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Poverty - Growth - Inequality Triangle in China

by Guanghua Wan

Poverty reduction can be achieved through growth and/or improved distribution. However, growth can lead to a decrease or increase in inequality. Thus, it may not translate into poverty reduction. Meanwhile, poverty and growth depend on the level and dynamics of inequality. This complex interrelationship among growth, inequality and poverty is termed the poverty-growth-inequality (PGI) triangle. The triangle poses a challenge or dilemma to development strategists and policymakers: should growth or inequality be prioritized in the design and execution of development policies?

Post-reform China represents a good opportunity for studying the PGI triangle. While growth in China has helped lift some 270 million rural poor out of poverty during 1980–2000, the effi ciency-driven-but-equity-ignoring development experience has lead to the rise of inequality with possible adverse consequences for poverty and future growth. In what follows, we summarize major findings from a recent WIDER project on poverty and inequality in China, and provide some policy recommendations.

Major findings

Growth-Inequality: Inequality is harmful to growth no matter what time horizon is considered. The growth-inequality relationship is non-linear, but positively correlated, suggesting further increases in inequality in China.

Poverty-Growth-Inequality: Income growth and favourable distributional changes in China explain reductions in rural poverty in the first half of the 1990s. However, in the second half of the 1990s, both rural and urban China suffered from rising inequality and stagnant income growth, leading to a slowdown in poverty reduction, and even a reversal in the poverty trend.

Determinants of Inequality: Fiscal transfers exert little or regressive effects on inequality. Residents in the central and western regions received less social benefits than those in the eastern regions. In addition, the elderly and the educated gained more while larger households gained little from the provision of social benefits. The working poor have not only fared poorly in earnings but have also been left behind with respect to social benefits.

Globalization as represented by trade and FDI is among the most influential factors causing fast rises in regional inequality in China. Moreover, domestic capital is the largest and increasingly important contributor to regional inequality. Uneven distributions of domestic capital, FDI and trade account for almost 50 per cent of total inequality.

In a dynamic sense, today’s inequality has a lot to do with development strategies. Poorer regions generally followed the comparative advantagedefying development strategy by adopting capital-intensive technologies while affluent regions followed comparative advantage-following strategy by emphasizing labour-intensive industries.

A further cause of inequality is gender discrimination. Females are often treated unfavourably in salary, employment and promotion opportunities. Gender discrimination is more evident in developed areas and has increased over time. However, resource endowments of females are found to have increased more than those of males. Rapid expansion of education in the last decade has helped to mitigate gender bias against girls.

Urban-Rural Gap vs East-Central-West Divide: China’s regional inequality consists of two dimensions: the eastcentral-west divide and the urban-rural divide. The latter constitutes some 70 per cent of the overall regional inequality. Since 1995, fluctuations and the increase in regional inequality are almost entirely attributable to the urban-rural gap. Conversely, the eastcentral-west divide only contributes some 30 per cent to the total regional inequality. Regarding components of the urban-rural gap, differences in the endowments of household characteristics contribute about half of the gap with the remaining half due to differences in the returns to these endowments. The contribution of location is found to have declined from 1995 to 2002.

Poverty Determinants: The rise in urban poverty in 1988–1992 is attributable to adverse distributional changes, which in turn are caused by negative income growth and large downward mobility among the poorest urban residents. Conversely, the sustained decline in rural poverty is due to income growth that has a propoor pattern.

At the aggregate level, inequality and domestic capital were the two most important contributors to the poverty difference between inland and coastal China. Consequently, policy measures to assist poor regions in accumulating physical capital and tackling within-region inequality are urgently needed. 

Policy recommendations

Leaving geo-political issues aside, there is every justification to tackle the urban-rural gap rather than coastinland disparity as a first priority. China can only cut its regional inequality by 20-30 per cent if the east-central-west disparities were eliminated. But, a drop of over 50 per cent can be achieved by eliminating the urban-rural gap. Clearly, a wise move is to target the rural poor in the inland areas.

To tackle the two major dimensions of inequality in China—the urban-rural gap and coast-inland divide, the Chinese government launched the ongoing campaign of ‘western development’ in 1999, and the recent campaign of ‘building a new socialist countryside’. Neither of these, however, is likely to work. The basic fact is that the rural sector takes up about 10 per cent of national GDP with some 60 per cent of the national population. It is simply irrational and infeasible, using carrots and/ or sticks, to tackle the urban-rural disparity. After all, on what ground can government transfer more than half of urban GDP to the rural areas? Without bridging the urban-rural gap, how can the inland-coast divide be resolved?

In the short run, poverty and inequality can be alleviated by (1) establishing and developing rural capital markets to promote capital formation in rural China. Policy support for investment in the poor regions is needed in terms of tax concession and bank lending. In particular, continued fi nancial reforms are necessary in order to eliminate discriminations against small farmers and rural activities; (2) making fiscal spending and redistribution progressive rather than regressive. All transfers can be conditional, gearing towards physical capital formation and education of the young. In particular, public R&D investment in agriculture must be increased to improve farming productivity and special attention must be paid to the quality of schooling in poor areas; (3) promoting trade and FDI in inland China. 

In the long run, it is vital to encourage rural residents to permanently settle in urban China. In this context, abolishing the household registration system is only a necessary but not sufficient condition for tackling the urban-rural gap. Fiscal, taxation and all socialeconomic policies must facilitate urban settlement of rural residents. 

To minimize social problems potentially associated with massive migration, a step by step procedure is necessary where migrants with long term jobs or secure housing should be given priorities. Those with better education should also enjoy concessions. In fact, application for migration can be assessed using a scoring system, with demographic and other characteristics of all family members being taken into consideration. To ease fiscal pressure, new migrants may be provided with limited and phasing out access to fi nancial assistance in housing, education, health care and other welfare provisions. Community colleges should be set up in the cities to provide training and education to temporary and long-term migrants and their family members.​​

​Guanghua Wan is a Senior Research Fellow at WIDER. Previously at Sydney University and University of New England, his research expertise includes poverty and inequality decomposition, applied econometric modeling, rural development and TFP analysis. An honorary Professor of several leading universities in China including Fudan University and Sichuan University, he has published several books and over 60 articles in refereed international journals.