# **4. Drivers of Poverty Reduction**

What are the main drivers of the unexpected yet remarkable poverty reduction in Nepal? The answers to this question are key to continued improvements in the well-being of the Nepali citizens and those less well-off in particular. A clear understanding of the drivers of poverty reduction is particularly important in Nepal because the improvements have come during a period roughly coinciding with a decade of an active, violent and debilitating Maoist conflict, and a half a decade of tumultuous post-conflict recovery when the overall economy has sputtered in fits and starts around a mediocre growth rate of 3 to 4 percent.

The most commonly cited driver of the remarkable poverty reduction is a drastic increase in remittances received from abroad since the late 1990s (World Bank 2006; World Bank 2013; World Bank 2011). While remittances are clearly an integral driver of Nepal’s recent improvements in living standards, it would be remiss not to examine other economy wide effects of the process of migration itself. For example, the large exodus of young, productive and predominantly male population is bound to have affected local economies through their effect on labor and other factor markets. The growth in income and consumption in Nepal’s rural, largely unconnected local economies could have fundamentally altered the demand for agricultural as well as non-agricultural commodities. These changes in wages and prices of other factors as well as other outputs such as food and non-food services could in turn have generated other opportunities in rural areas that may have benefitted non-migrant households indirectly. Accounting for these spillover effects would require a greater effort to construct a fuller general equilibrium model and data to operationalize such models are not readily available. However, we can use recently developed decomposition methods to get a sense of some other factors driving Nepal’s observed poverty reduction.

In this analysis, we apply a decomposition method developed by Inchauste et al (2010) and Azevedo et al (2013). This decomposition method first expresses household consumption as a function of the consumption-to-income ratio, share of adults, share of workers, labor income, capital income and transfers, which includes remittances and public transfers. In the second step, counterfactual consumption distributions are generated by replacing each of the household consumption components from one period to another. For example, the kind of question that is asked is what would be the effect on poverty if the labor income in the second period had been exactly the “same” as the labor income in the first period. Or alternatively, what would have been the effect on poverty if everything but labor income had stayed the same across the two periods, but the labor income had changed by the observed amount. Repeating this process for each of the consumption components produces the marginal effect of change in each of consumption components to poverty reduction.<sup>16</sup> The results of this decomposition applied to Nepal between 1995 and 2010 are presented in Figure 6.

The results show that remittances account for 27 percent of total poverty reduction between 1995 and 2010. In addition, labor income contributes to a larger share of the total change, explaining 52 percent of the overall poverty reduction (Figure 6 (a)). The role of labor income is even more pronounced once labor income is disaggregated into agricultural and non-agricultural

> 16 See Annex II for a detailed description of the methodology.

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