chapter  12
54 Pages

China’s income inequality at the provincial level: Trends, drivers, and impacts

Introduction The rising income inequality accompanied by rapid economic growth in China since it embarked on economic reforms in the late 1970s has attracted wide international attention, and there is now a large body of research aimed at measuring its magnitude, tracing its sources, and understanding the causal factors and policy implications. Three types of data have been used in this research: unit level household survey data, aggregate income data, and grouped household survey data. Due to the absence of consistent data sets covering the entire China,2 studies based on household level data often focus on a particular segment of the population, such as urban (Cao and Nee 2005; Meng 2004) or rural households (Gustafsson and Li 2002), for isolated years. Aggregate data, often in terms of average provincial income, have been used to investigate the spatial dimension of inequality in China (Hussain and Zhuang 1994; Kanbur and Zhang 2005). More recently, attempts have been made to study China’s income inequality by extrapolating unit-level data from grouped income data. Notable examples are Chotikapanich et al. (2007), Ravallion and Chen (2007), and Lin et al. (2008). Based on extrapolated unit-level urban and rural household income data of 23 provinces covering 85 percent of the Chinese population, Lin et al. (2008) found that the Gini coefficient of per capita income in nominal terms increased from 0.345 in 1990 to 0.456 in 2004 for China as a whole, similar to what was reported in most recent studies (Ravallion and Chen 2007; Li and Zhao 2006; He 2007). However, after adjusting for inter-provincial and between-urban-andrural cost of living (COL) differences, the national Gini coefficient was found to only increase from 0.287 in 1990 to 0.387 in 2004, 20 percent lower than the corresponding figures without the COL adjustment. Decomposing the COLadjusted national inequality into within-urban, within-rural, and between-urbanand-rural inequalities using the Theil index, the paper found that the absolute value of the three components all increased during 1990-2004; however, their relative contributions to the national inequality have evolved differently: while the contribution of the within-urban and between-urban-and-rural inequalities increased from 15.7 and 12.0 percent, respectively, in 1990 to 34.0 and 30.4

percent in 2004, that of the within-rural inequality declined from more than 70 percent in 1990 to about 36 percent in 2004. Decomposing the COL-adjusted national inequality into the within-provinces and between-provinces inequalities, the paper found that the contribution of the within-provinces inequality increased from 86 percent in 1990 to 89 percent in 2004, while the contribution of the between-provinces inequality declined from 14 to 11 percent during the same period. Based on these findings, the paper concluded that the rising income inequality in China during the past two decades has been largely driven by the increases in the within-urban and between-urban-and-rural-inequalities, and that increasing inter-province inequality was not a major source. Making use of the same data set compiled by Lin et al. (2008) and extending it to 2005, this chapter attempts to make three contributions to the literature on income inequality in China. The first is to provide more insights into the trend of China’s income inequality by looking at cross-province variations. Examining provincial level income inequalities enables us to clarify whether the relatively high level of income inequality at the national level, compared to its Asian neighbors, is partly due to the fact that China has a very large population, an explanation sometimes voiced in policy discussions. The second contribution is to identify underlying factors that have driven China’s income inequality during the past two decades, an issue which has important policy implications but has not been adequately researched and understood. Based on data for a panel of 30 Chinese provinces from 1996 to 2002, Wan (2007) tested whether there is an inverted U-shaped relationship between the level of income inequality and the stage of economic development, also known as the Kuznets hypothesis, at the provincial level, and also investigated other causal factors of rising income inequality. A key limitation of this study, however, is that it looked at the relationship between the income inequality as the dependent variable and a set of potential causal factors as explanatory variables for urban and rural populations separately, rather than as a whole, due to the unavailability of the provincial-level Gini coefficients covering the entire population. The data set on which this chapter is based allows an examination of causal factors of rising income inequality separately for urban and rural households, as well as for the entire population. The third contribution this chapter attempts to make is to examine how the rising income inequality in China has impacted on the outcomes of the country’s poverty reduction efforts. China has made significant progress in reducing poverty over the last three decades, as evidenced by the dramatic decline in rural poverty incidence measured at the official poverty line, from 31 percent in 1978 to 2.5 percent in 2005. However, poverty reduction remains a key challenge for China in the years to come. Although the proportion of population living before the official poverty line is now very low, the proportion living below the international poverty lines remains high. According to a recent study on global poverty by the World Bank based on the results of the 2005 International Comparison Program (ICP), in 2005, 15.9 percent of the Chinese population lived in poverty at a poverty line of $1.25-a-day (at 2005 PPP prices); at a $2-a-day, 36.3 percent

Chinese lived in poverty (Chen and Ravallion 2008). One of the reasons why income inequality matters is that increases in inequality could lead to increases in poverty and dampen the poverty reduction impact of growth. While growth generally reduces poverty incidence, the change in income inequality can either enhance or undermine such effect. Following the Datt-Ravallion approach, the chapter explores the impact of inequality on China’s poverty reduction, by decomposing the change in poverty from 1990 to 2005 into “growth effect” and “inequality effect” by province. The rest of the chapter is organized as follows. Section 2 describes the data. Section 3 introduces the methodology. Section 4 provides the estimation and decomposition of China’s inequality. Section 5 presents the results. Section 6 concludes.