Exploring the effect of nonfarm activities on income inequality in Ethiopia

This study examines the impact of nonfarm income on income inequality in Ethiopia, utilizing data from the Ethiopian Socioeconomic Survey (ESS) 2021/2022 and applying multiple analytical methods. The analysis includes Gini decomposition approaches, regression-based inequality decomposition, counterfactual simulations, and Lorenz curve comparisons. These methods provide a comprehensive understanding of how nonfarm income influences inequality at both local community and district levels. The findings reveal the contrasting effects of nonfarm income in rural livelihoods. While nonfarm income reduces extreme income disparities and stabilizes household incomes, its overall impact on inequality is moderate but uneven. Decomposition analyses reveal that nonfarm income can increase inequality due to systemic barriers, such as unequal access to credit, education, and infrastructure, which limit poorer households’ participation in high-return nonfarm activities. Counterfactual analysis demonstrates that excluding nonfarm income results in higher inequality, reflecting its importance in income smoothing, particularly for vulnerable groups. The study underscores the need for targeted policy interventions to enhance the equalizing potential of nonfarm income. Expanding access to education, financial services, and rural infrastructure can reduce systemic barriers and enable equitable participation in nonfarm activities. These findings offer important contributions for policy for policymakers seeking to address income inequality in Ethiopia and similar contexts globally, while contributing to broader rural development strategies. Key words: Income diversification, nonfarm income, income inequality, decomposition analysis, lorenz curve, counterfactual analysis, smallholder farmers, Ethiopia.