Blog 4: Fixing China's Harmful Inequality

            In the article “Fixing China’s Harmful Inequality”, Yukon Huang from the Wall Street journal wrote about how China recently announced a plan to deal with rising inequalities. He said that there was a problem reaching a consensus and that the debate was unusually broad, ranging from the need for property taxes and agricultural support prices to the role of the state in influencing returns to firms and labor. It is not clear as to how this plan will effectively tackle inequality because of the lack of detail and firm targets.

            China’s economy has rapidly grown, which has caused widening disparities. Their growth has lifted about 600 million people out of poverty even as its Gini coefficient, which is a measure of income inequality, has soared to 47% today from 25% in the mid 1980’s. Despite the high statistics, China’s Gini is still comparable to that of the U.S. and other successful Asian economies such as Singapore and Malaysia. Huang gives an explanation about the significance of the Gini number, “The Gini number is less important than the reasons behind it. Inequality is positive when it emanates from productivity increases, entrepreneurial risk-taking and structural changes that produce sustained growth. Harmful inequality comes from distortions that ultimately undermine the development process. It is the latter kind of inequality that Beijing has been slow to address. First, policy distortions have exaggerated geographical disparities. Second, the government budget has failed to provide equal access to social services. And finally, links between government-party officials and commercial activities have led to excessive rent-seeking.”

            China’s geographical inequality is actually extreme when compared to other countries. Their per capita urban incomes are more than three times that of rural residents, and coastal incomes are more than twice of the interior. Some of blame can be because of the fast industrialization that has been going on along the coast of China. You could also blame the policies such as restrictive residency system known as hukou. Hukou prevents more than 200 million migrant workers who have flocked to the major cities from gaining access to social services and jobs on the same basis as established residents. This exacerbates urban to rural and regional income disparities. The new plan has an intention to liberalize the hukou system.

            For a socialist economy where the state controls the bulk of resources, the budget plays a limited role in providing the level of social services needed to moderate rising disparities. China’s budget as a share of the economy is only two-thirds that of the other middle-income countries, and half that of the European Union, and as a result welfare spending has been inadequate, amounting to about half the level of comparable middle-income countries. Huang explains why budget plays such a limited role, “The limited role of the budget reflects, in part, a failure to secure more revenue from the state enterprises that control much of the country's resources. Their profits have soared over the past decade given their favored position, but compared with other countries, China's state enterprises pay much less to the state in the form of dividends. Even these modest amounts were largely allocated to other firms for investment rather than made available to the budget for social services. Thus, the proposal to increase payments by five percentage points is welcome, although this would still be quite low compared to other countries.“

            Another source of harmful inequality is the linkage between the government-party apparatus, state banks and enterprises. This leads to corrosive practices ranging from clear cases of corruption to grey areas where conflicts of interests and earnings built on relationships generate excessive incomes. Senior leaders recognize that these issues threaten the legitimacy of the political system. The new plan focuses on the symptoms of this problem by demanding that officials report their income and assets. Huang explains that there is much more needed to tackle the underlying causes and that at this broadcast level, dealing with China’s bad inequalities will require a change in the mindset regarding the importance of the rule of law, that is something highly unlikely to happen quickly.

            Reforms to labor migration and divided policies could go a long way toward eliminating bad inequalities. For example, channeling one-third of the overall profits of state enterprises to the budget to fund social services for households would help provide the resources necessary to equalize the quality of such programs across regions. This combined with eliminating hukou restrictions might increase household consumption by several percentage points of GDP. These reforms would dramatically affect the nature of global macro imbalances by increasing China’s imports. Dealing with the harmful sources of income inequality not only addresses a social concern, it also offers a way to reduce trade tensions between China and the West.    

Article Link: http://online.wsj.com/article/SB10001424127887323549204578317633183827770.html