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Rising Inequality in Post Reform China

by Guanghua Wan

Introduction

Inequality in income and consumption has been increasing dramatically in China since mid- 1980s. In particular, China’s regional inequality has attracted considerable attention. In the past 20 years or so, the costal areas have experienced phenomenal growth while the inland has lagged behind. Meanwhile, the urban biases that existed before the reform era seem to have become more serious. Policymakers are increasingly concerned about the regional divide and the rural-urban gap, which could undermine social security and political stability, and adversely affect long run economic growth in China.

A considerable literature exists focusing on China’s regional inequality. Earlier attempts were mostly focused on measurement of regional inequality. This is followed by inequality decompositions, aiming at gauging the broad compositions of regional inequality. More recently, efforts are being devoted to identifying fundamental sources of regional inequality. These research efforts certainly help enrich our understanding of the increasing trend in regional inequality in China. However, many unknowns still remain. In what follows, we will summarize major findings from the WIDER project on Poverty and Inequality in China.

Regional Inequality on the Rise since mid-1980s

It is widely accepted that regional inequality declined in the early years of economic reform and has been increasing since mid-1980s. As shown in the first diagram, the rise is quite significant. Although the Theil index is used here, other inequality indicators such as the Gini coefficient would produce a similar picture.

The diagram also shows that inequality among rural regions is always higher than that among the urban regions, reflecting the egalitarian nature of wage setting in pre-reform urban China. Income and consumption of rural residents were and are still largely dependent on local resources, which explain the high inter-region inequality. What is interesting is the faster growth of rural inter-region inequality than the urban counterpart, possibly attributable to the transfer payments which tend to equalize living standard among the urban households. The transfer payments are not relevant and the welfare system is absent in rural China.​

Decomposition of Regional Inequality

To identify causes of regional inequality, we can decompose the Theil-index along two dimensions. The first is to assess the contribution of urban-rural divide to the overall regional inequality. This decomposition is presented in the second diagram on the next page. Clearly, the urban-rural segregation contributes a very large proportion to the overall inequality. Some 70-80 per cent of total inequality is explained by the rural-urban gap while only about twenty per cent of the total is explainable by inequalities within the rural and within the urban regions.

We can also decompose the Theil-index along the east-centralwest dimension. The decomposition results are presented in the third diagram on the next page.

It is worth noting that the eastcentral-west disparity has received much more attention than the urbanrural gaps. This is best demonstrated by the historical launch of the ‘Western Development Program’ in 1999. However, a contrast of the above two diagrams reveals that the latter is much more important than the former. To be more precise, China’s regional inequality will drop by 20-30 per cent if the east-centralwest disparities are eliminated. On the other hand, eliminating the rural-urban gap will lead to a drop of 70-80 per cent of China’s regional inequality. Viewing from this contrast, we believe it is more effective to target the rural areas in the poor western and central China.​

Factor Contributions to the Regional Inequality

For policymakers, it is vital to estimate how much fundamental variables contribute to the regional inequality although the rural-urban and east-central-west breakdowns are useful. Such estimates could not be obtained until the emergence of the regression-based decomposition framework. Applying this new technique to China produced a number of interesting findings. First, globalization as represented by FDI and trade constitutes a positive and substantial share of China’s regional inequality and the share rises over time. Second, capital is one of the largest and increasingly important contributors to regional inequality. Third, economic reform characterized by privatization exerts a significant impact on regional inequality. Finally, the relative contributions of education, location, urbanization and dependency ratio to regional inequality have been declining.​

Policy Measures to Contain the Rising Regional Inequality​

A number of policy implications are readily derivable from the WIDER project. Further globalization will lead to higher regional inequality in China unless concerted efforts are devoted to promote trade in and FDI fl ows to west and central China. Policy biases which prompted trade and FDI but are gradually phasing out in coastal China should be implemented in other parts of China. Market potential and location consideration place the poor regions in a disadvantageous position in attracting FDI and promoting trade. However, a converging trend in FDI and trade is encouraging. More important is the domestic capital; equalization of which across regions will cut regional inequality by 20 per cent. To narrow down gaps in capital possession, it is necessary though diffi cult to break the vicious circle existing in capital formation. This calls for development of fi nancial market in China, especially in poor rural areas. Again, policy support for investment in the poor regions is needed in terms of tax concession and bank lending. In particular, continued financial reforms are necessary in order to eliminate discriminations against small farmers and rural activities. Finally, changes are needed in the collection and allocation of fiscal resources which so far have favoured the developed regions. An equalization in fiscal support would lead to an almost 15 per cent drop in regional inequality and a progressive fiscal scheme would result in a much larger impact. Adding together, these three variables contribute over half of the total regional inequality in China.​

Guanghua Wan is a Senior Research Fellow at WIDER and Co-Director of the project on Rising Income Inequality in Asia.