Four Decades of China’s Income Distribution Reform
Abstract: Income gaps in China kept widening over the past four decades of economic transition. First, this paper describes the change in income gaps before and after reform and opening-up in 1978 and found that income gaps had been expanding between urban and rural areas, within cities and within the countryside. However, this did not lead to income polarization since low-income groups only had a slower income growth compared with highincome groups. The number of poor people continuously reduced thanks to rapid economic growth. Over the past decade, the widening of income gaps has been initially curbed. Accordingly, we explained the impact of economic transition on income distribution from the perspectives of market-based distribution, ownership structure, opening-up and internal income distribution. Lastly, this paper provides an in-depth analysis on urban-rural income gaps, excessive compensation in monopolistic sectors and income inequalities arising from corruption. To address these problems, it is important to enhance tax regulation, increase transfer payments to poor people, improve social security, equalize public services, enhance poverty relief and develop a fairer income distribution system.
Keywords: income gap, economic transition, distribution fairness, Gini coefficient JEL classification code: D31, O15, P23
DOI: 1 0.19602/j .chinaeconomist.2018.07.01
Over the past four decades of economic transition, China has transformed from a low-income economy with per capita income less than 200 US dollars to one with per capita income above 8,000 US dollars - an achievement rarely seen in human history. China’s economic successes have been widely acclaimed and aroused a great deal of interest in “China path” and “China model” among Chinese and international scholars.
Rapid economic growth has been accompanied by rising income level for Chinese households since reform and opening-up in 1978. During 1949-1978, China’s economic growth far outpaced household income growth and people’s living standards did not keep pace with development. According to official statistics, during 1952-1978, China’s economy grew by 6.7% and per capita household income grew by less than 2% on an annual average basis. In the past four decades of reform and opening-up, however, household income growth (about 11%) slightly outpaced GDP annual growth rate (about 10%). In this sense, the three decades of economic growth before reform and opening-up in 1978 is a non-inclusive growth pattern that failed to improve people’s living standards. It also justifies the necessity of China’s economic transition.
China’s long-term economic transition and development have transformed its income distribution pattern. On one hand, income gaps have been widening between urban and rural areas, different regions, sectors, occupations and groups of people. On the other side, changes have occurred in the standards, principles and mechanisms of income distribution. These changes include both positive and negative aspects. To some extent, widening income gaps are inevitable amid economic transition. In a planned economy, income distribution is determined by ownership, industrial and employment structures and labor system. When China was under the planned economy, egalitarianism was both necessary and politically correct. Back then, leftist ideology, planned economic system and egalitarian distribution were the norms of China’s political and economic life. In fact, egalitarianism created another form of unfair distribution: the results of work were taken by force from those who worked more to those who worked less or did not work at all.
China’s economic reform introduced market mechanism that allows income distribution to be determined by individual enterprises free from government intervention. The virtue of this transition is obvious. It created incentives for all groups of people to participate in economic activity for self-interest. But it also led to widening income gaps that aroused public resentment. As mentioned in the Report of the 19th CPC National Congress, “The principal contradiction facing Chinese society in the new era is between unbalanced and inadequate development and the people’s ever-growing needs for a better life”. A major aspect of “unbalanced development” is excessive income disparities. The report also provides a basic assessment on the current status of income distribution in China: “The development gap between urban and rural areas is still large, and so are income disparities”. This assessment reflects previous and current situation of income distribution in China and implies that resolving excessive income gaps remains a priority for the CPC Central Committee in the foreseeable future.
Widening income gaps are not unique to China. Over the past three decades, income gaps increased in most countries by different degrees. According to a study report Divided We Stand: Why Inequality Keeps Rising (OECD, 2011) recently published by the OECD, 14 out of 15 OECD countries experienced rising Gini coefficients during the mid-1980s and mid-1990s with an average increase of 14%. From the mid-1990s to 2005, nine out of 15 OECD countries experienced rising Gini coefficient but the increase slowed. Of course, this does not mean that China’s income disparities are caused by the same reasons with other countries, nor does it suggest that China’s income disparities are inevitable and justified. It should be recognized that income distribution in China is not the most inequitable in the world but China’s income gaps are widening at a staggering pace. It is fair to say that China has transformed from an egalitarian society to a highly unequal society in a matter of three decades. China’s current priority is to reduce income gaps and achieve equitable development. On this issue, the Report of the 19th CPC National Congress has put forward clear requirements.
2008 is a watershed year for changing income gaps in China. Before 2008, income gaps in China had been widening. This trend is indisputable in the academia. Relevant studies including official statistics indicate that the first three decades of China’s economic transition coincided with widening income gaps1. This paper will specifically elaborate the characteristics of changing income gaps in this period and underlying reasons. As for what happened to income gaps in China after 2008, the academia is yet to reach a consensus. Moreover, huge differences exist regarding the estimation of income gaps. Gini coefficients estimated by different scholars vary by as much as 10 percentage points. In our view, income gaps in China have entered into a plateau since 2008 and will not keep increasing or decreasing in one direction despite short-term volatility. This assessment is based on China’s stage of economic development and public policy effect. The Chinese government has made great efforts to prevent income
gaps from expanding excessively since 2003 and issued various policies to reform income distribution system. These efforts have achieved certain effects in reversing widening income gaps.
Change in income distribution pattern can be attributed to various factors, including factors of economic transition, economic and social policies, as well as demographic changes. The impact and the relative importance of these factors will vary across different periods of time. This paper attempts to explain the four decades of China’s changing income pattern. Despite the complexity and difficulty of this issue, it is still necessary to try to offer some explanations on this topic.
The following characteristics can be observed in the long- term evolution of China’s income distribution pattern. First, widening income gaps were not accompanied by polarization. Although the rich became richer, the poor did not become poorer. That is to say, low-income groups still saw their income increase, although at a slower pace compared with high-income group. This has been verified by the significant reduction of rural poor people over the past four decades. Income growth allowed the poor to benefit from economic development despite widening income gaps. This is why China managed to maintain social stability amid increasing income gaps. Second, China’s employment priority policy played a pivotal role in reducing income gaps and poverty. Employment is the foundation for people’s livelihood and an antidote to poverty. The implementation of employment priority strategy by the Chinese government since the dawn of the 21st century has undoubtedly played an effective role in preventing income gaps from further increasing. Last, public policies also eased income inequalities to some extent, particularly inclusive social security, poverty relief and support to backward regions and agriculture. These policies have played out well and will play a bigger role in the future as they are improved.
2. Changes in the Pattern of Income Distribution and Explanations
It takes two perspectives to explain how the pattern of income distribution evolved in China: First, an empirical analysis needs to be carried out to measure income gaps, describe their changes and investigate the underlying reasons of change; second, a value-based assessment needs to be carried out to identify unfair income distribution systems, policies, process and results. As for the change of income distribution, people will first care about the magnitude of income gaps, particularly income gaps between themselves and other groups (especially comparable groups). They will care about both absolute and relative income gaps. Here, we use the following example to explain what absolute and relative gaps mean. If Jim makes 20,000 yuan per year and Tom makes 200,000 yuan a year, their absolute income gap is 180,000 yuan and relative income gap is 10 times. In the following year, their income both increase by 20% with absolute income gap widening to 216,000 yuan and but their relative income gap remains unchanged, i.e. still 10 times. Obviously, conclusions on the change of income gaps will be different depending on which standard is followed: absolute gap or relative gap.
Most studies of income distribution have followed relative standard such as Gini coefficient. It remains unclear why scholars tended to follow relative gap rather than absolute gap. Maybe a reason is that relative gap has temporal and spatial comparability. In addition to the magnitude of income gaps, people also care about whether income gaps are reasonable and fair based on a set of values, including cultural perceptions, social customs, ethics and mainstream ideology. In a society, mainstream values will change with these factors. For instance, before China’s economic transition, egalitarianism held sway in people’s perceptions and social development. After economic transition, egalitarian values gave way to the values that encourage the pursuit of wealth. Thus, income gaps that are considered as reasonable became gradually accepted by people. However, unreasonable income gaps or income gaps against universal values are still condemned. Regarding the fairness of income distribution, we should look at not only the result of income distribution but the process and principles as well.
2.1 Income Gaps before Reform and Opening-up in 1978
Upon the founding of the People’s Republic of China in 1949, huge income gaps existed in China. According to a study, China’s Gini coefficient in 1953 was 0.5582. Initially after the new government took over the economy, China’s economic landscape, income distribution and income gaps were left over from the old China. In this sense, the huge income gaps are understandable. As the planned economy took shape and especially after the first and second Five-Year Plan periods, household income gaps swiftly narrowed. In 1965, a year before the Cultural Revolution, China’s Gini coefficient was about 0.27 (Dowling and Soo, 1983). It is not difficult to explain the low level of household income gaps in China during the planned economy: First, state-owned and collective enterprises replaced private and individual businesses in cities and People’s Communes were created in the countryside; second, salary determination and distribution were brought under increasingly rigorous control under the planned economy. Despite the pyramid-shaped compensation standard, the difference between minimum and maximum compensation was small. Third, egalitarianism increasingly took hold, as reflected in the narrowing differences between salary grades through a few rounds of adjustment before the Cultural Revolution.
Small income gaps under the planned economic system were not tantamount to fair income distribution. In fact, egalitarian distribution system even ran against the China’s cherished principle of distribution according to labor, creating an unfair treatment to those who were more hard-working and talented. In addition, nonmonetary welfare and in-kind distribution systems represented an implicit form of unfair income distribution. Furthermore, income distribution system was tilted in favor of the privileged group. In the early stage of reform and opening-up after 1978, the academia extensively discussed the inefficiencies of distribution system under the planned economy. In fact, this distribution system was not only inefficient but created new forms of unfair distribution. For instance, despite its intention to reduce income gaps, the policy to freeze compensation standards created inter-generational inequality (Zhao, 1983).
It should be noted that significant income gaps still existed between urban and rural areas despite the mainstream ideology to narrow these gaps. In 1978, the year of reform and opening-up, income gap between urban and rural residents was still 2.56 times. If various social protection and welfare entitled to urban employees are taken into account, real income gaps between urban and rural residents were much more significant. This result stemmed from urban-rural divide under the household registration ( hukou) system and primary capital accumulation at the expense of farmers’ interests. In this sense, development was high on the agenda for policymakers, while egalitarianism became a mere slogan.
2.2 Rural Income Gaps during Transition Period
The initial stage of rural economic reform is the “best times” of simultaneous income growth and narrowing income gaps with a balance between fairness and efficiency. In the late 1970s and early 1980s, rural economic reform not only led to a rapid increase in farmers’ income but reduced income gaps in the countryside as well. During 1978-1984, real per capita income in the countryside grew by 16.4% on an annual average basis - a rare growth miracle in Chinese history that never occurred in the three decades preceding reform and opening-up and never repeated thereafter.
Various explanations have been offered on the surging income of farmers during this period. Some argue that household contract system incentivized farmers to increase agricultural yield. The reform also gave farmers greater freedom in the selection of crops and thus increased land allocation efficiency. In
addition, the reform allowed rural workforce to engage in non-agricultural activities and thus increased rural labor allocation efficiency. Others believe that farmers’ income increased because the Chinese government raised agricultural purchase price for a few times during this period3. More importantly, rural income gaps stayed flat during this period of time. According to a household survey conducted by the National Bureau of Statistics (NBS), rural Gini coefficient fluctuated within a range of 0.24-0.26 during 1979-1984. This shows that rural income inequality was limited and did not change much.
The reform in cities and towns was preceded by the reform in rural areas. Until the early 1980s, previous distribution system was still followed in cities without much change. Although wage growth for urban employees was less stagnant than during the Cultura Revolution4, it was far outpaced by the income growth of farmers. As a result, income gaps between urban and rural areas swiftly narrowed, down from 2.6 times in 1978 to 1.82 times in 1983 - the lowest level since China’s economic transition.
However, this period was short-lived. Income growth for farmers slowed as reform dividends diminished and stagnated for a rather long period of time since the mid-1980s. During 1985-1995, farmers’ per capita real income grew by only 3.6% on an annual average basis. Rural income gaps started to widen with industrial development and the emergence of non-farming jobs in the countryside. According to the NBS, the Gini coefficient of rural income gaps increased sharply from 0.26 in 1985 to 0.34 in 1995. According to an estimate by Chinese Household Income Project (CHIP) Series, rural Gini coefficient also increased during 1988-1995, up from 0.34 to 0.405.
Rural income gaps expanded swiftly primarily due to industrial development that provided nonfarming jobs to rural labor. Nevertheless, rural industrialization was accompanied by regional imbalance: While township and village enterprises mushroomed in China’s eastern coastal region, farmers in western parts of China were still tilling their crops. Industrial development not only created jobs for farmers but also changed their income structure: Wage became a source of income for farmers. But this also led to widening income gaps since only a few people had the opportunity to work outside agricultural sector. Compared with 1988, the share of wage income for rural households increased by almost 14 percentage points to exceed 22% in 1995, with the share of non-agricultural operational income reaching 6%. It should be noted that the distribution of wage income and household non-agricultural operational income was extremely unequal: Concentration ratio is 0.74 for the former and 0.54 for the latter, both far exceed Gini coefficient for rural residents (Khan and Riskin, 1999).
In the late 1990s, wage income and household non-agricultural operational income increased the share of rural household income as rural labor started to migrate to cities. By 2002, the share of wage income in rural household income approached 30%, up eight percentage points over 1995 and the share of household non-agricultural operational income rose to 12%. In this period, wage income distribution gaps reduced but still exceeded the Gini coefficient of net income for rural residents and contributed to widening income gaps. Distribution of household non-agricultural operational income was still rather unequal with concentration ratio higher by net income Gini coefficient by 18 percentage points. This process lasted until early 21st century.
Over the past decade, rural income gaps have stabilized. Income gaps are still widening but at a much slower pace compared with the 1990s. According to calculations based on CHIP survey, China’s rural Gini coefficient in 2013 increased by about two percentage points over 2002 (see Figure 1). Such change is closely related to a host of rural development policies. Rural social protection system and pro-
farmer and pro-poor policies have greatly increased the income of poor farmers and improved living standards for poor and low-income people.
2.3 Changing Urban Income during Transition Period
In the early stage of economic transition, urban household income gaps were limited in China. Urban Gini coefficient was only around 0.16 according to calculations based on NBS urban household survey data ( see Figure 2). In the 1980s, economic reforms, including minor adjustments to SOE compensation system, were carried out in cities to increase SOE efficiency. But these reforms did not cause much change to urban income gaps. During this period, urban household income gaps widened to a limited degree. In the decade after reform and opening-up in 1978, urban Gini coefficient was still below 0.2. Private and individual economy and double-track price system were responsible for widening urban income gaps in the late 1980s. During 1985-1992, urban Gini coefficient significantly increased by about nine percentage points. In the late 1990s, reforms in urban areas entered into a substantive stage. As overstaffed SOEs and collective enterprises laid off workers, private and individual businesses developed by leaps and bounds, causing income gaps to widen further. As Figure 2 shows, urban Gini coefficient increased by 7 to 8 percentage points during 1995-2002. Effects of economic transition can be manifested in the change of household income structure: While the share of wage income reduced by about two percentage points, the share of pension increased by three percentage points and the share of household operational income increased by two percentage points (Li, Sicular and Sato, 2008). This reflects an increase in the number of retirees under unemployment pressures and an increase in the revenues from private and individual business activities.
After the dawn of the 21st century, urban income gaps continued to widen. People’s perception that income gaps widened more in cities than in the countryside is contradicted by relevant data. For
instance, the National Bureau of Statistics (see Figure 2) estimates that in the first three years in the new century, urban income gap remained unchanged and Gini coefficient was 0.32; during 2002-2005, urban Gini coefficient increased to 0.34 and stayed at this level for a few years thereafter; in 2009, urban Gini coefficient started to fall from 0.34 to 0.33. This result was challenged by some scholars who believed that urban Gini coefficient was underestimated - such underestimation is caused by a very low proportion of high-income samples in household survey as it became increasingly difficult to acquire high-income household samples (Li, Luo and Terry, 2013). Of course, sample deviation also led to the underestimation of urban-rural income gaps and national income gaps. Based on relevant studies, China’s urban Gini coefficient would have already exceeded 0.4 (Li and Luo, 2011), which is above rural Gini coefficient.
Migrant workers have transformed the workforce structure of cities. While most migrant workers are less educated and non-skilled, their diligence and obedience still make them cost-effective employees. Their migration into cities created pressures for the employment of less educated urban employees, causing their wage level to grow slowly ( Cai and Du, 2011). Industrial upgrade and technology development spurred demand for educated and skilled employees, causing their wage to increase at a faster pace. As high-income group expanded in proportion, urban income gaps kept widening. These factors largely increased urban income gaps.
2.4 China’s Changing Income Gaps during Transition Period
In the first few years of the 21st century, China’s income gaps reached the highest level in half a century (Li et al., 2013). According to NBS estimate, China’s income gaps kept expanding during 20002008 with Gini coefficient up from 0.44 to above 0.496. In recent few years, however, income gaps in
China narrowed slowly. According to NBS estimate, China’s Gini coefficient dropped from 0.49 in 2008 to 0.47 in 2014. Based on CHIPs and CFPS data, Kanbur, Wang and Zhang (2017) proved that China’s income gaps narrowed after 2012. Based on NBS grouped data and national income distribution data, Piketty, Yang and Sucman (2017) verified the reduction of wealth gaps between high-income and lowincome people.
As can be learned from Figure 3, China’s national Gini coefficient decreased only slightly. Whether or not this trend will continue in the long run still requires further observation. Given the sample deviation of high-income group in household sample survey, China’s national income gaps are underestimated to some extent and whether such underestimation may reflect the real picture of changing income gaps is also a question7. Based on the latest CHIPs data, Luo, Shi and Li (2017) estimated China’s changing income gaps during 2007- 2013 and the result shows a downward trend of Gini coefficient. If the deviation in high-income group samples is corrected, Gini coefficient will increase. More importantly, we cannot over-interpret the slight reduction of income gaps in the short run, still less should we consider it as the beginning of a long-term trend. In general, current income gaps in China are the highest in six decades. Given the underestimation, China’s national Gini coefficient should be no less than 0.58.
3. Economic Transition and Income Distribution
China’s income distribution pattern is largely shaped by its economic transition - such an influence is manifested in both the mechanism and result of income distribution. Specifically, as China moved from the planned economy to a market-based one, its highly centralized income distribution system became decentralized. Income distribution was also transformed by the reform to diversify the ownership structure of enterprises - reform that also transformed income gaps for enterprises within the same sector. These results are all attributable to the different income determination and distribution systems followed by sectors with different ownership systems. Another influencing factor is foreign trade and investment. Foreign and joint-stock companies offered high wages to attract and retain talents, which also contributed to widening income gaps between foreign and domestic enterprises. Furthermore, compensation reform in the public sector also affected income distribution. SOEs widened income gaps not only between the management and ordinary employees but among employees as well.
Under market- based income distribution mechanism, the income of each employee is jointly determined by the market and the employer. The average income level of people with the same competence and skills is determined by market supply and demand ( equilibrium wage). Real compensation is determined by employers according to the contribution of employees. Marketbased distribution mechanism also provides return to production factors other than labor. Material capital, human capital, management competence, innovative concepts and creativity will all receive compensation under the distribution mechanism at micro-level. Market-based income distribution also allows risk and opportunity to receive return. The diversity of income determination entities and factors has transformed income determination mechanism, making widening income gaps inevitable.
Ownership diversification not only transformed income distribution but led to widening income gaps as well. If SOE reform is appropriate, changing ownership structure will only lead to widening income gaps within a sector. Otherwise, inappropriate reform will lead to widening income gaps both within a sector and between sectors of different ownership. While reform reduced the size and headcount of SOEs, large SOEs enhanced their monopolistic position and turned their monopolistic profits into excess compensation for employees and senior management. This not only caused rising wage income gaps between sectors but led to unfair income distribution as well (Zhao, Li and Li, 1999).
Opening-up provides a key driver of China’s economic growth by increasing employment and absorbing surplus labor, particularly rural surplus labor. This process helps rural residents increase their income and narrow urban-rural income gaps. With greater demand for skilled and educated workforce, foreign-funded enterprises will also increase return to human capital. Given the existence of rural surplus labor in China, foreign capital also has an effect on increasing income gaps. The overall effect of foreign trade and investment also requires careful analysis.
The income distribution mechanism of public sector, given its large share in total employment, directly or indirectly influences overall income distribution pattern in China. Public sector includes government agencies, non-profit institutions and SOEs. Therefore, income distribution mechanisms in China’s public sector are decentralized but also subject to central control to different degrees. While decentralization led to widening income gaps, centralized compensation system also resulted in income inequality in some respects.
4. Create a Fair Income Distribution System
Income distribution inequalities have existed in China and showed no sign of abatement over the years. But in the recent few years, some improvements have occurred as a result of income distribution
reform and anti-corruption campaign.
First, significant income gaps still exist between urban and rural areas. According to NBS data, urban-rural income gaps noticeably increased from 2000-2009 with urban and rural household income ratio up from 2.78 times to 3.33 times, reaching the highest level in 2009 (see Figure 4). Afterwards, urban- rural income gaps increased slightly and this process lasted for eight years. The difference dropped to 3 times in 2013 and further decreased in 20169. But compared with the early stage of reform and opening-up, current urban-rural income gaps are still rather high. How did urban-rural income gaps occur? There are both historical and institutional reasons. In the planned economy, the Chinese government adopted differentiated socio-economic systems and policies between urban and rural areas to finance for industrial development at the expense of farmers’ interests (Lin, Cai and Li, 1999). Urban and rural divide was manifested in backward social security and public services in the countryside as compared with cities and slow income growth of farmers as compared with urban residents (Sicular, 2008; Cai and Yang, 2010). After reform and opening-up, urban-rural divide left over from the planned economy persisted, so did the hukou system that impeded rural labor and population migration. The countryside remained relatively backward in its socio-economic development. In this sense, tremendous urban-rural income gaps resulted from an unfair development strategy. It stemmed from an unfair socioeconomic system and unfair public service policies that led to serious income inequalities.
Second, employees in monopolistic sectors are overpaid. In the early 1990s, income gaps between sectors were insignificant and average compensation in the highest paid sectors was only 30% to 40% above average compensation. Since the 2000s, wage level has increased rapidly in some monopolistic sectors, where average compensation far exceeds the national average. For instance, average compensation in financial sector exceeded average compensation for urban employees by 94% in 2011. Average compensation of Beijing’s financial industry was 2.3 times higher than average compensation for urban employees in Beijing and over three times higher than manufacturing sector in Beijing. According to relevant studies, most of these high-income sectors are monopolistic sectors, whose high
income largely stems from monopolistic profits (Yue et al., 2010). For some monopolistic sectors, their high income is also associated with surging pay to corporate executives. According to a survey on the pay to executives of 197 large SOEs in 2011, 35% of SOEs paid an average compensation of 500,000-1 million yuan for their top three executives, 8.12% of SOEs paid an average compensation of 1 billion-1.5 million yuan, 5.58% of SOEs paid an average compensation of 1.5 million yuan-2 million yuan and 13.7% of SOEs paid an average compensation of over 2 million yuan (China Institute for Income Distribution, Beijing Normal University, 2012).
Another problem facing Chinese society is corruption and associated unfair income distribution. Fortunately, the spread of corruption has been greatly contained in recent few years. Before an effective anticorruption system is created, corruption remains a huge challenge to Chinese society. Without doubt, corruption mainly occurs among medium and high-income privileged group and will increase income gaps at large. Corruption also breeds rent- seeking that widens income gaps, as proven by relevant empirical studies10. By breaking the rules of income distribution, corruption gives rise to public resentment and confidence crisis and spawns the risks of social crisis.
As shown in extensive literature, excessive income inequalities are harmful to a country’s economic development and social stability (Acemoglu, 1997; Alesina and Rodrik, 1994, 1996; Murphy, Shleifer and Vishny, 1989; Perotti, 1993, 1996). Excessive income inequalities will lead to insufficient consumer demand and inefficiency that take a toll on economic growth momentum, prevent poor and low-income people from accumulating human capital and escaping poverty trap, undermine mutual trust among social members and trigger social conflicts. More importantly, serious income inequalities will cause public policy and redistribution policy to fail (Vandemoortele, 2013), making it hard to create a social system and distribution mechanism that provide equal opportunities.
Over the years, China’s socio-economic stability has been maintained despite widening income gaps largely thanks to rapid economic growth and low unemployment. While income gaps increased, lowincome people became better off with increased income and more people were lifted out of poverty. As China’s economy enters into the new normal, growth deceleration becomes inevitable. If growth decelerates or recession kicks in, unemployment, income gaps and inequalities will take a deep toll on social stability.
It takes a comprehensive approach to address income inequalities. The government must introduce income distribution and redistribution policies to prevent income gaps from widening and address the root cause of income inequalities.
In primary distribution, the share of labor compensation in national income continuously declined. During the decade between 1998 and 2007, in particular, the share of labor compensation dropped from 53% to less than 40% and stayed at a relatively low level despite some increase in the following years11. The government will face greater challenges in regulating income distribution.
Resolving income inequalities requires efforts to adjust primary distribution and redistribution. Regarding primary distribution, the government has unshirkable responsibilities. First, the government plays an essential role in improving market systems to enable the decisive role of market mechanisms in resource allocation. Despite a well- functioning commodity market, industry monopoly, market distortion and excessive government intervention still exist in China’s production factor market. These imperfections have led to inefficiencies in production factor allocation and serious income inequalities. For capital markets and especially financial sector, the monopoly of state capital makes it hard for private capital to participate in financial activities, particularly in highly profitable sectors and areas. For
employees and executives in monopolistic sectors, their income is far above market average. China’s labor market is also imperfect, as manifested in the segregation of urban and rural labor markets (Demurger et al., 2006), identity discrimination associated with hukou system, influence of family background, as well as unequal pay for equal work12. Without doubt, these problems have led to unreasonable income gaps for employees. More problems exist in land market. To some extent, no real land market has come into shape in China. Land market is important to farmers’ interests and helps increase their income, improve rural income distribution and reduce income gaps. Creating an effective land market involves the reform of land system, protection of ownership rights, improvement of land transaction market, and issues that may only be resolved by the government.
Second, the role of government is also essential in creating a reasonable order of primary income distribution. As shown by the experience of developed countries, a compensation negotiation mechanism is essential to ensuring regular wage hikes. Chinese scholars also called for creating a compensation negotiation or consultation mechanism but saw limited progress. An important reason is the lack of an institutional environment necessary for such a mechanism. Trade unions are not independent and cannot represent workers’ interests. Workers’ representatives must represent workers’ interests in order for the negotiation to bear fruit in favor of workers. It is the government’s responsibility to reform trade unions to make them independent and represent workers’ vital interests.
Lastly, the government must also reform and adjust systems and policies that lead to income inequalities. The much anticipated hukou reform and pension reform are good examples. Unfair hukou and pension systems constitute both the root causes of urban-rural income gaps and the barriers to urbanrural integration. Instead of narrowing income gaps, China’s differentiated pension system has in fact increased income gaps. Reforming these systems may only be the responsibility of the government.
When it comes to redistribution, the government has more work to be done. As mentioned in the report of the 19th CPC National Congress, “the government must fulfill its role of income redistribution”. Indeed, the government has worked a lot to promote income redistribution over the past decade with some results (Li and Sicular, 2014), as manifested in the following aspects: First, the government has taken steps to create a minimum income security system covering urban and rural residents since 2003. By the end of 2014, 70.89 million people have benefited from the minimum income security system, including 18.8 million urban residents and 52.09 million rural residents13. Minimum income security has some effects in alleviating poverty, raising the income of the poor and reducing income gaps. Second, pro-farmer policies such as grain production subsidy, rural cooperative medical system and rural pension system play an important role in increasing the transfer income of farmers, improving their living standards and narrowing urban-rural income gaps. Lastly, reform to rescind agricultural tax greatly increased farmers’ income and helped narrow income gaps within the countryside and between urban and rural areas.
Nevertheless, the Chinese government needs to continue adjusting its income redistribution policy to fulfil its role of income redistribution. According to international comparisons conducted by some scholars, Gini coefficients in some developed countries were as high as over 0.5 before income redistribution and dropped to about 0.3 after income redistribution, down 20 percentage points. Some studies conducted similar estimations on the effects of China’s redistribution policy and found that China’s Gini coefficient reduced by less than five percentage points after the implementation of income distribution policy (Li, Zhu and Zhan, 2017). The slight decrease of Gini coefficient suggests that China’s income redistribution policy achieved limited effect. When it comes to income redistribution,
the Chinese government must work on the following fronts:
First, enhance the role of taxation in regulating income distribution. China’s current tax system has a limited effect in regulating income distribution. Tax structure, for instance, is tilted in favor of indirect tax such as VAT that contributes to increasing income gaps, while the share of direct tax such as personal income tax that helps narrow income gaps is too small (Nie, Yue; 2012). Moreover, personal income tax is a salary tax imposed on salarymen and cannot regulate the income of people with other income sources. As Table 1 shows, personal income tax contributed more to narrowing income gaps between urban and rural residents since 2005 but the effect was limited. In 2009, personal income tax only reduced Gini coefficient between urban and rural residents by about one percentage point. It is necessary, therefore, to adjust tax structure by including taxes that help regulate income distribution: among them, property tax and inheritance tax are worth considering. Property tax will increase the share of direct tax and allow the government to conditionally exempt certain indirect taxes and invigorate enterprises. It will also effectively regulate the income of high-income groups.
Second, increase transfer payment to low-income and poor people. China has created a minimum subsistence production system ( Dibao) covering urban and rural areas but the effect of income redistribution is insignificant (Li and Yang; 2009). According to statistics of the Ministry of Civil Affairs, more than 60 million people received Dibao relief by the end of 2016, including 47 million rural residents. Even with Dibao relief, there were still about 50 million poor people in the countryside. This means that Dibao coverage needs to further increase and that the level of protection remains limited for some poverty-stricken areas. Due to limited fiscal resources, some rural localities have set very low protection standards, making Dibao system ineffective. Future reform must continuously raise Dibao standards and maximize its coverage. In addition, the types of transfer payment in China are limited. For
instance, child education subsidy (such as child Progresa Program in Mexico) and allowance for elderly persons (such as Older Person’s Grant in South Africa) are considered as important means of income regulation but are not put on the agenda of the Chinese government. Regarding transfer payment, the government may continuously increase welfare programs for special groups and vulnerable groups to narrow the income gaps with other social members.
Third, improve social security system and narrow the gaps in the level of protection. Today, China has initially created pension security and medical security systems with universal coverage. But both systems have a common problem: Different groups are entitled to different systems and levels of protection (Li, Zhao, Gao; 2013). For instance, China’s pension system is differentiated for public servants, retirees from public institutions, enterprise employees and rural residents. The level of pension varies greatly among these pension systems. Medical security is also differentiated for public servants, public institution employees, enterprise employees and rural residents. The level of protection also varies greatly among these different systems. In the long run, it is unsustainable for one type of protection system to be divided into different grades and levels with huge difference in the levels of protection for different groups. It is the government’s responsibility to narrow the differences in the level of protection.
Fourth, strive to equalize public services. Much remains to be done to accomplish this widely recognized goal. In addition to market mechanism, the government should play a greater role in providing public services, particularly when it comes to the equalization of public services.
Lastly, enhance poverty relief and bring hope to the poor. Despite tremendous achievements in poverty alleviation, there is still a large group of poverty-stricken populations in China. The government made huge investments on poverty relief but results are far from desirable. In many cases, poverty alleviation funds were not effectively utilized to help the poorest people by enabling them to take part in economic development and escape poverty. The government must increase the effectiveness of poverty relief policies and ensure the reasonable use of poverty relief funds.
Four decades of economic transition have transformed China’s landscape in every aspect, particularly income distribution. In the first three decades of the reform and opening-up, the “efficiency first” strategy led to widening income gaps in China in all respects. Income gaps kept widening between urban and rural areas, within cities and within the countryside. Income gaps also widened to different degrees between regions, industries and income groups. Income gaps between high-income and lowincome groups widened more significantly. Compared with other countries, however, China’s income gaps are not a form of polarization and did not make the poor poorer and the rich richer. Low-income groups also saw their income increase but at a slower pace compared with high-income groups. The number of poor people kept falling thanks to rapid economic growth. This is also the reason why China managed to maintain social stability despite widening income gaps.
Over the past decade, the trend of widening income gaps abated in China. Comparable data suggest that household income gaps are relatively stable and somewhat reduced. This change is mainly due to narrowing urban-rural income gaps. In particular, rural household income growth outpaced urban household income growth since 2010. Income gaps within cities and the countryside, however, continued to expand. There are many determinants of income gaps between urban and rural areas. One of them is China’s pro-countryside and pro-farmer policies implemented over the past decade.
Despite an initial abatement, income gaps remain high in China and require relentless efforts to narrow. More importantly, the problem of income inequality still needs to be addressed. Both income gaps and inequalities cannot be resolved without income distribution reform.
After the 19th CPC National Congress, the Chinese government will continue to enhance income
distribution reform, narrow income gaps, mitigate income inequalities, strive to build a fairer society and ultimately achieve prosperity for all.
Figure 1: Rural Gini Coefficient, 1978-2011Source: NBS China Rural Household Survey Yearbook for various years.
Figure 2: China’s Urban Gini Coefficient, 1978-2011 Source: NBS China Rural Household Survey Yearbook for various years.
Figure 3: China’s National Gini Coefficient Source: Gini coefficients of 1995-2001 are from Ravallion and Chen (2007); Gini coefficients of 2003-2015 are from NBS press releases in recent few years; Gini coefficient of 2002 is from Gustafsson, Li and Terry (2008).
Figure 4: Change in China’s Urban-Rural Income Gaps Source: China Statistical Yearbook.