequalities using decomposition methods because they provide rigorous and powerful tools for identifying the underlying structure of income or wealth, which allow for direct interpretation of the estimated contribution in terms of the inequality index – the relative contribution of a set of population characteristics and of each income factor source that may be found within household income, expenditure and wealth. Chapter Five investigates the inequality of income in the process of development in Nepal. We first examine the Kuznets’ proposition according to which ‘the degree of inequality varies systematically with the level of income per head – initially increasing as incomes rise and then, beyond some point, decreasing, with further increases in income per head’. By considering historical, structural, institutional, political and socioeconomic issues, we offer an alternative explanation of reducing economic inequality in Nepal, with an emphasis on economic development. Key words: Income, wealth, inequality, economic development, inequality indexes INTRODUCTION 1 I THE BACKGROUND AND OBJECTIVE OF THE STUDY 1 II SUMMARY OF THE THESIS 5 III THE SIGNIFICANCE OF THE THESIS 16 CHAPTER 1 17 INTRODUCTION TO NEPAL 17 1.16H INTRODUCTION 17 1.1.1 Unification and the Background of the Shah Dynasty 18 1.1.2 Post Unification Political scenario and the Rana Regime 18 1.1.3 Modern history and politics 19 1.2 GEOGRAPHICAL DIVISION OF NEPAL 21 1.2.1 The Himalayan region 21 1.2.2 The Hills 21 1.2.3 The Terai region 22 1.2.4 The river system 24 1.3 THE POPULATION 25 1.4 CASTE AND ETHNICITY 31 1.5 THE INHERITANCE SYSTEM AND WOMEN'S COMMAND OVER RESOURCES 34 1.6 SOCIALISATION PATTERNS OF THE MALE AND FEMALE CHILD 36 1.7 RURAL SOCIETY AND KINSHIP 37 1.8 SOCIAL CLASSES AND STRATIFICATION 39 1.9 THE ECONOMY OF NEPAL 40 1.9.1 Agriculture 40 1.9.2 Non-agriculture 41 1.9.3 Income, consumption and saving 43 1.9.4 Distribution of productive assets and income 46 1.9.5 Poverty in Nepal 46 1.10 MOST RELEVANT CAUSES OF POVERTY IN NEPAL 48 1.10.1 The centrality of agriculture 48 1.10.2 The dearth of infrastructure 48 1.10.3 Low social indicators 49 1.10.4 Poor productivity of rural labour 49 i 1.10.5 Early stage in industrialisation 50 1.10.6 Late start in economic development 50 1.10.7 The unstable new democracy 51 1.10.8 Poor governance and increasing allegations of corruption 51 CHAPTER 2 52 THE CHANGING INCOME INEQUALITY IN NEPAL (1984-96) AND ITS COMPARISON WITH OTHER COUNTRIES OF SOUTH ASIAN ASSOCIATION FOR REGIONAL COOPERATION (SAARC) 52 2.1 INTRODUCTION 52 2.2 TOOLS OF ANALYSIS 53 2.3 THE LORENZ CURVE 54 2.3.1 The features of the Lorenz curve 56 2.3.2 The axiomatic approach 59 2.4 INEQUALITY MEASUREMENTS 61 2.4.1 The Gini coefficient 61 2.4.2 The Kuznets index 63 2.4.3 The Theil index 64 2.4.4 The Atkinson index 66 2.4.5 The variance of logarithms 70 2.4.6 Champernowne’s index 71 2.5 SENSITIVITY OF SELECTED INEQUALITY MEASUREMENTS 71 2.6 MEASURING THE TREND OF INCOME INEQUALITY IN NEPAL 82 2.7 MEASURING THE TRENDS OF INCOME INEQUALITY IN OTHER SAARC NATIONS 87 2.8 MEASURING INEQUALITY TRENDS IN BANGLADESH 1981-96 88 2.9 MEASURING INEQUALITY TRENDS IN INDIA 1981-96 96 2.10 MEASURING INEQUALITY TRENDS IN PAKISTAN 1985-97 106 2.11 MEASURING INEQUALITY TRENDS IN SRI LANKA 1980-95 113 2.12 COMPARISON OF NEPALESE INCOME INEQUALITY WITH OTHER SAARC COUNTRIES 120 2.13 CONCLUSIONS 131 2.14 DATA APPENDIX 133 2.15 APPENDIX 2A 135 2.16 APPENDIX 2B 139 ii CHAPTER 3 142 WEALTH DISTRIBUTION IN NEPAL 142 3.1 INTRODUCTION 142 3.2 AN OVERVIEW OF NEPAL LIVING STANDARD SURVEY (NLSS) 1996 143 3.3 WHAT ARE THE COMPONENTS OF NEPALESE FAMILY WEALTH? 146 3.3.1 The value of dwellings 147 3.3.2 The value of land-holdings 148 3.3.3 The value of enterprises 149 3.3.4 The value of farm assets 149 3.3.5 The value of durable goods inventory 150 3.3.6 The value of live-stocks 150 3.3.7 Credit and savings 151 3.3.8 The value of other assets 151 3.4 NEPALESE WEALTH COMPARISON WITH INDUSTRIAL COUNTRIES 152 3.5 RURAL AND URBAN HOUSEHOLDS IN NEPAL 153 3.6 WEALTH DISTRIBUTION IN URBAN AND RURAL NEPAL 154 3.7 THE HOUSEHOLD WEALTH STRUCTURE IN RURAL AND URBAN NEPAL 155 3.8 THE HOUSEHOLD WEALTH DISTRIBUTION IN DEVELOPMENT REGIONS OF NEPAL 161 3.9 THE HOUSEHOLD WEALTH STRUCTURE IN THE DEVELOPMENT REGIONS OF NEPAL 163 3.10 THE HOUSEHOLD WEALTH DISTRIBUTION IN THE ECOLOGICAL REGIONS OF NEPAL 166 3.11 THE HOUSEHOLD WEALTH STRUCTURE IN THE ECOLOGICAL REGIONS OF NEPAL 167 3.12 THE HOUSEHOLD WEALTH DISTRIBUTION OF RELIGION GROUPS OF NEPAL 169 3.13 THE HOUSEHOLD WEALTH STRUCTURE OF RELIGION GROUPS OF NEPAL 172 3.14 THE HOUSEHOLD WEALTH DISTRIBUTION OF ETHNIC GROUPS OF NEPAL 175 3.15 ETHNIC GROUPS OF NEPAL AND CAUSES OF THEIR WEALTH INEQUALITY 181 3.15.1 The Nepalese 181 3.15.2 The Newar ethnic group and causes of their wealth inequality 182 3.15.3 The Mongoloid ethnic groups and causes of their wealth inequality 183 3.16 CONCLUSION 187 iii CHAPTER 4 189 DECOMPOSITION OF INCOME, EXPENDITURE AND WEALTH INEQUALITY BY POPULATION CLASS AND SOURCES IN NEPAL 189 4.1 INTRODUCTION 189 4.2 BACKGROUND INFORMATION ON THE NLSS (1996) AND HCSRN (2001) DATA 191 4.2.1 Income and expenditure data for 1996 from NLSS 191 4.2.2 Income/expenditure data for 2001 from the HCSRN 194 4.3 A REVIEW OF INCOME AND CONSUMPTION INEQUALITY IN NEPAL 198 4.4 THE DECOMPOSITION OF INEQUALITY BY POPULATION SUBGROUPS 202 4.4.1 Decomposition of the Gini coefficient 202 4.4.2 The models for the Gini decomposition 203 4.4.3 The decomposition of the Theil indexes 204 4.5 MAIN FINDING OF THE DECOMPOSITION BY POPULATION SUBGROUPS 205 4.5.1 The decomposition analysis for the inequality of expenditure, income and wealth in 1996 205 4.5.2 The decomposition analysis of the inequality for rural Nepal 1996 and 2001 212 4.6 DECOMPOSITION BY INCOME COMPONENTS 215 4.7 THE DECOMPOSITION OF INEQUALITY BY INCOME SOURCES AND COMPONENTS OF EXPENDITURE 218 4.8 CONCLUSION 226 APPENDIX 4A 228 CHAPTER 5 231 INCOME INEQUALITY AND ECONOMIC DEVELOPMENT 231 5.1 INTRODUCTION 231 5.2 GROWTH AND INEQUALITY – A BRIEF HISTORY OF THE THEORIES OF GROWTH AND DISTRIBUTION 232 5.2.1 The effect of growth on distribution 237 5.2.2 Empirical evidence: Kuznets’ hypothesis 239 5.2.3 The recent empirical studies 240 5.3 A CASE STUDY OF INCOME DISTRIBUTION AND DEVELOPMENT FROM THE LOW INCOME COUNTRIES 242 5.4 TESTING KUZNETS’ HYPOTHESIS 246 5.4.1 A trade-off between income inequality and growth 249 iv 5.4.2 A trade-off between income inequality and the demographic transition 249 5.4.3 A trade off between income inequality and education 249 5.4.4 A trade off between income inequality and labour force shift 250 5.5 OUR EMPIRICAL RESULTS 251 5.5.1 The results from the case study of Nepal 252 5.5.2 The results from the case study of the South Asian nations 256 5.5.3 The results from the case study of the world (ca 1988 and 1993) 260 5.6 CONCLUSION 264 CHAPTER 6 265 CONCLUDING REMARKS 265 6.1 METHODOLOGY USED IN THIS STUDY AND FUTURE PERSPECTIVES 265 6.2 ON SOME EMPIRICAL RESULTS OBTAINED 269 6.3 EPILOGUE 271 REFERENCES 272 v INTRODUCTION I The Background and Objective of the Study This dissertation is a study on the inequality of income, expenditure and wealth distribution in Nepal. A number of recent economic theories postulate that inequality might be necessary to generate extra savings required for fast growth. A number of new studies published in the 1990s have found a negative relationship between inequality and growth (see Alesina and Rodrik, 1994, Persson and Tabellini, 1994, Clarke 1995 etc). Deninger and Squire (1996) found a negative relationship between the unequal distribution of assets and growth. Aghion and Bolton (1991) have examined the effect of wealth inequality on growth in the presence of imperfect capital markets. In this latter context, poor people are liquidity constrained; which leads to a more unequal wealth distribution.