Economic Growth and the Imbalance of Wealth Distribution in China

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After the 1978 economic reforms, China has become the world’s fastest-growing major economy, with growth rates averaging double-digits over the past 34 years (Figure 1). In 2010, China became the world’s second largest economy by nominal GDP, second only to the United States. Moreover according to Kenneth Rapoza of Forbes, China could become the world’s largest economy as early as 2020. But the benefits of this rapid growth have not reached all sections of the population equitably. In recent years, as the economy has expanded, the wealth inequality in China has also increased dramatically. And in some cases, especially in rural areas, this inequality has reached alarming levels.

Economic Development and Growth in China

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Figure 1. Economic growth of China (1978-2011) (Data Source: China Statistics Yearbook 2012)

In China, economic activities are categorized into the following three strata of industry: Primary industry refers to agriculture, forestry, and animal husbandry and fishery industries. Secondary industry refers to mining and quarrying, manufacturing, production and supply of electricity, water and gas, and construction. Tertiary industry refers to all other economic activities not included in the primary or secondary industries, mainly the services industry (China National Bureau of Statistics, 2012). China’s success and economic growth has been primarily attributed to its low cost secondary economic sector as China became a key world manufacturer, and the tertiary economic sector with the development of high technology and more profitable services industries.

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Figure 2. Economic growth of China by economy sectors. (Data Source: China Statistics Yearbook 2012)

Income Inequality of China Economy 

On January 18, 2013, the National Bureau of Statistics of China (NBS) released an estimate for the Gini coefficient for the past decade. The 2012 Gini index was listed at 0.474. This value, just higher than the 2004 Gini coefficient of 0.473, was the second lowest in 10 years (a higher coefficient indicates more inequality).

However, the Gini coefficients published by NBS are considered lower than most economists’ estimates.  Most economists also agree that the coefficient might not reflect the current reality of China’s income disparities. NBS uses data on household income, which comes from occupational wages. But this fails to account for non-wage income, which is often not recorded by wealthy people as part of their earnings. Moreover, undeclared income – including money earned via corruption or other illicit activities – is not accounted for in the Gini index. In fact, Chinese officials said they were unable to publish previous years’ Gini coefficients because of incomplete data for high-income groups, lack of consistency in the income index for urban and rural residents, and unclear classification of migrant workers.

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Figure 3. Gini coefficients of China in the last 30 years (Data Source: Ravallion and Chen of World Bank (1981-2001), China Statistics Yearbook 2012 of NBS (2003-2012))

Furthermore this discrepancy widens when one takes into account different regression models. For example, the Gini index published by the NBS has a slightly negative regression line, which indicates that the coefficient will decrease in the future. Models calculated by the World Bank, on the other hand, have a positive regression line, and predict that the coefficient for 2012 could be as high as 0.54, in the linear model, or even 0.595 in the exponential model (Figure 3). These predications seem to agree with most economists’ suspicions that the Gini indexes published by China’s government are low estimates, and that the real Gini index of China could be higher than 0.6 (Shen Hu, 2012). This value would place China high on the list of the world’s most unequal societies and definitely much higher than the global average of 0.44.

Income Inequality Between Urban and Rural Economy

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Figure 4. Income gap between Urban and Rural economy (Data Source: China Statistics Yearbook 2012)

The reforms of the last three decades have led to rapid economic growth throughout the country, but this growth has been skewed towards urban areas. The Gini index published by Martin Ravallion and Shaohua Chen in 2007 concluded that China has made huge overall progress against poverty, but that this progress has been uneven. In fact, the ratio of rural to urban incomes has been consistently decreasing over time from a peak of around 54% in 1980 to around 30% in the last few years. Furthermore inequality even within urban and rural areas has been increasing, with urban areas experiencing a steeper increase in inequality over time. Chinese officials have even recently begun to acknowledge these phenomena: Yang Yiyong, Director of the Social Development Institute at the National Development and Reform Commission, says the rural-urban income gap contributes the most to China’s Gini index (Bao Congying, 2011):

“The rural-urban income gap takes up more than 60 percent of the unequal income allocation. The urban areas are developing much faster than rural areas. At the same time, the labor income gap has been widened during the last few years.”

Absolute inequality has thus increased both between and within urban and rural areas, indicating that while there has been a significant reduction in poverty, there is still a long road ahead.

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Figure 5. Gini coefficients of urban and rural economy (Data Sources: M. Ravallion, S. Chen, 2007)

Reducing Inequality and Continuing Economic Growth

China’s economy has been expanding exponentially since Deng Xiaoping first instituted reforms, but the ratio of total wages to GDP has declined from 45% to about 36% in the last 10 years. With one of the highest levels of inequality in the world, income gaps between urban and rural households in China continue to widen as the growth in the economy and the consequent wealth generation is not shared equitably across all households, and especially rural households. In recent years, the gap between the rich and poor in China has deepened with the widespread corruption of government officials.  The inequality of wealth, alongside other social injustices, causes great discontent and threatens the stability and growth of China’s economy and has triggered a series of social and economic problems.

Though most people blame the corruption of the Chinese government and officials for the inequality of income, the roots of inequality are the economic growth models and wealth distribution policies that have been instituted since the beginning of the reforms. As China tried to adapt to the western model and make its economy more market-oriented, it loosened regulations and decentralized state functions. But as these controls transferred to local government, the fiscal transfers to the local government either dramatically decreased or were completely cut off. The central government has not been collecting adequate tax revenues from enterprises and this has led to massive inequality among households. In addition, funding for education, healthcare, pensions and other public services has been decreased dramatically with the result being that wealth inequality has been made even more acute.

In any country, income redistribution policies are the key to reducing inequality, and encouraging consumption in order to maintain growth. Countries in the Organization for Economic Co-operation and Development (OECD), for example, reduced inequality by about 30% between 1985 and 2005 by instituting measures such as progressive taxation, a broader tax base, and increased government transfers.

In many developed economies, large fiscal transfers in the form of subsidized healthcare, education and pensions have been used to reduce inequality in the economy. The Gini index of United States decreased to 0.38 from 0.49 after many of the features of such a welfare state were introduced over the course of 20th century. The annual household income of the bottom 25% in America is only about $30,500, but without wealth redistribution, it could be as low as $7,800 if we were to discount major programs like Medicaid and Food stamps. The Chinese government has realized this need for increased social expenditure, as an increase in public spending on healthcare, education and pensions will lead to an increase in private household consumption, which will then drive growth.

China’s 12th Five-Year Plan (2011-15) recognizes this large income inequality and recommends that in order to decrease it, the government must reform tax policies and strengthen tax collection by broadening the tax base, and strengthening legislation against tax evasions. Even with tax reform and wealth redistribution, the Chinese still have a long way to go in order to reduce the grave inequality that the country faces today.

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Sharon Yin is a junior in Davenport. Contact her at sharon.yin@yale.edu.

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