University of Groningen Essays on socio-economic development

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University of Groningen Essays on socio-economic development

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University of Groningen
Essays on socio-economic development in India Pieters, Janneke
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Publication date: 2011 Link to publication in University of Groningen/UMCG research database
Citation for published version (APA): Pieters, J. (2011). Essays on socio-economic development in India. University of Groningen, SOM research school.
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Introduction

Given the complexity of the process of economic development, improving our understanding of that process often requires more detailed analysis than aggregate crosscountry comparisons allow. The microeconomic analysis of development has become increasingly popular as more and more reliable firm- and household-level data have become available for developing countries. There is a trade-off, however, between depth and width; at least for the individual researcher. The four empirical analyses in this dissertation, therefore, focus on economic development in one country: India.
With a population of more than one billion, India is the world’s second largest country and largest democracy. After a fiscal crisis in 1991 the country underwent widespread liberalization reforms, including deregulation of the industrial sector and liberalization of international trade and capital flows. Though the debate on the ultimate cause of India’s growth acceleration has not settled yet (e.g., Basu, 2008), the economy has grown increasingly fast since the early 1990s (Figure 1).

Figure 1 - Economic growth in India (real GDP per capita, %)

12 GDP per capita growth rate,

10

3-year moving average

8

6

4

2

0

-2 Source: Penn World Tables 7.0 (Heston et al., 2011)

Underneath India’s remarkable growth performance, however, lie a number of socioeconomic developments that are less rosy. Persistently high growth in gross domestic product (GDP) is bound to be accompanied by substantial structural changes within the economy, which altogether constitute the development of a country. Rising inequality and growing informalization of the labor force, for example, define India’s development as

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least as much as its fast GDP growth. Due to such underlying processes, GDP may be a poor measure of the progress perceived by a country’s population. This discrepancy has received much attention since the report on measuring economic performance and social progress by Stiglitz, Sen, and Fitoussi (2009). They stress, for example, that with rising inequality many people may not find their situation improving despite fast economic growth. Inequality in India has not risen so much as to make the poor even worse off, but the rich are undeniably benefitting more than the poor. This is illustrated in Figure 2, which shows the long term trend, with recent increase, in inequality of consumption as measured by the Gini index.

Figure 2 - Inequality in India: trends in rural and urban Gini Index

Note: The lines show predicted Gini indices of consumption expenditure after controlling for differences in surveys. Source: Copy of Figure 5 in Datt and Ravallion (2009).
This thesis consists of four studies on inequality, female labor force participation, and the informal sector, focusing on India over the past two high-growth decades. These topics are key research areas in the field of development economics, and the following sections give some broader background to chapters 2 through 5, as well as summaries of the main findings.
1.1 Inequality In the seminal work of Kuznets’ (1955), he hypothesized an inverted U-shaped
relationship between growth and inequality. His prediction was based on the importance of industrialization and urbanization in the process of growth, encompassing a shift of the

Introduction

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population from a low-income-low-inequality traditional sector to a high-income-highinequality modern sector. Similarly, in the work of Marx and in Lewis’ (1954) surplus labor model, economic development was characterized as the shift from traditional (agriculture) to modern (industry) production. More explicitly than Kuznets, they focused on the distribution of income between laborers and capitalists and emphasized that growth will be inegalitarian in the early phases of development, as the income share of capital owners increases at the cost of workers’ income share. Reflecting these views, the early policy-oriented development literature called for labor-intensive growth as a way to secure equitable development (e.g. Adelman, 1975). More recent studies have also emphasized the equalizing effect of growth in labor-intensive industries (Ravallion and Datt, 1996; James and Khan, 1997).
An important limitation of these analyses is that they fail to account for inequality among owners of the same factor (Atkinson and Bourguignon, 2000), notable inequality among workers. Since the largest part of household’s income consists of remuneration for labor, earnings inequality is a major component of total income inequality, which is to a large extent due to differences in educational attainment. A key factor in the relationship between education and earnings inequality is the returns to education, which depends on both the demand and supply side of the labor market. This goes back to Tinbergen’s (1975) notion of the race between technology (increasing the demand for skilled labor) and education (increasing the supply of skilled labor). In recent research, models of international trade and skill-biased technological change have been developed to explain the rising returns to education observed all around the world (Goldberg and Pavcnik, 2007): the relative demand for skilled labor rises with the growing importance of skillintensive industries and greater skill-intensity within industries.
Educational endowments of the population also determine earnings inequality. Due to the increasing convexity of the education-earnings relationship, that is, the marginal returns to education are higher and rise faster at higher educational levels, a rise in the average level of education can lead to higher earnings inequality (Bourguignon et al., 2005). Furthermore, growth in the average level of education is often accompanied by deterioration in the distribution of education itself, which also raises earnings inequality.
In addition, education has indirect effects on inequality, through fertility and labor market participation choices (Ram, 1989). Ram concludes there is no encompassing theory that provides a clear prediction of the relationship between education and income inequality. Much depends on characteristics of the labor market and wider social and

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political processes. Unsurprisingly, De Gregorio and Lee (2002) find that education explains very little of cross-country differences in inequality. According to Kanbur (2000), there is a need for thorough analysis through case studies, which can give a detailed characterization of the development process and of inequality itself.
The aim of the research in chapters 2 and 3 in this thesis is to improve our understanding of the relationship between education and inequality through in-depth analyses of the Indian case. At the macroeconomic level, the main question is how education and inequality relate through the sectoral structure of growth, given the skillintensity of industries (chapter 2). At the microeconomic level, the focus is on the impact and relative importance of direct and indirect effects of growth in the average level of education, changes in educational distribution, and increasing returns to education (chapter 3).

Figure 3 - The structure of GDP (% shares)
100%
80%
60%
40%
20%
0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: World Bank World Development Indicators

Services Indus try Agriculture

As illustrated in Figure 3, the share of agriculture in India’s GDP is declining, mirroring the increasing importance of the services sector, while the share of manufacturing and other industry has remained more or less constant around 27 per cent of GDP. In chapter 2, I analyze how the sectoral structure of growth affects inequality, based on India’s 2002-03 Social Accounting Matrix (SAM). Value added in a given sector of the economy is divided between the production factors employed in this sector, and flows to households that own these production factors. As different sectors employ different production factors and households differ in terms of their factor ownership, the sectoral structure of growth affects the distribution of income between households.

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Whereas previous research has shown that growth in labor-intensive industries is more equalizing (or poverty-reducing) than growth in capital-intensive industries (e.g., James and Khan, 1997; Loayza and Raddatz, 2010), I extend the focus of analysis by taking three different education levels of workers into account. Beyond the division between capital and labor, the value added share of workers is further divided between the low-, medium-, and high-skilled.
For each industry, an exogenous ten per cent increase in final demand is simulated to trace the effect on income of different household groups and different types of workers within each household group in the SAM. The results show that growth of community, social and personal services increases inequality, and to a lesser extent so does growth of heavy manufacturing and other services sectors. Only agricultural growth reduces inequality, because the value added flows mainly to unskilled agricultural workers, who are initially poorest. But the actual pattern of Indian growth has been skewed towards services.
An important implication of this analysis is that the skill-intensity of growth matters more for inequality than the labor-intensity of growth. That is, employment generation as such will not secure equitable growth, because what really matters is jobs for the lowskilled labor force. This is especially critical for India, which has one of the most unequal education distributions in the world.

In chapter 3, the link between education and inequality is further explored at the micro level. Using household survey data for 1993-94 and 2004-05, I carry out a regressionbased decomposition analysis (Bourguignon et al., 2008) of changes in household consumption inequality and ask how education has contributed to rising inequality during this period. One question is whether rising returns to education in the labor market, which have increased wage inequality (Kijima, 2006), have also translated into rising household inequality. I find that this is not the case, since a large share of households depends on selfemployment income and among these household, returns to education have not contributed to rising inequality. In many developing countries a large share of the labor force is selfemployed, and these workers are often not covered by analyses of earnings inequality. This finding for India therefore has the more general implication that the education-earnings inequality relationship may give a poor indication of the overall education-household inequality relationship, because the self-employed are often not accounted for in the former.

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A second question is whether changes in the average level and distribution of education itself have contributed to higher inequality. Though education of the population is rising in India, with the adult literacy rate up from 48 per cent in 1991 to 63 per cent in 2006, educational inequality remains high. My analysis shows that inequality of education has increased, because educational progress has been relatively slow at the bottom of the education distribution. This increased educational inequality contributes to higher consumption inequality between households, especially in rural areas, where it is even reinforced through the effect of education on fertility: women with higher education tend to have fewer children, so among initially richer households, where women’s education levels rise faster, the decline in number of children is larger. Another conclusion in chapter 3 is, therefore, that the distribution of education is worsening and this constitutes an important ingredient of India’s rising consumption inequality. Reducing illiteracy will therefore be crucial to fight both consumption inequality and inequality of education itself.

1.2 Female labor force participation The rise of women’s labor force participation is one of the most significant global
developments of recent decades. This rise has occurred in a context of major changes in labor markets due to ongoing globalization and flexibilization of production. Especially in developing countries, where much of the labor force is not covered by labor legislation and social security, it is important to understand what drives women’s labor force participation. Does it reflect increased opportunities and empowerment of women, or are women pushed into the labor force by growing labor market insecurity, essentially reflecting deterioration in the labor market position of men?
A prevailing hypothesis in the development literature is that female labor force participation declines in the early stages of development and starts to rise only in later stages. This “feminization-U” hypothesis appeared first in Sinha (1967) and Durand (1975), and was later formalized with a theoretical model by Goldin (1994). In early stages of development, employment opportunities for women decline as the agricultural sector contracts and women’s education levels remain low. At the same time, men’s earnings increase as their education levels increase and they enter the industrial sector, which increases household incomes and thereby removes the need for female employment. Furthermore, social norms often work against women participating in manual work outside the household. With further economic growth, women’s education rises as well, while demand for white-collar workers increases with the expansion of the services sector.

Introduction

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Higher wages and socially acceptable types of non-manual work lead to higher female labor force participation. Rising participation rates thus reflect an improvement in women’s situation as their social position and earning opportunities increase with economic growth.
An opposing view, however, is the theory of women’s participation functioning as an insurance mechanism for households (Attanasio et al., 2005). In this view, global workforce feminization is the result of growing insecurity, pushing women into the labor force out of necessity (Standing, 1999). Especially in developing countries this could drive women’s employment, where poor households have few other means of insuring against income shocks and where the informal sector facilitates temporary work spells. Recent empirical research has shown that in Latin-American and Asian countries, female labor force participation is counter-cyclical, in line with the insurance theory (Bhalotra and Umaña-Aponte, 2010).
The aim of chapter 4 is to contribute to the debate on female labor force participation using individual level survey data for India, to determine what has driven women’s participation during India’s economic boom. On the one hand, attractive opportunities resulting from the country’s remarkable economic performance may be expected to draw women into the labor force. But on the other hand, flexibilization and insecurity are beyond doubt important features of the Indian labor market, so push factors may well be driving women’s employment.
Despite persistently high growth rates, the female labor force participation in India remains rather low, but started to rise after 1999-2000. Besides a detailed description of trends in participation and earnings in urban India, chapter 4 includes an econometric analysis of the determinants of women’s participation at the individual level. As in the preceding chapters, there is a special focus on education, with particular attention to differences between lowly and highly educated women.
While women’s participation in urban India started to increase, real earnings stagnated or even declined between 1999-2000 and 2004-05. Women with less than secondary education joined the labor force predominantly as domestic servants and as self-employed workers in the garments industry, which are occupations characterized by vulnerability and low and volatile earnings. The picture for highly educated women looks somewhat better, as their employment also grew in activities such as adult education and software consultancy. Given India’s skill-intensive growth pattern it is not surprising to find more attractive labor market opportunities for the highly educated minority.

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To what extent is participation of women induced by declining income of her household members and increasing insecurity in the labor market? We estimate a probit model of participation in paid employment to answer this question, and compare the behavior of lowly and highly educated women. The most important result is that only highly educated women are more likely to participate in paid employment when their expected wage increases. On the contrary, the expected wage has no effect on participation of lowly educated women. Rather, economic push factors and the social status of the household determine her participation.
All in all, this chapter conveys that for India’s lowly educated women, rising participation is not the outcome of improving labor market opportunities drawing women into the labor force. Instead, participation is determined by economic necessity and social restrictions, and should therefore not be considered a sign of increasing empowerment and improved economic position of women. Only for the highly educated minority of women in urban India there is evidence that they respond to attractive employment and earnings opportunities.

1.3 The informal sector A final aspect of development analyzed in this thesis is the informal sector. The
informal sector became an important topic within development economics in the early 1970s, when the focus of development strategy shifted from GDP growth to employment generation. It was observed that in many developing countries there was chronic unemployment and a large group of working poor: adults forced to find some means of livelihood in the absence of unemployment benefits and social security. Studies within the International Labor Organization (ILO) World Employment Program launched in 1969 drew attention to this dualistic nature of the urban economy. Nowadays, the informal sector still plays a crucial role in developing economies, employing the largest part of the labor force and accounting for a sizable share of output. But the term informal sector is not only used to refer to the working poor. A recent report on the informal sector (ILO and WTO, 2009), gives an instructive overview of three widespread schools of thought on the informal sector: dualism, legalism, and structuralism.
The dualist view considers the informal sector an inferior segment of the urban labor market, without direct links to the formal sector. It is the product of the structural transformation of development, from predominantly agricultural to industrialized along the lines of Lewis (1954) and Harris and Todaro (1970), absorbing workers who cannot find

Introduction

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employment in the formal sector. With development, the informal sector will ultimately disappear as formal sector growth generates enough employment.
Structuralists, on the other hand, stress the interdependence between the informal and formal sector. The former, consisting of small firms and unregistered workers, supplies cheap inputs and provides access to a flexible pool of workers to the latter, improving formal firms’ competitiveness. According to this view, the informal sector is not likely to disappear with economic growth. Especially in a context of globalization and flexibilization of production, and strict regulation of formal sector production and employment, formal-informal production links are inherent to development (Moser, 1978; Portes et al., 1989; Ranis and Stewart, 1999).
According to the legalist view, finally, the informal sector consists of microentrepreneurs who are informal by choice as long as the costs of formality exceed the benefits. Reducing the costs of formality, such as taxes, would therefore reduce informality, as more entrepreneurs would chose to operate formally (see Fields, 1990; Maloney, 2004).
In several Latin American and Asian countries, economic growth has been accompanied by persistently high or even growing informality. The aim of the final chapter of this thesis is to assess how well the structuralist view of the informal sector is able to explain the persistence of informality. India has one of the largest informal sectors of the world, employing over 80 per cent of the non-farm workforce. Though the Indian economy has grown fast over the past two decades, informality has remained at its very high level. The analysis in chapter 5 is based on nationally representative survey data for Indian manufacturing, using different measures of production linkages between the formal and informal sector and taking into account that only a part of the informal sector is likely to be engaged in these production links. This latter aspect is important as is it increasingly realized that the informal sector itself consists of multiple segments, such that different views are likely to apply to different segments within the informal sector (Fields, 1990; ILO and WTO, 2009; Günther and Launov, 2011). Little is known, however, about which informal activities have production links with the formal sector, and especially how much these linkages matter for the evolution of informality.
In Indian manufacturing, the informal sector accounted for almost 90 per cent of employment and 40 per cent of output in 2005-06. These shares have remained roughly constant throughout the post-1991 period of industrial and trade liberalization and persistently high GDP growth. Informal manufacturing in India consists of all firms
SectorEducationInequalityGrowthIndia