Is Inequality Bad For China's Economic Growth?

Understand China’s Inequality and Is It Bad for Economic Growth?

Paul Deng prepared for the Asian Lunch Seminar @ Brandeis University April 6, 2009

Kuijs and Wang (2006)

Fast growth comes with rising inequality: Two layers of Inequality 

Urban vs. Rural 

Policy legacies from pre-reform Mao-era  

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Divergent effect resulting from dual price system  



Focused on heavy industries and favored urban workers Household registration system restricted labor movement Prices in agricultural sectors were squeezed Urban dwellers enjoyed heavily subsidized welfare

Coastal vs. Inland 

Preferential treatment to coastal area since reform  



Concentration of FDI-trade in coastal area  higher capital intensity Attracted both rural and skilled labor from the inland to coastal area

Inland’s location disadvantage

Urban-Rural Inequality Accounts for 70-80% of Overall Inequality in China

Source: Wan (2007)

This is the most cited graph on China’s inequality: China's Urban-Rural Income Ratio 1978-2006 3.5

Started at high level 3.0 2.5 2.0 1.5

SOE restructuring and layoffs in urban area

1.0

Household individual responsibility system

0.5

Source: NBS and authors’ own calculation

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1985

1980

1978

0.0

Is market reform to blame? China’s high inequality has its historical roots

Source: Kanbur and Zhang (2005); The disparity is expressed in Generalized Entropy index developed by Shorrocks (1980, 1984)

Trade and globalization have contributed to China’s coastal-inland disparity

Source: Kanbur and Zhang (2005); The disparity is expressed in Generalized Entropy index developed by Shorrocks (1980, 1984)

But trade has reduced China’s urbanrural income gap

Source: Shang-jin Wei (NBER Working Paper 2001)

Ranking inequalities

1

3 Source: Sicular (2007)

Within Urban: East/West = 9,038/7,498= 1.2

4

Within Rural: East/West = 4,781/2,150= 2.2

2

Sources of Rising Inequality in China

Source: Wan, Lu and Chen (2007)

China’s Inequality in International Perspective Inequality: A Comparison Around the World Country/Year

Japan 2002 Sweden 2000 Netherlands 1999 Germany 2000 France 2000 Serbia 2003 India 2004 Spain 2000 Indonesia 2002 Tanzania 2000 Italy 2000 UK 1999 United States Congo, D.R., 2004 China 2001 Nigeria 2003 Turkey 2003 Kenya 1998 Malaysia 2001 Thailand 2002 Peru 2002 Mexico 2000 Chile 2003 South Africa 2000 Brazil 2002

Source: Williamson et. al (NBER, 2007)

Gini

26.0 27.3 28.1 30.3 31.2 32.2 32.6 33.0 34.3 34.6 35.9 37.4 39.9 41.0 41.6 42.1 43.6 44.4 47.9 50.9 52.0 53.8 54.6 57.3 58.8

Mean Income ($, PPP)

21,060 15,660 21,600 18,600 20,820 3,360 1,920 15,270 3,210 540 18,750 19,830 23,310 450 3,450 900 6,600 1,350 7,800 6,390 3,690 7,230 10,110 4,410 4,170

Where is China on “Kuznets Curve”?

Latin America

Anglo-Saxon

Continental Europe

Scandinavia

Source: Glaeser (NBER WP 2005)

The top 10% income share: China vs. US

Note: In comparison, the top 10 percent of earners in the U.S. saw their share of overall income rise from 27 percent in 1966 to 45 percent in 2001. Source: Nancy Qian (2004)

But we certainly hope China will not… Latin America

Source: Glaeser (NBER WP 2005)

Inequality and Growth: Theoretical discussions 

Negative relationship 



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The median voter model (Persson and Tabellini,1992): High inequality leads to higher tax and more redistribution in democracy, thus hurting investment and growth Sociopolitical unrest model (Alesina and Perotti,1996, etc.): Social/political instability brings investment uncertainty, and escalated unrest, or coup, or even revolution, hurts property rights and other market institutions

Positive relationship  

People with higher income tend to save more, and it leads to higher investment and growth Rising inequality is a result of correction of past incentives distortion (in most transition economies), so higher inequality is positively correlated with faster economic growth

Inequality and Growth: Empirical findings 

Most cross-sectional regressions confirm the negative relationship (PT 1992, etc. ), but they do not directly address the dynamic relationship between inequality and growth within a given country



Panel data regression with control on country-specific effects cast doubt on the negative relationship Forbes (AER, 2000) finds positive relationship  Barro (2000): negative when per capita GDP is below $2000 (1985 $), and positive when per capita GDP is above $2000 

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Critique: the time lag of growth variable was chosen very arbitrarily: 5-year (Forbes 2000), 10-year (Barro 2000), 20-year (PT 1992)

Does China have a choice? 

Grow out of poverty and let inequality run its natural course But the social-unrest model’s prediction is quite ominous  Government will have hard time persuading poor people to only look at their own past (everyone has gotten richer) and not to compare with their peers  (Fogel 2005): CCP IS aware of the high inequality and its consequences and measures have already been taken 

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Or kill growth prematurely for the sake of lower inequality But China’s CCP builds its legitimacy on high growth  It’s a very delicate balance 

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Jefferson’s view from the perspective of sustaining China’s high economic growth. I call it “one-stone-two-birds-strategy”

China's regional and sectoral productivity distributions in relation to coastal industry, 2004 region

industry

service

agriculture

coastal

1.00

0.67

0.24

central

0.76

0.34

0.20

northeast

0.94

0.51

0.20

west

0.72

0.27

0.12

Source: Derived from Jefferson, Hu and Su (BPEA 2006)

Source: Bosworth and Collins (NBER WP, 2007)

Re-allocating China’s surplus labor China Labor Force Share (% ) by Sectors 1978-2005 agricultural

industrial

services

80 70

60 50

40 30 20

10 0 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: NBS and author’s own calculation

Sources of China's Economic Growth by Sectors, 1978-2004 contribution of: Output

Employment

Output per worker

Physical capital

Land

Education

Factor productivity

4.6 5.2 3.7

0.3 0.9 -0.6

4.3 4.3 4.3

2.3 2.5 2.1

0.0 -0.2 0.2

0.2 0.2 0.1

1.8 1.8 1.8

10.0 9.3 11.0

3.1 4.4 1.2

7.0 4.9 9.8

2.2 1.5 3.2

0.2 0.2 0.2

4.4 3.1 6.2

10.7 11.3 9.8

5.8 6.5 4.7

4.9 4.7 5.1

2.7 1.8 3.9

0.2 0.2 0.2

1.9 2.7 0.9

Agriculture 1978-2004 1978-1993 1993-2004

Industry 1978-2004 1978-1993 1993-2004

Services 1978-2004 1978-1993 1993-2004

All numbers are percentage rate of change

Source: Bosworth and Collins (NBER, 2007)

Coastal industries have the highest productivity but the convergence already started to happen across regions

Source: Jefferson, Rawski and Zhang (2007)

China’s Productivity in International Perspective Industrial Labor Productivity at the International Frontier and in China, 1995 and 2002 Region Year

Coastal

Northeastern

Central

Western

market exchange rate

PPP

market exchange rate

PPP

market exchange rate

PPP

market exchange rate

PPP

Ratio of productivity in China to frontier productivity

0.12

0.29

0.06

0.16

0.04

0.10

0.03

0.08

2002 Ratio of productivity in China to frontier productivity

0.23

0.59

0.11

0.28

0.13

0.32

0.09

0.23

1995

Calculate national-average of regional ratios weighted by the employment-share of each region, we get ratio on national level: 1995: LP_China/US = 0.19 2002: LP_China/US = 0.43 But using national PPP tends to overestimate China’s labor productivity in manufacturing.

Labor Productivity International Comparison using Industry-level PPPs

Source: Ren (2006)

Inequality and Income

Source: Barro (2000)

Robert Fogel’s assumption 2000-2040 Population growth on average: China 0.2%, US 0.8% per year GDP growth on average: China 8.4%, US 3.8% per year.

Catch-up year: 2044

Robert Fogel’s assumption 2000-2040 Population growth on average: China 0.2%, US 0.8% per year GDP growth on average: China 8.4%, US 3.8% per year.

Catch-up year: 2023

Due to changing exchange rate, the catch-up year should fall between year 2023 and 2044.

More on catch-up prospect

Is inequality bad for China’s economic growth? 

Yes, in the sense that in order to achieve highsustained economic growth for another 30 years, China will need to rely more on sources offering faster growth potential:  



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Services sector Regional growth convergence, i.e., more balanced growth

However, China’s policy makers should avoid intervening too much in the already highly governmentcentered economy And good luck on finding the optimal balanced path between inequality and growth

Un-presented ‘secret’ slides

China’s urban-rural gap will last for a while…

Source: Albert Kiedel (Carnegie Endowment, 2008)

China’s SOE restructuring

Source: Deng, Haltiwanger and McGuckin (TCB WP, 2007)

Sources of Future Growth I 

Lewis model predicts more labor will move out of agriculture and productivity tends to rise over time  

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Less surplus labor leads to higher productivity Land reform (currently in experiment) and more clearly-defined property rights will also increase labor productivity

But agricultural labor force will be shrinking at the same time, so don’t count on agriculture on China’s future economic growth

Sources of Future Growth II 

The labor productivity of those who moved out of agriculture will rise. The productivity growth due to labor reallocation will continue to be one of the main sources of China’s economic growth

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More urban labor have moved out of industries and into services sector in the past, and this offsets the labor inflow from the rural area. This trend will continue. On net, during past 30 years, we have only seen moderate employment growth in industries

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China’s labor productivity growth in industries will continue to be strong, but the productivity growth in coastal area will be slower than in other regions

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The biggest growth potential and productivity gains could come from more efficient allocation of labor and capital. This requires government to retreat from making investment decisions on behalf of individuals and firms

Sources of Future Growth III 

Services sector will witness the largest employment growth in coming decades

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China needs to quicken its steps to introduce more foreign competition into its domestic sectors, especially in services sectors

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In the short run, due to current financial crisis, the speed of this structural change, from industries to services, will pick up

Potential problem of using labor productivity to infer on income

Source: Chen, Wu and Van Ark (TCB Working Paper, 2008)