Bert Hofman
Since reforms took off in 1978, China has experienced rapid growth and hundreds of millions of people have been lifted out of poverty. But the fruits of rapid development have not always been equally shared. Indeed, China moved from being a society with relatively equal income distribution in the early 1980s to one that is far less equal today.
The Gini coefficient, a widely used measure for inequality, rose from 0.25 in 1980 equal to that of Germany to an estimated 0.45 now less equal than Russia or the United States. While the richest 10 per cent of Chinese earned seven times the income of the poorest 10 per cent in the 1980s they now earn more than 18 times as much. Income inequality has been increasing in several respects urban versus rural, intra-urban and intra-rural, and coastal versus inland provinces. It is therefore no surprise the topic is being hotly debated.
China's rising income inequality should be put in perspective.
With opening up and reforms, economic opportunities broadened and people were increasingly rewarded according to their productivity rather than equal but low administratively-set pay.
China's rising inequality is also due to the transformation process any developing country experiences. In the 1950s Nobel Prize winner Arthur Lewis had already seen that when people move from low productivity to high productivity activities, income inequality first rises and then falls.
Some more specific factors have made the rise in China's income inequality particularly steep.
First, China's rapid growth has reduced the time it took the country to transition from an agricultural to an industrial society, thus accelerating the inevitable rise in income inequality.
Second, productivity differences between agriculture and industry, which drive rural-urban disparities, are very high in China. Labor productivity in urban industry is about 9 times that of agriculture, compared to 6.5 times in Indonesia, 2.5 times in Malaysia, and 3.3 times in Japan. This is in part the result of the highly capital intensive industrialization strategy China followed.
Third, China's coastal development strategy, which gave special privileges to coastal provinces, may well have added to the rise in regional inequality.
Finally, the hukou system prevented rural labor from competing for better-paid jobs in urban areas, and may have increased urban-rural disparities.
Rising income inequality has become a central policy concern. There are several reasons why policy-makers should worry about inequality.
Countries with high income inequality tend to be less stable than more equal countries. Nations that are more equal seem to manage economic crises better, perhaps because the pain of economic adjustment is more equally shared, and therefore more accepted. Large income inequalities could exclude people from education, healthcare and credit, which could damage the efficiency and growth of the country.
China would do well to pursue policies that promote equity in the sense of equal opportunities. In fact, China's past reforms offer some of the best examples of improving equal opportunity. Notably, the household responsibility system introduced at the start of reforms allowed hundreds of millions of people to pursue better living conditions.
Accession to the WTO made China more productive and competitive, and created millions of jobs for those laid off from unproductive State enterprises. The recent removal of bank interest rates limits has greatly expanded access to credit for non-traditional borrowers.
China is also pursuing more direct policies to reduce inequities. The western development strategy aims to provide western provinces with the means and infrastructure to catch up with the east. The drive to make nine years of basic education free for poor students in rural areas will vastly increase opportunities, as has the rapid expansion of university enrolment since the end of the 1990s. The urban dibao system of income support ensures that recipients remain above a minimal standard of living.
China can do more. First, it can further expand economic opportunities for all citizens. Relaxing the hukou system will provide more opportunities for rural citizens to improve their income and living conditions, and promoting migration by offering migrants the same social services as other urban dwellers could speed up this process.
A shift to a more services-oriented economy will help, as services will create more jobs for those that want to move to cities. Better use of rural areas, by making market transfer of land titles easier, would increase agricultural labor productivity and income. Investing in rural roads and agricultural technology are among the best anti-poverty programs in the world.
Second, China could further improve access to basic public services. The country can improve access to healthcare through better insurance, which is now largely limited to urban areas, and by setting aside more public resources for public health such as immunization programs.
Implementing nine-year compulsory education and improving the quality of that education in lagging regions will level the playing field among the young, while a further expansion of student loan programs for higher education could establish access solely on the basis of capability.
Third, a better social security network promotes equity. A safety net not only prevents destitution, but also furthers economic growth, because with a safety net in place, resistance to reforms is likely to be less, and acceptance of risk is likely to be higher. Currently urban dibao only reaches one-third of those that deserve it, so better targeting is required. A national policy on rural dibao is for now lacking, which means the program has to rely completely on local resources.
With some 22 percent of GDP in government spending, China has the resources to assure access to basic services for all. But these resources are far from equally distributed across the country. In recent years, the central government has devoted more resources to the poorest regions. Yet inequalities remain prevalent, with the richest province spending more than eight times per capita than the poorest province, and with sub-provincial inequalities an order of magnitude larger. Rebalancing these inequalities, and at the same time assuring that the fiscal resources are spent well is a key challenge for the 11th Five-Year Plan.
Pursuit of more income equality, rather than equality of opportunity, should be handled with care, as there are trade-offs. Indeed, some of the measures other countries have taken in the past to achieve more income equality have proven to be detrimental to growth.
An example is highly progressive income taxation which was pursued by many European countries in the post-war period, but which is now seen as part of the reason why growth is so lacklustre and unemployment so high.
China's marginal income tax rate is, at 45 percent, already at the higher end of the international scale, so improving tax administration to ensure taxes are actually paid is the priority.
The author is the World Bank's lead economist for China
(China Daily January 20, 2006)
