DETERMINANTS

OF RURAL INCOME INEQUALITY IN ETHIOPIA (The Case of

Diguna Fango Woreda)

BY:DESALEGN DAWIT

ADVISOR: MIRIKAT D. (MSC)

A senior essay proposal submitted to the department of Economics in partial fulfillment of

the requirements for the Bachural Art of Degree in Economics.

MARCH, 2019

ARBA MINCH, ETHIOPIA

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 CHAPTER ONE

INTRODUCTION

1.1. Background of the study

Income inequality has been regarded as one of the most serious problem that most countries
(both developed and developing countries) are facing today. Inequality with in most advanced,
emerging markets and developing countries is a phenomenon that has received considerable
attention. President Obama called widening income inequality has the “defining challenge of this
time” (Obama, 2014)

In 2009, 43% of the world population (3.14 bill people) have an income of less than $2.5 per
day, 21.5% of the world population (1.4 billion people) have an income of less than $ 1.25 per
day (World Bank, 2014). The combined wealth of the richest 1% will overtake that of the other
99 percent of people next year unless the current trend of rising inequality is checked (Oxfam,
2015). The richest 1% has seen their share of global wealth increase from 44 percent in 2009 to
48 percent in 2014 and at this rate will be more than 50 percent in 2019.

High and sustained levels of inequality, especial inequality of opportunities can entail large
social costs. Entrenched inequality of income can significantly undermine individual’s education
and occupation choices further inequality of outcomes does not generation the “right” incentives
if it rests on rents (Stylist, 2015). In that event individual have an incentive to divert their efforts
toward securing favored treatment and protection, resulting in resource misallocation, corruption,
and nepotism, with attendant adverse social and economic consequences.

Unequal distribution of income or wealth has been a subject of immense concern to economists
for a long time. This is because high level of income inequality produces unfavorable
environment for economic growth and development (British council, 2016). Widening income
disparities can depress skills development among individuals with poorer parental educations
background, both interms of the quantity of education skill proficiency, education outcomes of
individuals from richer backgrounds however, are not affected by inequality (Cingano, 2014).
Kumh, in 2012, said that raising inequality enables investors to increase their holding of financial

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assets backed by loans to marks, resulting in rising debt to income ratios and thus financial
fragility. The latter can eventually lead to financial crisis.

Unequal distribution of income or wealth has its effect on economic growth and leads to poverty
in Africa.It is series problem in the sub-Saharan African countries and requires immediate policy
areas possess. In a country like Ethiopia where the per-capita income is the lowest in the world
and far below one dollar per day, even a person earning the mean income would be far below
this international poverty line Economic Development and Human Services (EDHS, 2011). At
regional level, household income inequality increased on average in all regions of the developing
world except for Africa and Latin America and Caribbean. Africa is the region with the largest
average decline in inequality 7%, followed by Latin America and Caribbean, with a decrease of
5% driven by significant reductions inequality during the 2000s in the large countries of the
region(namely, Argentina, Brazil and Mexico).

According to human development report of Ethiopia (HDRE), in 2017 income inequality was
9.5% and related inequalities like inequality of education 44.3%, inequalities in life expectancy
at birth 30.2% and human inequality coefficient 28% while the proportion of the population
below the poverty line stood at 30.4% in rural area and 25.7% in urban area. Inequalities should
lead to unequal development of region in a country. Well-being of the urban population is greatly
affected by the rising price for consumers goods. The inflation rate for consumer goods was
17%.2 in 2007 and rose to 44.4% in 2008 that has significant effect on the standard of living and
poverty situation of society (Burea of Africa Affairs,2008).

In Ethiopia, there is also strong variation on the percentage share of household income or
consumption, 10% of the lowest consumed 4.1% of the income where as the highest 10%
devoured 25.6%(Ibid).

1.2. Statement of the problem

Inequality can be a signal of lack of income mobility and opportunity a reflections of persistent
disadvantage for particular segments of the society. Widening inequality also has significant
implications for growth and Marco economic making power in the hands of a few, lead to a
suboptimal use of human resources, cause investment reduction, political and economic
instability, and raise crisis risk. The economic and social fallout from the global financial crisis

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and the resultant head winds to global growth and employment have heightened the attention to
rising income inequality, (Era dabble Norris, Kalpana Kocchar, 2015).

Higher inequality lower growth by depressing the ability of lower income house to stay healthy
and accumulate physical and human capital (Galor and Moav 2012), for instance, it can lead to
under-investment in schools and are less able to go on to college. As result, labor productivity
can be lower than it will be in a more equitable world (Stieglitz, 2012).

According to Minster of Finance and Economic Development (MOFED, 2014) report of

inequality measures the gini coefficient. Ethiopia has a gini coefficient of 0.64, from these gin
coefficient for urban area is 0.37 while it is 0.27 for rural areas. It shows that there is more
inequality in urban than rural areas. Large imbalances can be challenging for macroeconomic
and lord financial stability and growth (Bernanke, 2011). Extreme inequality may damage trust
and social cohesion and thus is also associated with conflicts, which discourage investment.
Conflicts are particular prevalent in the management of common resources, for example,
inequality makes resolving disputes more difficult, see, for example bardhare (2012).

Although in Diguna Fango Woreda there is a high level of unequal distribution of resources
exists between people of Diguna Fango. For example, unequal distribution cultivated land
between them at most time these leads to be conflict (clan war) with in the woreda. This is
because most of the people are depend on agriculture and they lack sufficient knowledge of
equal distribution of wealth. However “income inequality results to discontent, violence and
corruption and as part of micro economic objectives governments give equitable distribution of
income apriority. Most studies on income inequality are conduct at the world and national level
and very little will do household level and in small woreda. There are different climatic
conditions in the woreda. To the best of the researcher's knowledge, the effect of land size
difference on rural income inequality has not been studied well in the woreda. Since this study
will conduct in a small woreda by including variables land size and demographic characteristics.
The researcher will study furthermore previous studies, about determinants of rural income
inequality at household head level.

1.3. Research Questions

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 What is the extent of rural income inequality in the Woreda?
What is the effect of land size on rural income inequality in the study area?
What is the effect of demographic characteristics on rural income inequality in the
study area?

1.4. Objective of the study

1.4.1. General objective of the study
A general objective of the study will be identify the major determinants of rural income
inequality in Diguna Fango Woreda.

. 1.4.2. Specific objectives of the study

To examine the extent of rural income inequality in the Woreda
To examine the effect ethnicity on rural income inequality on the study area
To examine the effect of demographic characteristics on rural income inequality on
the study area

1.4.Significance of the study

The study will provide essential information to bring sustainable and fair distribution of income
among residents. Identifying its determinants of rural income inequality is necessary for a
number of reasons. It will be important from the view point of fair distribution of income and to
alleviate the poverty from the society. The study will be identify main causes of income
inequality and to suggest the way to strengthen short term and long term plans to alleviate
income inequality from the society. In addition the identification of the key determinants of rural
income inequality helps policy makers with appropriate ways of intervention for controlling
income inequality.

1.6 Scope of the study

Income inequality Will be the basic problems that exist not only in Ethiopia, but also all over the
world. It is also difficult to assess the whole Ethiopia due to shortage of time and finance.It will
be focus on Diguna Fango.The factors that affects rural income inequality are :demographic
characteristics, the status of the house,the households asset ownership, income of the household,
land size and consumption expenditures of household head.

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1.7. Limitation of the study

Explicitly mentioning the limitations of the study helps to cautiously judge the findings that
come out from the analysis. Having in mind this, there will be limitations worth of mentioning
here.As the unit of analysis of these study will be households of Diguna Fango woreda So the
study will collect data only from the household heads. Hence the study will not give the
information's on others like youth groups. In addition to that the main limitation of this research
paper will use some alternative references for writing theoretical and emperical literature.Lack
of time and finance.

1.8. Organization of the study

The study will organize in five chapters.The first chapter deals about the introduction part which
include background of the study, statement of the problem, objective of the study, siginificance
of the study, scope of the study, limitation of the study and organization of the paper.The second
chapter deals about the reviewes of the related literature on relevant topics of the determinants of
income inequality.The third chapter deals about the methodology of the study.The fourth chapter
will be discussion part.In this part, the collecting data will analyze through appropriate data
analysis techniques and the last chapter contains conclusion and recommendations.

CHAPTER TWO

LITERATURE REVIEW

2.1 Theoretical literatures

2.1.1 Definition and meaning of income inequality

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Income inequality is the unequal distribution of household or
individual income across the various participants in an economy. It
is often presented as the percentage of income to a percentage of
population. For example a static may indicate that 70% of country
income is controlled by 20% of that country residents and is
considered as “unfair” if the rich have a disproportionally larger
portion of countries income compared to their population.

2.1.2 The Concept of Income Inequality

Inequality has to do with differences in the share of something

between/among two or more persons where the share of one/some is
greater than that of the others. According to Ray (1998), economic
inequality occurs when one individual is given some material
choice/resources and another is denied the same thing. Inequality
can be in income, consumption, wealth, gender, employment, health
variables and many more. But for this study we are interested in
income inequality. Income inequality is defined as the inequitable
distribution of income among the members of a particular group, an
economy or society. Income inequality can be measured generally
using the Lorenz curve, the Gini coefficient and General Entropy
class. The Gini coefficient is most frequently used measure and it is
close to the Lorenz curve. The Gini coefficient measures income
inequality based on the Lorenz curve and has values between 0 and
1 (0 and 1 inclusive) where figures closer to 0 signifies more equality

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in the distribution, values closer to 1 shows higher inequitable
distribution of income while 0 signifies absolute equality in the
distribution. Income inequality can be within the country or
between two or more countries. Some of the factors that lead to
inequality as noted by scholars are gender, globalization,
educational level and the level of technology in the country.
According to the neoclassical school, income inequality is as a result
of different productive capacity of an individual or group of
individuals and this leads to different wage levels and income levels.

2.1.3. Poverty and Inequality Linkage – Theoretical Issues

Poverty and income inequality have theoretically been identified to

be inextricably linked and that the existence of one often implies the
existence of the other (Burtless and Smeeding, 2011; Bourguignon,
2012). A better income distribution helps people of the lowest
income group to increase their income so that they can exit from
their poverty. Basic economic theories that try to explain income
and consumption are the life cycle analysis and permanent-income
hypothesis but they fail to explain inequalities in income which
affects the consumption pattern of the individuals.

Inequality can have a direct and indirect link with poverty. The
direct link is more obvious when we look at the individual.
Inequitable distribution of resources in the society hinders the

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person or group of persons affected negatively so that they will not
have enough to take care of the basic needs of life as well as care for
their children in terms of human capital development (education
and health) thus they are classified as being poor. The indirect link
between inequality and poverty are through growth, employment
among others. The link through growth is based on the notable
Kuznets‟s theory of the “inverted U shaped” relationship between
inequality and growth (although not generally accepted
empirically). At the early period of economic development where the
economy is growing and increase in inequality, those affected by the
rising inequality are classified as poor hence the negative impact of
growth on inequality also leads to an increase in poverty given that
there is a positive relationship between the level of inequality and
poverty affecting an individual or in a country.

2.1.4. Trends in inequality in Africa

1. Income and expenditure inequality

In some countries where income inequality is declined it will be

considerable amount (e.g. Gambia, Kenya, Mauritania, Tanzania
and Uganda). Another class-country study (ECA, 2009) showed a
mixed picture, with both increases and decreases in inequality.
However Uganda, Ethiopia, Mozambique and Rwanda (one of the
start significant in the1990 decades) all witnessed significant

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increases in income inequality which hampered the pace of poverty
reduction to certain extent.

2. Asset inequality

Trends in inequality using asset indicates in seven African countries

(Ghana, Kenya, Mali, Senegal, Tanzania, Zambia and Zimbabwe)
using DHS data. The analysis showed that five countries out of the
seven experienced improvements in overall inequality, and only
Zambia showed a clear increase inequality. However, four countries
showed a clear increase in urban inequality and only four countries
showed an education in rural inequality. (Booysen et al 2011).

3. Education inequality

Although figures from international agencies suggest that rural

urban and gender inequalities in education are on the decline. Only
a few institutes have focused on inequalities in education. The three
available recent studies examining trends in education are for
Kenya, (Njeru and Orodho 2010; Bedi et al. 2012; kimalu et
al.2013).

Njeru and Orodho (2010) showed that gross enrollment rates in

secondary education had declined and that gender and regional
inequalities in access to secondary education persist, with the
hardest hit regional being the arid and semi-arid lands and the
medium to low agricultural potential areas. Bedi et al (2014),

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however, showed that deposit variations in the overall GER, the
gender gap in primary education has narrowed considerably and
since 1989 has ranged between three and four percentage points.
Nevertheless the analysis also showed that regional differences in
enrollment rates are substantial 1990, the central and western
regional of the country had the highest enrolment rates at around
94% north eastern province had the lowest rate, at around 24%,
followed, somewhat surprisingly, by Nairobi at around 66%.during
the 1990s enrolment rates fell in nearly all the provinces.

4. Inequality in use of public services

Abestho study (may et al 2012) showed that in 1986, 30% of the total
population had access to safe drinking water 27% of the poor and
35% of the non-poor. By 1994, 63% of the total population had
access to safe water 55% of the poor households and for urban
dwellers. Leibbranst et al (2013), in an analysis of trends in
inequality in South Africa between(2008-2014), showed that
inequalities in access to safe water bet still remained: access
increased from 73.6% to 78.3% for Africans households over 90%
of other racial groups had access.

5. The effect of inequality

ECA (2009) investigated the rate of growth in real per capital GDP
required must the target of reducing extreme poverty by half.

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Accordingly to the results, on average real GDP of sub Saharan
Africa would need to grow at a rate of 14% per annum to meet the
target obviously, this growth rate will extremely high in comparison
with what SSA had registrar in the past three decades. Thus ECA
(23009) more are less concluded that Africa could needed a
substantial boost to its investment formation, as well as some degree
of reduction in income inequality, if it were to achieve this global
target.

6. Gender inequality

Gender inequality has far reaching consequence for any society

because it hurt not only women but also society at large. In most
parts of Africa, gender disparities in access to education, health and
labor market are common. A study by the IMF shows that gender
gap in labor market can cut GDP per capital by about 27 percent in
certain regions (Elborgh-Woytek et al 2013).

This is a significance percentage despite the common perception that

classified women is work and their contribution to society as “Un
visible” however, it is true that women apply a key role for
agricultural productivity in agrarian societies such as Ethiopia.
“Gender equality is smart economics” as stated by the World Bank
gender action plan and further described in the world development
report (WDR) on gender (World Bank, 2012). First, women’s

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economic empowerment is a global to which all poor countries
should aspire to. By respecting women right and promoting social
justice, effort can be strength and to design, target interventions and
support woman’s economic empowerment.

Ethiopia has long history of discrimination against women in social

and economic sphere through oppressive social norms and unequal
pay in labor markets, in the gender equality index by social watch
measuring the gender gap in education, and economic and political
empowerment, Ethiopia ranked 133rd out of 154 countries in 2012,
hence there is a daunting task of bridging the gender gap at various
levels of society and across many dimensions. (Harrigon et al,2012).

2.2 Empirical literatures

2.2.1 Evidences from other country.

There has been reasonable shift in research previous by focused on

economic growth and its determinates to the analysis of income
distribution, its development overtime and the identification of
factors determining it. Heshmati (2013) attributes this shift to the
awareness of the growing disparities and the emerging important of
redistribution and poverty reduction.

Since, Kuzents (1995) researchers have studied the theoretical

causes of income inequality in various ways. Kuznets starts off by
indicating that there an inverted U shape explaining the relationship

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between economic developments an income inequality. This
hypothesis will supported by De Gregorio and Lee (2007) and
Nielsen and Alderson (2009) and has been challenged by Ram (2010)
and Ravallion (2012).

Field (2009) presents a methodology to account for income

inequality levels in a given country and differences in income
inequality between one time period and another. This technique is
then applied to the US using survey for two time periods, 1957 and
1999, to analyze labor earning inequality. The technique stats off by
estimating a semi-logarithmic income generating, using OLS, which
included the following variables, gender industry, occupation,
education, race, region and experience. Field (2003) further
demonstrates the relative factor inequality might have and the
corresponding percentage contribution would be virtually the same
for any inequality measure used. The study finds that schooling is
use variable that contributes most to high level of inequality
followed by occupation, experience and gender. In explaining the
increase in inequality between the two time periods (1979 and 1999)

Schooling will again the single most important variable followed by

occupation. Gender worked in the equalizing direction.

Wan and Zhou (2005) combine the regression based decomposition

technique and the shapely value frame work developed shorrocks

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(2009) in analyzing income inequality in rural china between 1996
and 2002. The decomposition of income inequality is provided by
the Theil-land the Gin coefficient. The only equalizing variable is
land input but its impact is minimal. Baye and Epo (2011), apply the
regression-based inequality decomposition approach to explore
determinants of income inequality in Cameron using the 2007
Cameron house hold consumption survey. They use also shapely
value decomposition rule to conduct the decomposition and also use
a control function approach that tests for potential endoginity and
unobserved heterogeneity of synthetic variable for education and
health. The result of this & study indicates that education is the
main contribution to inequalities

Voitchovsky (2005) investigated the importance of the shape of the

income distribution as a determinant of economic growth in a panel
of countries. Using comparable data on disposable income from the
Luxembourg Income Study, results suggested that inequality at the
top end of the distribution is positively associated with growth, while
inequality lower down the distribution is negatively related to
subsequent growth. The central hypothesis of his paper will that the
positive and negative influences of inequality on growth are mostly
associated with inequality in different parts of the income
distribution. Many of the positive mechanisms were linked to
inequality at the upper end of the income distribution, while many

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of the negative mechanisms were associated with inequality further
down the distribution.

He highlighted the potential limitation of investigating the effect of

income distribution on growth will using a single inequality index; a
single inequality statistic is likely to capture a relatively
unimportant average effect of inequality on growth, and mask the
underlying complexity of the relationship. The results of the study
suggested that growth will facilitated by an income distribution that
is compressed in the lower part of the distribution, but not so at the
top end. In this view, redistributive policies - such as progressive
taxation and social welfare - are likely to facilitate growth through
their impact on the bottom of the distribution, And to inhibit growth
through their impact on the top of the distribution.

A study by Nel (2003) used high-quality household-expenditure-

based data to estimate the effect of income distribution on economic
growth for a sample of sub-Saharan African states. He used an
ordinary least squares (OLS) technique to estimate the effects of
income inequality in a standard reduced-form growth regression for
a set of cross-section data for the period 1986-97. He found that
higher levels of inequality seem to impinge negatively on growth
prospects over the medium term, but that this effect is weak and
that the finding of a negative relationship is not robust. He then
tested whether this negative consequence of inequality for growth is

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attributable to inequality's effect on political instability, as the
literature suggests. The evidence indicated that high levels of
inequality do not affect political instability in any statistically
significant manner for the countries in the sample, but that they do
negatively affect the risk perceptions of potential investors, and so
may contribute to lower growth prospects.

2.2.2. Evidence from Ethiopia

The previous researcher (e.g. Alemayehu and john 2012) focused on

the empirical correlation or association between growth and income
distribution, it does not say much about the determinates of income
distribution. Previous work (e.g. Bigsten and Shimeles, 2010)
attempted to decompose the determinate of income inequality in
Ethiopia using aggression made of consumption expenditure at the
house hold level. Result, variation in income inequality could be
captured by different in village level characteristics.

Ayal Kimihi (2011), inequality decomposition techniques were used

in order to analyze the consequence of entrepreneur’s activities to
household income inequality in southern Ethiopia. A House hold
income inequality will first decomposed by income sources, and
marginal effects of each income source on inequality were derived.
However increasing the number of entrepreneurs does not affect
inequality.

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Tassew W, Hoddinott, J and Dercons S. (2013) in their poverty and
inequality analysis in Ethiopia found that while inequality remained
unchanged in rural areas, there will substantial increase in urban
inequalities. In Ethiopia, income growth reduces poverty and
increases in inequality increase poverty of -1.7 to -2.2. In rural
Ethiopia, the increase in consumption has led to a reduction in
headcount poverty.

Regarding to trends in consumption inequality as measured by the

gini coefficient are reported in Ethiopia (2010/11), the Gini
coefficient for urban areas become 0.37 and rural 0.27. Inequality is
higher in urban areas than in rural areas. However, rural
inequalities marginally increasing while urban inequality declined
substantially leaving the national Gini coefficient unchanged.
Likewise, according to EDHS mini-survey (CSA, 2017), 77 percent
iof the urban population is in the highest wealth quintile, in shop
contrast to the rural areas, where only 9 percent of the population
are in the highest wealth quintile.

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