Changes in income inequality in China in the last three decades

Changes in income inequality in China in the last three decades Li Shi Institute of Income Distribution Beijing Normal University, Beijing, China 1. Introduction Economic growth and income equality are the two primary objectives of governments across the world. However, in the last three decades, while China has achieved successfully the objective of fast economic growth, it has failed to achieve the objective of income equality. In terms of growth in GDP and household income, China has achieved the best record in her history. The GDP grew by nearly 10 percent, and household income in urban and rural areas by 8 percent, between 1978 and 2012. By the end of 2012, the GDP per capita reached about $5500, making China one of the upper-middle income countries. However, at the same time, China, which was an egalitarian society 30 years ago, has been experiencing sharply increasing income inequality since the beginning of the 1980s. This paper examines the parallel changes in income inequality in the last three decades. The trend of income inequality needs to be looked at separately for urban and rural China. As a developing country, China has implemented separate economic and social policies for urban and rural areas, with apparent urban-biased features, which has resulted in significant differences between urban and rural households in terms of income level, accessibility of public services and human development (Knight and Song (1999); Riskin et al. 2001; Gustafsson et al. 2008). Looking at income inequality, variant estimates indicate that income inequality has increased significantly in both urban and rural China. For example, from estimates based on comparable datasets, the Gini coefficient increased from 0.16 in 1978 to 0.37 in 2011 in urban China, and from 0.22 to 0.39 in rural China at the same time. The Gini coefficient for China as a whole was estimated around 0.48 in 2011 1, a much higher level compared to 0.30 in the early 1980s. Moreover, the income gap between urban and rural households also shows a rising trend in the last decade. The ratio of urban household income per capita to rural household income per capita rose from 1.8 in 1996 to 3.12 in 2011, in nominal terms. 2 Rising income inequality along with declining equity in accessibility of public services between urban and rural areas and among provinces has received much public criticism in China. One urban household survey in 2002 indicated that over 80 percent of the respondents regarded the distribution of income as unfair or very unfair when they were asked to evaluate the 1 The national Gini Coefficient is higher than the Ginis for both rural and urban areas because the income gap between urban and rural China is extremely large. 2 See China Statistics Abstract 2012, p.101. 1

current status of income distribution. The continuing rise in income inequality could likely lead to social instability in China. Hence the Chinese government s recent emphasis on the importance of building a harmonious society and creating balanced economic and social development. The government started to introduce more profound and effective redistribution policies to narrow the income gap between urban and rural areas and among different population groups. However, it should be realized that the urgent need for redistribution policies has not found a consensus among Chinese scholars and policy makers as well. This paper, using the datasets from the CHIP (China Household Income Projects) surveys, finds that a large part of rising income inequality is due to the extremely large income gap between urban and rural households, considerable regional income disparity and wage differentials between monopolistic sectors and competitive sectors. These elements contribute to widening income inequality in China as a whole, and can be understood further by looking at institutional arrangements and biased policies, some of which are the legacy of the planned economy. The structure of the paper is as follows: the next section discusses some features of income inequality and its changes over the last three decades. Section three explains the changes in China s income inequality regionally and nationally. The final section summarizes the conclusions and offers policy suggestions. 2. Changes in income inequality during three decades of transition China is an urban-rural divide society like most developing countries. It is very important to examine income inequality in rural and urban areas separately, when understanding income inequality in China as a whole. This section therefore examines each separately, and then looks at the rural-urban inequality gap as a whole. 2.1 Income inequality in rural areas China started economic reform in rural areas at the end of the 1970s, when income inequality was wider in rural areas than in urban areas. The larger inequality within rural areas was largely due, endowment of natural resources, cultural traditions, development of the non-agricultural sector and accessibility to international markets across regions and provinces. Figure 1 indicates that the Gini coefficient was 0.24 in rural China in 1979, which is comparably lower than in other countries. It is surprising that in the first stage of rural reform, income inequality was narrowing slightly, with a huge rise in rural household income. The Gini coefficient declined by one percentage point in the 1979 1982 period 3, while household income per capita increased by 61 percent in real terms. These may be regarded as the golden years of rural development in China s history. The reason why income inequality narrowed in that period is that the type of rural reform privatization of the user-right of land led to a significant increase in farming production, which had an equalizing effect on income distribution. 3 See the appendix of this paper. 2

Nevertheless, income inequality has risen since the mid-1980s. As shown in figure 1, the Gini coefficient rose for more than a decade, from 0.23 in 1982 to 0.34 in1995 an increase by 1 percentage point per year during this period. The rising income inequality was largely due to the unbalanced development of the rural non-agricultural sector and township-village enterprises across regions and provinces. As a share of household income, the income from non-agricultural activities rose constantly, and was becoming more and more unequally distributed. For example, the concentration ratio 4 for wage income increased from 0.71 in 1988 to 0.74 in 1995 while its share in rural household income increased from 8.7% to 22.4% in the same period (Khan and Riskin 1998). This rural income inequality fortunately had a significant fall in 1996, the Gini coefficient declining by 2 percentage points. It was mainly due to the rising prices of agricultural products in the previous two years 5. The rise in prices of agricultural products generated an obvious equalizing effect within rural areas, because it led to an increase of household income for those engaged in agricultural activities, resulting in a narrowing of the income gap between these households and others that were mainly doing non-agricultural activities. As the rural, non-agricultural activities were more concentrated in coastal areas, the rise in prices of agricultural products also helped reduce the regional income inequality within rural China. Figure 1. Changes in income inequality in rural China, 1979 2011. Source: Annual Report of Household Income Distribution in China, 2011. 4 The concentration ratio is computed in the same way as Gini coefficient except the individuals are ranked in order of total income rather than in order of the income source. The concentration ratio for a particular income source measures the distribution of the income source over all income recipients, not over the recipients of this income source. The Gini coefficient is a weighted average of the concentration ratios, where the weights are the shares of income sources in total income (see Khan et al, 2001). 5 The grain prices increased by 47% and 29% in 1994 and 1995 (See China Statistical Yearbook 2001, page 358). 3

Since 2000, the speed of widening income inequality has slowed down compared to the previous two decades. As indicated in figure 1, the Gini coefficient has a slight increase from 2000 to 2011, from 0.35 to 0.38. On average, the income inequality increased by less than 0.4 percentage points per year in terms of Gini coefficient in the last decade. Moreover, especially in the last five years, rural income inequality maintained almost at the same level. The slowdown of the rise of income inequality can be explained partly by the more equal spread of non-agricultural activities across regions, provinces and counties, partly by an increasing proportion of labourers migrating from less developed regions to more prosperous regions and partly by a series of government policies implemented to raise income of rural households in the last decade. For instances, by 2006 had the agricultural taxes been removed from rural households; and from 2007 minimum living allowance program started to spread in rural areas and at the end of 2011 there were about 53 million of rural population supported by the program; and from 2004 the governments started to grant grain subsidies to households engaged in agricultural production. These policies and programs have benefited low-income households more in rural areas. 2.2 Income inequality in urban areas Turning to urban China, the trend of changes in income inequality has a pattern quite similar to that of rural China. As shown in Figure 2, the Gini coefficient increased from 0.16 in 1978 to 0.33 in 2010. Income inequality, on average, increased by around 0.5 percentage points per year in terms of Gini coefficient in the last three decades. It is not difficult to see that a significantly huge rise in urban income inequality occurred in the period 1984 1994, in which the Gini coefficient increased from 0.15 to 0.30. It was largely due to changes in wage distribution within enterprises, either state-owned or urban collective, resulting from the enterprise reform started in the late 1980s. The reform focused on raising incentives for workers and improving the efficiency of urban enterprises by closely linking wages and bonuses with workers performance. As the proportion of wage income in the urban household income increased, and its distribution became more uneven, income inequality began to display a rising trend within urban China. An analysis based on two comparable datasets from CHIP surveys in 1988 and 1995 indicates that while wage income as a percentage of urban household income increased from 44 percent in 1988 to 61 percent in 1995, the concentration ratio of the wage income rose from 0.18 to 0.25 (Khan and Riskin 1998). In addition, the rapid development of the private sector and individual firms, which had been prohibited during the era of planned economy, also contributed to the rising income inequality in urban China, although there are no reliable data and analyses to show how big the contribution has been. 6 After the Asian financial crisis and with the entry into the WTO, China witnessed a new wave of rising income inequality in urban areas. As indicated in figure 2, from 1998 to 2007, the Gini coefficient of urban household income distribution went up by 20 percent. It is hard to find evidence to show that this was closely correlated with China s entry into the WTO in 6 The number of workers in the private sector (including private and foreign-invested firms and the self-employed) rose from 4.7 million in 1985 to 14 million in 1994 (See China Statistical Yearbook 2008). 4

this period, but faster economic growth driven by rapid growth of exports had no doubt an impact on income inequality. As a consequence of increasingly faster economic growth, the returns to education in urban areas have risen very quickly since the mid 1990s, which has led to a wider income gap between workers well educated and those less educated. Li and Ding (2003) and Zhang et al (2005) indicate that the rate of private returns to education has increased from less than 2% in the early 1990s to around 10% at the beginning of the new century. Educational attainment has played an increasing role in explaining earnings inequality in urban China. For instance, the results from a decomposition based on earnings regression analysis indicate that the contribution of variation of educational attainment to total earnings inequality in terms of Gini coefficient increased from less than 2% to about 6% during the period of 1988-2002 (Deng and Li, 2009). Figure 2. Changes in income inequality in urban China, 1978 2010. Source: Annual Report of Household Income Distribution in China, 2012. Furthermore, the official data show a slowdown of rising income inequality among urban households in the last five years. The Gini coefficient of income distribution of urban household income decreased by 1 percentage point during 2007-2010 as indicated in Figure 2. However, it is argued that the official Gini coefficients above are somewhat underestimated due to under-representativeness of extremely high income households in the sample. If the sampling bias would be corrected, the urban Gini coefficient would be 5-8 percentage points higher than the officially published (Li and Luo, 2011). 5

2.3 The urban-rural gap Like in most developing countries, China has a large income gap between urban and rural areas, and becomes one of the countries with the highest gaps in the world. It is surprising that the gap has not narrowed significantly even after three decades of fast economic growth and the economic liberalization. As indicated in Figure 3, the ratio of urban household income per capita to rural one rose from 1.8 in 1996 to 3.3 in 2009. The income difference between rural and urban households has already reached a relatively high level at the early stage of China s reform, with the ratio between urban and rural households disposable income per capita being 2.6 in 1978. Before 1985, the urban-rural income gap was basically declining with urban-rural households income ratio lowered to 1.9 in 1985, reaching the lowest point in the past 30 years. However, following the rapid increase of urban households income, the urban-rural income gap has been expanding ever since. The urban-rural income ratio reached its highest point in 2009. Fortunately, the gap declined slightly since 2009, but it is still at a very high level (See Figure 3). Figure 3. Urban-rural income gap in China, 1978 2012. Source: China Statistics Yearbook 2012. 2.4 The overall income inequality From the point of view of inequality decomposition, all the three components inequality within urban areas, inequality within rural areas and inequality between urban and rural areas contribute to changes in inequality in China as a whole. Therefore, as a result of rising income inequality in both urban and rural areas, and the widening urban-rural income gap, income inequality in China as a whole has constantly risen since the late 1990s. As indicated in Figure 4, the Gini coefficient in China as a whole was estimated at around 0.49 in 2008. Figure 4 clearly shows two periods in which national income inequality 6

significantly increased. The first period is 1987 1994 and the second 1997 2007. Looking at the two periods separately, one can conclude that the rise in national income inequality was mainly driven by widening inequality within both urban and rural areas in the first period, and predominantly by the growing income gap between urban and rural areas in the second period. Figure 4. Changes in income inequality in China as a whole, 1981 2012. Sources: The figures for national Gini coefficients for the years 1986 2001 are obtained from Martin Ravallion and Shaohua Chen (2004), the figure for 2002 from Gustafsson et al. (2008) and the figure for 2003-2012 from NBS estimates. 3. Explaining changes in income inequality Given that income inequality has been increasing constantly in both rural and urban China and the country as a whole in the last three decades, how do we explain it? To answer this, we must take China s regional characteristics into consideration. Due to the historically different policies for cities and rural areas, the changes in income inequality in Chin as a whole can be understood at the same time by looking at the changes in income inequality within urban areas, and within rural areas, and between rural and urban areas. The changes in the composition of national income inequality are affected by different factors; therefore, when we look at the trend and reasons for income inequality, we must take a multidimensional perspective instead of a single factor such as economic growth. Relatively speaking, the changes in income inequality within rural areas are more likely explained by the process and features of economic development, while the changes within urban areas are 7

more associated with economic transition. And the income disparity between urban and rural areas is more likely affected by pro-urban economic policies. 3.1. Reasons for changes in rural income inequality Since the early 1980s, income inequality within the rural areas has increased over 60 percent, with its Gini coefficient rising from 0.23 in 1980 to 0.39 in 2011 (see Figure 1). The privatization of land-user rights in the early 1980s is a major institutional change which has definitely created a significant impact on income distribution among rural households. However, the impact is a positive and equalizing one at the beginning. It has reduced the income inequality instead of increasing it. The reason is that this reform promoted the rapid growth of agricultural income for farmers, and narrowed the income disparity between farmers engaged in agricultural farming and those engaged in industrial work, which was one of the major factors that later led to the expansion of rural income inequality (Khan et al. 1992; Khan and Riskin 1998). This reform has also narrowed the income gap between agricultural regions and the relatively industrialized regions. Since the mid-1980s, the development of the non-agricultural sectors and increased employment opportunities in these sectors displayed a regional unevenness within rural areas, which led to rising income inequality among rural households. During the early stage, the development of the non-agricultural sectors was mainly concentrated in the relatively developed coastal regions. There was still a scissors gap between industrial and agricultural products. Therefore, the development of the non-agricultural sectors promoted rapid income growth in some regions and increased the income disparity between these regions and the agricultural regions, as well as the income inequality within the coastal regions. This kind of income inequality mainly presented as an income disparity between non-agricultural families and agricultural families. The abolition of the food ration system made rural migration to the cities possible. The food ration system was introduced immediately after the Great Famine in the early 1960s, stipulating that food purchasing in cities required food coupon which only urban residents were entitled to obtain. It was extremely difficult for rural people to survive without food coupon. The relaxation of restrictions on employment in urban state-owned and collective enterprises as well as the demand for rural labourers in private enterprises also encouraged the migration of rural labour. But one important fallout for poor rural families cannot be ignored: Those families usually could not afford the high cost of labour migration in the 1990s, even though they had job opportunities in cities (Zhao 1997; Cai and Wang 2003). Therefore, the pattern of rural migration during the early stage of economic development is as follows: migrant labour from the relatively developed regions was mainly from middle-income families and migrant labour from the less developed regions was mainly from high- and middle-income families. This pattern therefore increased the income inequality within rural areas instead of reducing it, especially in the poorer areas (Li 2001). It is worthy to note that the pattern has changed in rural areas in recent years due to more and more migrant laborers from the poorer areas and from low-income households. Therefore, the remittance from rural migration recently becomes one of the important income sources for 8

low-income households and reduces income inequality in rural China. Other factors that increased income inequality within the rural areas since the late 1990s cannot be overlooked. First of all, the income growth of the high-income households and their wealth accumulation has been in a virtuous circle. The households that got rich first became entrepreneurs and investors with their accumulated wealth. The proportion of property income as part of their total income has been increasing. At the same time, the income of the low-income and poor households in rural areas has always been unstable, and their income level has always been fluctuating up and down the poverty line (Whalley and Yue 2006; Yue et al. 2008). The growing income inequality has been accompanied by growing inequality in wealth distribution over the past 10 years (Zhao and Ding 2008; Li et al. 2005). Secondly, the poor population has not been protected and assisted sufficiently. There is a consensus that the number of rural poor in China has been underestimated. 7 Although the rural subsistence allowance system (Dibao) was initiated widely since 2006, the allowance standard is still too low. 8 The new rural cooperative medical care system aims to cover all rural households, but a majority of the low-income population still faces the problem of unaffordable medical services due to low reimbursement. Disease and illness among the poor and low-income farmers are yet to be properly addressed. 3.2. Reasons for changes in urban income inequality The causes for the changes in income inequality within urban China are different from those for those in rural China. Before the economic reform, the urban economy was under the control of a planned economic system. Under single ownership and a uniform wage standard, even if there was some wage differential it was maintained at a very low level. Moreover, the egalitarianism in income distribution was advocated ideologically. All these factors contribute to the lowest level of income inequality in urban China in history. According to the National Statistics Bureau, the Gini coefficient of the income of urban residents in 1978 was 0.16 (see Figure 2). But problems such as low efficiency due to lacking incentives resulting from the income distribution system were self-evident. From the perspective of the change in the income distribution system, the four major reforms which contributed most to rising income inequality in urban areas are discussed here. First, economic freedom or the privatization of state-owned enterprises or collective enterprises promoted the fast development of the private sector, which introduced the market mechanism in wage determination. The economy of private sectors that emerged in the 1980s, although limited in size and number, generated hot debate on its income distribution model, which was different from the earlier egalitarian income distribution. The development of private enterprises and their fast profit growth resulted in the rapid rise of income inequality within the private sector. 7 Opinions on this issue can be found in China Development 2007: Eliminate Poverty in the Economic Development by the China Development Research Foundation, published by China Development Press. 8 The average annual subsistence allowance was 840 Yuan per person in rural areas in 2008 and the average monthly subsidy was 37 Yuan per person (see China Development 2008: Construct China s Social Security System (discussion version) by the China Development Research Foundation. 9

Second, the state-owned enterprises carried out reforms in their own wage system. The new wage distribution was based on the principle of efficiency and performance, which aimed at increasing the internal income disparities so as to improve the incentive function of wages. This wage system reform took place not only within the state-owned enterprises and collective enterprises but also within the government sectors and public institutions. While the ratio of the wages of managers to employees in the state-owned enterprises was controlled by their supervision departments, they were still on the increase. Every wage system reform within the government sectors and public institutions has exceeded the previous ratios of maximum wage and minimum wage. This series of income distribution system reforms led to an increase in income inequality among urban employees. Third, the restructuring of the state-owned enterprises increased the number of urban unemployed people, which was definitely one of the most important factors contributing to rising income inequality in urban China. The aim of the restructuring of the state-owned enterprises was to downsize for efficiency. In the late 1990s, the laid off employees lost not only their jobs but also their income security, due to the absence of the social security system. Many of them were thrown into the low-income group all of a sudden, which led to the increase of the urban poverty rate (Li and Sato 2006). The employees in the state-owned enterprises who were not laid off benefited from the efficiency, with the rapid growth in their wages. 9 Fourth, the rapid income growth in the monopoly industries resulted in the sudden expansion of the income disparity between different industries, which was as an important reason for the growing urban income inequality. In the early 1990s, the income inequality among industries was negligible. There were hardly any differences between the wages in some monopoly industries such as finance, electricity, telecommunications and the manufacturing industries. 10 But in 2006, the wages in these monopolistic industries were two to three times higher than those in the manufacturing industries. The above explanations for urban income inequality are centered on the impact of the economic transition. This doesn t mean that socio-economic development and policies did not play a role in the rising income inequality in urban China. For instance, the increase of the urban returns to education has led to the rising income disparities between people with different educational attainment and people in different professions. To some extent, the income inequality is the result of changes in the urban labour market structure. A large number of rural workers with less education entered the urban labour market, which caused an excess of supply over demand. On the one hand, the restructuring led to the decrease of the employment elasticity of the urban industries; on the other hand, it also led to the excess of demand over supply in the skilled labour market, which resulted in increased wages for workers with higher education and consequently an increase of the returns to education. 9 The number of urban, self-employed people reached 4.5 million in 1985, the number of employees in the cooperative enterprises (a different form of private enterprise) was 380,000. The total number accounted for 3.8 percent of all urban employees (see China Statistics Abstract 2008, p.45). 10 Since 1999, the wage growth rate of the state-owned enterprises has exceeded 10 percent, much higher than the average growth rate of the wage of urban employees (see China Statistics Abstract 2008, p.45). 10

However, there is no evidence showing the rural-urban migration leads directly to rising income inequality within urban China. Theoretically the movement of rural migrants into cities may causes wider income inequality within cities, but it can not become a justification for restriction on rural-urban migration. 3.3. Reasons for changes in the urban-rural gap The income disparity between the urban and rural areas is the legacy of the planned economy as well as a new form that emerged during the economic transition. During the period of the planned economy, the Chinese government implemented the heavy industries priority strategy and acquired funds for heavy industries development by depriving farmers of their surplus labour, with the aim of catching up. One of the outcomes of this strategy was the vast income disparity between the urban and rural areas (Lin et al 1994). At the beginning of the implementation of the reform and opening-up policies around 1978, the ratio of the income of urban households to rural households was close to 2.6 and the ratio of the expenditure per capita of urban to rural households was almost 2.7. 11 In the early 1980s, when rural reform was carried out, the income disparity between the urban and rural areas began declining, reaching its lowest point in the mid-1980s. When calculated at the prices of 1978, the urban-rural income ratio in 1985 was 1.9 (Li et al. 2008). This decreasing income disparity was attributed to the income growth of farmers, which had overtaken that of the urban households. 12 The reform, as well as government policies, played a role in the income growth of farmers. The former refers to the privatization of the land-user right which stimulated the enthusiasm of farmers for agricultural production. The latter refers to the policy of raising the prices for agricultural products to closer to market prices. In this sense, the reform of marketization doesn t necessarily lead to the widening of the income disparity. However, since the mid-1980s, urban-rural income disparity has been expanding (see Figure 3). It reached its highest level ever in 2009, and since then it has been slightly falling. Compared with other developing countries, the income disparity between rural and urban areas in China ranks the highest (Sicular et al. 2007). Moreover, the impact of the urban-rural income gap on income inequality nationwide has become stronger, its contribution rising from 37 percent in 1988 to 41 percent in 1995 to 46 percent in 2002 and to 51% in 2007 (Li et al, 2008; Li et al, 2013). How do we explain the increasing urban-rural income disparity that started in the mid-1980s? It is not difficult to understand that the income growth of urban households exceeded that of rural households. However, this raises a question: whether the income growth of urban households was abnormal or the income growth of rural households was not sufficient. In fact, to answer the latter question is much more important, since the income growth rate of urban households is synchronized with the growth rate of the GDP while the 11 See China Statistics Abstract 2008, pp.101 102. 12 Between 1978 and 1983, the income per capita of urban households increased by 40 percent, while the income per capita of rural households increased by 120 percent (see China Statistics Abstract 2008, p.101). 11

income growth rate of the rural households is much lower than the growth rate of the GDP. 13 Therefore, our analysis will be concentrated on the causes of the slow growth of rural household income. Firstly, the system and the policies that restrained the free mobility of labour in the planned economy period did no good to the income growth of the farmers. The development of China s labour market has always lagged behind the development of the commodity market, with labour management policies for cities different from those for countryside. At the turn of the century, the forces that encouraged the migration of rural surplus labour were restrained rather than promoted by various systems, laws and regulations, and local policies. With the growing number of rural workers, the delayed migration only increased the size of surplus rural labour. 14 It not only cost the farmers great opportunities to make a better income but also resulted in the longer term oversupply of unskilled labour in rural areas. It suggests that the income growth of farmers would have been faster if the restrictions to the free flow of rural labour had been lifted earlier. Secondly, the government always overlooked the need to invest in social development and human capital in rural areas, a major factor contributing to the slow income growth of farmers. It is well known that social development in the rural areas in China has always been lagging, with a lack of public services and severely insufficient levels of social security, in stark contrast with urban households (China Development Research Foundation, UNDP 2005; Dollar 2007). The investment in human capital, in particular, which is closely related to income growth, was too little to be worth mentioning. Before the implementation of the economic reform and opening-up policies, poverty was very high in the rural areas. Hunger and malnutrition was common. 15 One can imagine that the health of those who were born in the 1960s and 1970s and later entered into employment would have been affected by their malnutrition in their childhood. This group of workers would also have been especially vulnerable to disease. But the rural medical care system in this period was wholly inadequate. Most farmers covered their own medical 13 During the period between 1986 and 2006, the annual growth rate of GDP was 9.7 percent, the annual growth rate of urban income per capita was 7.1 percent and the annual growth rate of rural households was 4.4 percent, less than half of the growth rate of the GDP. 14 Due to the complexity of estimating the size of surplus rural labour, we could only approach this question using other relevant data. The number of rural workers rose from 306 million in 1978 to 490 million in 1997 (see China Statistics Abstract 2008, p.45). During this period, local township enterprises absorbed 102 million labourers (Li 2007), migrant labourers were about 60-70 million, with a 30 million increase of them being rural labourers. Besides this, agricultural mechanization and technological progress created an even bigger labour surplus. As far as the number of employed persons in the three industries is concerned, the number of employed persons in the industry with agriculture as its major occupation increased between 1978 and 1991 by 110 million. The number has been declining gradually since 1991, reaching its lowest point in 1996, at about 350 million, followed by an increase, reaching 370 million in 2002 (see China Statistics Abstract 2008, p.44). 15 Some relevant data shows that the calorie intake of rural households from 1996 to 1997 didn t reach even 2,100 calories per day per person. According to nutrition standards, 40 to 50 percent of the rural population lived in poverty (Zhou 1991). When using a poverty line of one US dollar per day per person, the estimated poverty occurrence rate would be 64 percent in 1981, dropping to 16.6 percent in 2001 (Chen and Ravallion 2004). 12

expenses. 16 And medical expenses kept growing. Therefore, great difficulty and high cost in seeking medical service and disease-induced poverty were common, and undermined their income growth. Another factor that contributed to the slow income growth was the government s inadequate investment in education in rural areas. Even though the number of schooling years for rural workers had been increasing steadily and the illiteracy rate had been declining gradually, the accumulation of human capital in rural areas was still lagging behind when compared with that of the cities. According to the data from the 5 th National Population Census in 2000, the illiteracy rate of the rural population over the age of 15 was 2.5 times higher than that of the urban population. For the population between 20 and 24 years of age, the share of the population with no more than junior high school education in 2000 was 45 percent in the urban areas and 88 percent in the rural areas. These are just differences in numbers; the difference in educational quality is even more significant, which is reflected in the investment in educational resources. In 2001, the average budgetary educational expense per student in rural primary schools was 85 percent of the national level, and for junior high schools it was about 80 percent of the national level. The public spending per student in rural primary schools and junior high schools was far less, at about 62 percent and 54 percent of the national level respectively (see China Development Report 2008). Only in the past two years has the situation improved. Finally, the farmers had been in both low-income group and high tax-rate payers for quite a long time. Before the agricultural taxes were repealed, the Chinese taxation system presented a strong regressive characteristic, which can be seen from the following two aspects. The first is the disparity in the taxation systems between the urban and rural areas. The low-income, rural households shouldered a much higher tax rate than the high-income, urban households did. For example, the CHIP rural survey indicates that the average rate of taxation of the bottom income decile group was 10.1 percent and 8.3 percent in 1995 and 2002 while it was only 3.4 percent and 1.8 percent the two years for the top income decile group in rural areas (Sato et al, 2008). Second, most of the taxes were levied according to the size of the land and number of household members, so the low-income households on average have faced a higher tax rate than the high-income households within rural areas. Thus, the taxation system increased income inequality within the rural areas as well as between urban and rural areas, which did nothing to alleviate the poverty, instead causing it to increase. 17 This kind of taxation system has completely lost its social fairness. At the beginning of this century, the central government realized the consequences of the taxation system and began to cancel the various agricultural taxes and fees in rural areas until their total repeal in 2007. 16 A survey carried out by the Ministry of Health shows that less than 10 percent of farmers participated in the rural collective medical care system, and merely 8.5 percent participated in commercial insurance. Seventy-nine percent of farmers today do not have any kind of medical care and pay for their full medical expenses (see China Public Health Statistical Abstract 2008, http://202.96.155.169/publicfiles/business/htmlfiles/zwgkzt/ptjty/200805/35671.htm). 17 A simple simulation analysis shows that the income per capita would increase by 5.4 percent if rural households were exempted from all taxes and fees. The income disparity between rural and urban households would decrease by 13 percent and the Gini coefficient would drop by 1.4 percent (Li and Yue Ximing 2003). 13

4. Conclusion and policy suggestions This paper has examined the changes in income inequality in China during economic transition. Our evidences indicate that the change in income distribution in China has its own characteristics. We therefore analyzed income inequality and its changing pattern within rural areas, within urban areas and between urban and rural areas. Our explanations emphasize not only on the impact of economic development but also the impact of economic transition and government policies on income distribution. Generally speaking, there are many factors leading to increases in income inequality, while there are some that reduce income inequality. Since the disequalizing effect has exceeded the equalizing effect, the growing income inequality turns out to be a rising trend in the last three decades. Even if income inequality has widened, it can be either fair or unfair. So a mechanism aimed at resolving unfair income distribution should be taken into consideration when the relevant policies are made. Therefore, this paper offers the following policy suggestions. First, our analysis shows that unemployment is also a major contributing factor to the growing income inequality. The Gini coefficient presents a strong correlation with the unemployment rate. Therefore, improving employment opportunities for rural migrants either in urban or rural areas can be a policy to prevent growing income inequality. It has the same significance in increasing urban employment and reducing the amount of rural surplus labour by encouraging development of labour-intensive sectors such as service sector. Second, the huge income disparity between urban and rural areas, the great regional disparity and the growing income inequality among industries in China all suggest that there is severe segmentation in the labour market and institutional obstacles to labour mobility. So, accelerating the development of a more open labour market with more mobility will be an effective way to narrow urban-rural, regional and industrial disparities. This not only includes abolishing or overhauling the policies that directly prevent labour migration, such as the household registration system and restrictions on rural workers migration to the cities, but also includes eliminating the discrimination in access to public services, by including school-age children of migrant workers in the urban public education system, medical care system and housing system. At the same time, breaking industrial monopolies needs to be hastened. Third, an income redistribution policy needs to be established that aims to protect vulnerable groups. These include not only the poor in both rural and urban areas but also other disadvantaged groups such as farmers who have lost their land, migrant workers in the cities and laid-off workers. These are low-income groups because they lack the potential to earn a certain income. Therefore, the key rationale for income redistribution policies is enhancing the potential earning capability of these groups, which includes creating more employment opportunities, and providing necessary educational subsidies, medical care and other social security measures. Fourth, the fiscal transfer from the central government to rural areas and less developed regions should be increased so as to narrow the disparities in public expenditure between urban and rural areas and between different regions. Under the market economy, the major function of public finance should be shifted to providing public services, with more emphasis on public security, public health, public education, professional training, public relief systems and so on, to relieve social conflict, maintain social stability and realize 14

national equalization in public services. The transfer of payments from central funds to local governments should prioritize public services and social protections such as elementary education, medical care and social relief measures. Fifth, a more equalizing taxation system needs to be established. The progressive nature of the income tax should be increased, which means that high-income people will pay a higher rate of tax while the low-income people pay a lower rate of tax and the poor will be subsidized with the transfer payment, instead of paying taxes. Property taxes can be used to adjust the vast differentials in wealth distribution. In sum, the income inequality will not be inevitably narrowing in the future without implementation of long-term public policies in China. One of the most important policies is to promote employment by generating job opportunities and removing barriers to labor mobility. The Chinese governments can also play a more important role in narrowing income inequality by introducing more redistributional policies. 15

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Appendix Urban and rural income inequality, 1978 2011 (Gini coefficients). Year Rural Urban National National with adjustment 1978 0.212 0.16 n.a. n.a. 1979 0.237 0.16 n.a. n.a. 1980 0.238 0.16 n.a. n.a. 1981 0.239 0.15 0.310 0.280 1982 0.232 0.15 0.285 0.259 1983 0.246 0.15 0.283 0.260 1984 0.258 0.16 0.291 0.269 1985 0.264 0.19 0.290 0.265 1986 0.288 0.19 0.324 0.292 1987 0.292 0.20 0.324 0.289 1988 0.301 0.23 0.330 0.295 1989 0.300 0.23 0.352 0.318 1990 0.31 0.23 0.349 0.316 1991 0.307 0.24 0.371 0.331 1992 0.313 0.25 0.390 0.342 1993 0.329 0.27 0.420 0.367 1994 0.321 0.30 0.433 0.376 1995 0.342 0.28 0.415 0.365 1996 0.323 0.28 0.398 0.351 1997 0.329 0.29 0.398 0.350 1998 0.337 0.30 0.403 0.354 1999 0.336 0.30 0.416 0.364 2000 0.354 0.32 0.438 0.385 2001 0.36 0.32 0.447 0.395 2002 0.365 0.32 0.450 n.a. 2003 0.368 0.33 0.479 n.a. 2004 0.37 0.33 0.473 n.a. 2005 0.38 0.34 0.485 n.a. 2006 0.37 0.34 0.487 n.a. 2007 0.37 0.34 0.484 n.a. 2008 0.38 0.34 0.491 n.a. 2009 0.39 0.34 0.49 n.a. 2010 0.38 0.33 0.481 n.a. 2011 0.37 n.a 0.477 n.a. 2012 n.a n.a 0.474 n.a. Sources: Tang Ping, The Analysis of the Income Level and Inequality of the Rural households in China, Management World, 1995, 2; Ren Caifang and Cheng Xuebin, The Impact of Income of Urban and Rural Households on Income Distribution Disparity, Review of Economic Research, 1996, 157; The Gini coefficient 19

for rural and urban areas after 1996 is provided by Zhang(2012); the figures of 19812001 for China as a whole are provided by Ravallion and Chen,2007 ; the figure of 2002 is provided by Gusstafsson et al, 2008; the figures of the country as a whole after2002 are provided by NBS (2013). 20