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China’s War on Inequality

BEIJING – A major new target in the “Five-Year Plan for Economic and Social Development” that China just unveiled is to boost the growth rate for household (disposable) income so that it equals the growth rate of the country’s GDP. The reason is simple: over the past 10 years or so, China’s household income grew more slowly than GDP, making it a smaller and smaller proportion of total national income.

Many important structural problems have resulted from this trend. Lagging household income has held back private consumption, even though the economy has the capacity to produce more consumer goods. It has also driven up corporate savings, because firms’ earnings are growing faster than household income and (and, for that matter, faster than overall GDP). That, in turn, may cause higher investment or asset bubbles, as businesses seek to reinvest their savings somewhere. And lagging household income clearly contributes to China’s trade surplus, because low domestic consumption tends to keep exports higher than imports.

But there are even more problems related to China’s disproportionately small household income, particularly growing income disparity. Indeed, not all of China’s “households” have benefited alike from rapid GDP growth. Some social groups, such as skilled workers, engineers, and financial-sector employees, have seen their wages rise strongly. Urbanites – people with formal registration as urban residents – have recorded income gains as well, owing to their coverage by the government-run education system and social safety net. And, as corporate profits have grown, those who share the capital gains in one way or another have also seen their incomes increase faster than the national average.

Those with less education, however, such as migrant workers and farmers, have fared much worse. The former earn an annual salary (including fringe benefits!) totaling $2,000; the later may earn only half that. They comprise, in roughly equal parts, the low-income workers who account for up to 65-70% of the total workforce. Their average income has grown, but more slowly than the 8-10% annual GDP growth rate of the past 20 years.

The target set by the new five-year plan is thus also a policy manifesto to battle these social disparities, which are now a burning issue for the country. But why did these disparities arise in the first place?

Thirty years ago, 80% of China’s labor force was composed of farmers. But, while that figure is down now to about 30%, rural education has continued to suffer from inadequate funding and human capital relative to urban, industrializing regions. That caused rising inequality between the urban privileged and the rural poor. Geographical differences and government social policies that have been more favorable to urban and industrial sectors may be also be to blame.

But the most fundamental problem is that development does not take place overnight. It takes a long time to bring education and better-paid jobs to everyone. During this long period, some get rich first, which means that others lag behind.

Thirty years of rapid growth brought only half of China’s famers (about 200 million people) into the industrial or service sectors, where their wages doubled. But at least another 150 million famers are still coming into the labor market, competing for higher-paying jobs.

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The old generation of farmers may stay put, but younger generations will continue to leave the land, creating a seemingly infinite supply of labor, which suppresses wages in all industries and services for lower-educated workers. As a result, the income of almost 70% of the labor force cannot increase as fast as their labor productivity, and average household income thus cannot grow as fast as the economy as a whole. Given China’s massive stock of “surplus labor,” this trend will not reverse itself soon. Indeed, the situation may worsen for another decade or two before it improves.

This is why the government wants to intervene. In recent years, the central government has increased its spending on rural compulsory education and poverty relief, and local governments have changed regulations to increase the minimum wage by 20-30% in all 30 provinces.

In the next five years, more efforts in that direction are planned. The social-security system is to be extended to cover all workers and farmers. Fiscal and taxation reform is to be accelerated in order to transfer more income from the corporate sector to households and public budgets for social programs, including low-rent housing for the urban poor and more and better services for new immigrants from rural areas.

But none of this will solve the problem. The best a government plan can do is to prevent the worst. Government subsidies may (temporarily) redress income disparity in a developed country where farmers account only for 2% of the labor force, or in a country in which low-income groups count for only 10% of the total population. But in China, where farmers make up 30-35% of the labor force and 70% of the population falls into low-income categories, government can play only a marginal role.

In such circumstances, the old adage that the best social-welfare program is economic growth is all the more applicable. All the lessons from developing countries from the 1950’s through the 1980’s, and recent lessons from some advanced developed countries, tell us that over-burdening social programs with too great a focus on redistribution may cause large fiscal deficits, debt crises, hyper-inflation, or financial meltdown, with the end result being not a narrowing of disparity but an enlargement.

China must keep these lessons in mind over the next 20-40 years. Indeed, continued growth and job creation is the only real solution for lifting hundreds of millions of Chinese out of poverty permanently.

Fan Gang is Professor of Economics at Beijing University and the Chinese Academy of Social Sciences, Director of China’s National Economic Research Institute, Secretary-General of the China Reform Foundation, and a former member of the Monetary Policy Committee of the People’s Bank of China.

Copyright: Project Syndicate, 2010.

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