The Poor Get Poorer: General Equilibrium Effects of Labor Supply as a Smoothing Mechanism

Type Working Paper
Title The Poor Get Poorer: General Equilibrium Effects of Labor Supply as a Smoothing Mechanism
Author(s)
Publication (Day/Month/Year) 2003
URL http://www.econ.yale.edu/conference/neudc03/papers/2b-jayachandran.pdf
Abstract
In an agrarian economy in which individuals vary in landownership, the poorer workers are and the less easily they can borrow, save, or migrate in response to productivity shocks, the more inelastically they supply labor. Underdeveloped and isolated areas therefore experience more wage volatility. This makes the poor worse off. But for landowners, inelastic labor supply is a form of insurance. One ramification is that a village-wide reduction in the cost of borrowing and saving can make a landowner worse off. For a given level of income volatility, he can smooth consumption better; but general equilibrium effects increase the volatility of his income. Data on the agricultural wage in 271 districts in India for 1956-87 are consistent with the model. In districts with a more developed banking sector or more integration with other areas (e.g., higher road density), the agricultural wage is less influenced by weather shocks, controlling for factors such as geography, irrigation, and sectoral composition. Landlessness among agricultural workers also decreases volatility. This may be because the landless are especially likely to migrate in response to negative shocks. In sum, productivity risk is one of the roots of underdevelopment; poverty and isolation exacerbate this very risk.

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