China Center for Contemporary World Studies

China’s Income Distribution: Completed and Uncompleted Missions
From:Xinhua Wenzhai (Issue 2, 2014) | 07-14-2014 | By:Cai Fang visitors:544

When discussing how to improve the policy on income distribution, people often argue about a theoretical question on the relationship between equality and efficiency, centering on prioritizing which one, the former or the latter. The policy problem regarding the debate is to attach more importance to the primary distribution field or the redistribution field when handling the problem of income gap widening. However, behind such debates, we should identify the actual conditions of China’s income distribution, continuation or slowdown of income gap widening in China. Only after reaching more consensuses in the above aspects, we can gain the beneficial conclusions in some crucial problems, namely how to reduce the income inequality.

I. A Rethink of Relationships between Equality and Efficiency

Strictly speaking, when Confucius stated, “people do not worry about poverty, but rather about the uneven distribution of wealth,” he didn’t emphasize “not worry about poverty” but put stress on “rather about the uneven distribution of wealth.” Therefore, his thought doesn’t contradict our ambition of making and properly distributing big cakes. Actually, according to Chinese or foreign histories, even though making big cakes is not the sufficient condition of properly distributing cakes, undoubtedly, it is the necessary condition. For example, in the first decade of 21st century, some countries in Latin America, such as Brazil, achieved good performance in economic growths and accordingly, those countries’ Gini coefficients dropped remarkably. However, since the 1970s, the US economic growth has been slowing down dramatically in addition to some policy deviations and increases of poverty rate, which widens the residents’ income gap. As a result, the USA becomes the one with the most uneven income distribution and the largest Gini coefficient among all developed countries.

In contemporary China, most people are aware of the close connection between income distributions and policy inclinations. Thus, the discussion on equality and efficiency has lasted a long time. With the elapse of time and changes of income distribution status, various viewpoints oppose each other and the furious debates frequently occur.

Equality and efficiency has become a topic of argument that focused on the equalitarianism and the shortage of incentive mechanisms in the planned economy originally. Then, there existed a widespread phenomenon of “extreme equalitarianism” that made the way of becoming rich inaccessible legitimately and practically. Hence, Deng Xiaoping set forth a goal of “getting some people rich first and then leading others to achieve the common wealth” in the mid 1980s. Correspondingly, an official presentation of “giving priority to efficiency and concurrently taking into account equality” took shape in theory. Since it was proposed at the Third Plenary Session of the 14th CPC Central Committee in 1993, the presentation has become a widely accepted consensus for a comparatively long time. It aims at removing the traditional institutional disadvantages of then popular extreme equalitarianism and emphasizing the prioritization of efficiency. Great efforts are made to establish the incentive mechanism that plays an active role in arousing employees and entrepreneurs’ enthusiasms.

As the production factor market mechanism becomes the basic methods of resources allocation and income distribution gradually, the income gaps between different regions, cities and rural areas, departments and social members got widening and then, people began to attach importance to the equality of the income distribution once again. Especially, some institutional factors led to the irrational income gaps and even resulted in the polarization between the rich and the poor. Therefore, many people suggested the policy pay more attention to the equality. Those suggestions were also reflected in the government’s presentations on the relationships between equality and efficiency. For example, in the report of the 16th CPC National Congress, the new presentation was, “the primary distribution attaches importance to efficiency but the secondary one values the equality,” which denoted the government pledged to improve the adjustment function of income distribution and narrow the excessively wide income gap. After the 17th CPC National Congress, the official presentation became increasingly clear to state, “both primary distribution and redistribution focus on proper treatment of relationships between efficiency and equality and meanwhile, the redistribution attaches more importance to equality.”

The general discussions usually reflect most people consider the efficiency and equality contradictive and believe it is impossible to obtain both them simultaneously. Actually, the theoretical tradition stemmed from the Equality and Efficiency: The Big Tradeoff by Arthur M. Okun published in 1975. However, in the Chinese version of the book, the subtitle was mistranslated from “The Big Tradeoff” into “Zhong Da Jue Ze (meaning “the big choice” in English)” that implies that both of them can’t be got simultaneously.

Such an understanding that equality and efficiency are incompatible with each other may mislead people, make policies inconsistent or even lead to the polarization-prone income distribution policies, which could undermine the coordinative role of primary distribution mechanism and redistribution policy. Furthermore, it may result in the replacement of social distribution policy with populism policy. In some countries, it may brought about disastrous results and generate the significant deviation of policy’s purpose from its result.

The misunderstanding may mislead the formulation of some income distribution-related policies. Essentially, the primary distribution and redistribution cause the different income gaps so they need collaborate with each other. However, if we regard efficiency and equality incompatible, a tendency of ignoring redistribution policy intentionally in the name of valuing efficiency will occur, or a situation under which great attention is only paid to redistribution policy but few concerns are expressed about the income gaps generated in the primary distribution may take shape. Both of them impact the effective solution of income distribution problems.

Both efficiency and equality are the goals of development. To ensure the efficiency is the keynote to arouse the enthusiasms of economic development players and also the core issue to set up the effective incentive mechanism. At the same time, the equality is the final goal of economic development and also the ruler to measure the efficiency. Fundamentally, efficiency and equality are not inconsistent with each other. On the prerequisite of pursuing high efficiency, if we want to provide the equitable distribution with the material base and share the fruitful results of economic development, we have to make the cake bigger. Only through ensuring the equality of distribution, we can achieve the high efficiency and have efficiency fulfill its final goals. However, both efficiency and equality each have different emphases so it is impossible to make them balanced automatically.

To pay same attention to both them, we should select the different priorities and policy favorites based on different times, different development phases and different main contradictions under the scientific outlook on development. Then, what are the most prominent problems facing China in the current income distribution, where do the difficulties lie when reforming the income distribution system, where should we make breakthroughs when advancing the reform and where can we achieve the substantial results? In the following article, we will discuss those questions based on the combination between the general rule of income distribution and the special contradictions of China.

II. Opposite Factors That Influence the Income Distribution

Simon Kuznets, a Nobel Prize Laureate in Economics, once had a famous observation that the income gap widens with the economic development but narrows after an inflection point. The observation was called “Kuznets inverted U curve” (Kuznets, 1955). Up to now, different experiential researches that corroborate or negate the observation all coexist so the relationship between economic development and income distribution summarized by Kuznets can only be regarded as a hypothesis to the greatest extent. We must acknowledge that there are various factors influencing the income distribution and they are totally different according to the state’s economic system, development phase and policy orientation. Thus, even though the development trend similar to the Kuznets’ observation exits, it must show in numerous forms.

With the change of China’s economic development phases, the income distribution pattern also experiences some corresponding change trends. Generally, the changes of income distribution conditions are mainly influenced by three factors that can widen or narrow the income gap. Each factor has different relative impact strengths so their integrated impacts bring about the specific change curves.

First, with the labor market maturing gradually, laborers’ collective or individual differences in human capital cause the division of income levels that widens the income gap. In a sense, such an effect is beneficial to stimulating enthusiasms for labor and education. The economic growth process accelerated by reform and opening up is by no means a simultaneous nationwide growth process so different regions and people may embrace different opportunities of economic development. Thus, the improvement of income level must experience different speeds. Although in the same opportunity, the differences of family conditions, ages, genders and education backgrounds of laborers also cause the different abilities to grab opportunities to increase incomes and even become rich.

The most popular topic among economists, the rate of return to schooling, is used to measure the income gap caused by the different human capital and generally, is indicated through the percentage of income growth brought about by one year more education. Such a return from human capital includes personal return got by the individual of labor and the social return gained by the society. Given that the salary is not decided by the labor market, the laborers’ human capital also generates additional values but most of them are gained by the society rather than the individuals. Under such a situation, the remunerations to laborers are short of incentive effects and can neither stimulate the innovative work nor encourage people to accept more education.

According to Figure 1, during reform and opening up, as the corporation establishes internal incentive mechanisms and the labor market matures and improves, the human capital produces personal returns and the personal returns’ proportion to all returns from education (total social and personal returns) tends to increase. For example, according to results calculated by Chinese scholars with micro-data, the personal return rate from education rose from 1.2% in 1989 to 2.2% in 1993, 3.8% in 2000 and 8.9% in 2006 (Wang Zhong). Actually, it doesn’t mean the return rate of human capital is increasing year by year but indicates the individuals are gaining more shares of all returns from human capital. Such changes are brought by the development of labor market undoubtedly. Although the income gap between laborers is widening, it has some incentive functions in general.

However, the increase of personal return rate also leads to the widening of income gap. Some scholars found the education return rate of high-income people is much higher than that of low-income ones. However, the former has inherent advantages in obtaining education opportunities for the institutional reasons. For instance, due to the uneven distribution of public education resources, the metropolises embrace more education opportunities and higher education quality than small and medium-sized cities and rural areas. Furthermore, the high-income people enjoy more social relations and even privileges so as to have their children get higher quality education resources. The income gap arising from it is not unfair morally and the efficiency is low in terms of education investment and development. Additionally, it may result in the generation-to-generation poverty transmission.

Second, as the employment scopes of urban and rural residents are expanded and especially, the nonagricultural sectors’ employment opportunities increase for the rural laborers, with the income gap between urban and rural areas narrowing and the income distribution improving as a whole. The original employment and development opportunities are usually taken by people with strong human capital, but more and more laborers will get benefits with the increase of employment opportunities.

During reform and opening up, in general China lies in a development phase of dual economy, which means a large number of surplus laborers transform their employment choices from agriculture to nonagricultural sectors and the labor participation rate continues increasing. As a result, more and more ordinary families and laborers can share the fruits of economic growth. The wages-based jobs that are taken by migrant workers and provide higher incomes than farming can relieve the poverty in general. They may not narrow the income gap between urban and rural areas but rein in the widening of income gap. The land-equalization system-based household contract system guarantees the labor flow is a voluntary choice to pursue higher incomes and better lives. Therefore, even if the rate of wage keeps unchanged, the expansion of labor flow size can remarkably increase the incomes of rural families. The labor flow’s effects on raising rural families’ incomes and narrowing the income gap between urban and rural areas can be observed in the following three aspects.

Initially, we study the labor flow’s effect on reducing poverty. Except for those families with insufficient labor or defects of employability, many poor families’ poverty is due to the insufficient employment. Furthermore, according to the past studies, the nonagricultural employment opportunities of rural areas are usually taken by people who have outstanding technologies or influential family backgrounds but most poor families can’t grab such opportunities. Hence, the out-migration for work brings more opportunities to earn higher incomes. According to the research, the poor rural families may increase per capita net incomes of family by 8.5-13.1% through the out-migration for work (Du et al., 2005).

In addition, we study the contribution of incomes from wage and salary to the rural families’ income increase. According to the statistics by the National Bureau of Statistics, the net incomes of rural families consist of four parts, namely income from wage and salary, net income from family’s business, income from property and income from transfer. The increase of opportunities of out-migration for work significantly promotes the rural families’ incomes from wage and salary. To raise the proportion of the incomes has become the main source of rural families to increase their incomes. According to the official statistics, the proportion of rural families’ incomes from wage and salary increased from 20.2% in 1990 to 42.5% in 2011, in which year the contribution of incomes from wage and salary to the growth of farmers’ net income accounted for 50.3%.

Actually, the existing statistics system fails to cover a majority of incomes from out-migration for work. As the official statistics system comprises urban and rural parts, rural families of which all members immigrate into cities or migrate from rural areas for work were excluded from the urban census or rural census. Therefore, the incomes of migrant workers have been underestimated to a large extent. Some local surveys indicated the problems existing in the permanent residential household sampling and definition in the official statistics system caused the urban residents’ disposable incomes were overestimated by 13.6%, the rural residents’ net income underestimated by 13.3% and the income gap between urban and rural areas overrated by 31.2% (Gao Wenshu, et al, 2011).

The labor migration will lead to the elimination of the characteristics of limitless labor supply in the development phase of dual economy. A milestone inflection point is the Lewisian Turning Point. This point doesn’t refer to the absolute shortage of labor but indicates the labor will be short if the wage doesn’t rise substantially. Therefore, after the Lewisian Turning Point, the migrant workers’ contributions to rural families’ incomes will significantly increase so as to narrow the income gap between urban and rural areas. As one of important factors causing China’s income inequality is the income gap between urban and rural areas, the narrowing of income gap between urban and rural areas must lead to the improvement of income inequality.

Third, such problems arising during reform and opening up or temporary phenomena appearing in some special phases of reform and opening up as have resulted in widening or being not able to narrow the income gap can be resolved only through deepening the economic reform and reform of social policies. To enhance the utilization efficiency of natural resources and asset stocks, some state-owned assets have been privatized during the system transformation, including numerous mineral resources transferred to individuals or groups and rights to derive benefit from land going to individuals or corporations. As a result, various resources and assets were divided and allocated to individuals or groups from the status of nominal state ownership and actual non-ownership in order to generate individual incomes.

The allocation of such resources and assets is short of supervision and involves many irregular, nontransparent and even illegal conducts. Thus, the subsequent benefits are often of the nature of gray incomes and distributed in the extremely uneven way, constituting the major factor widening the income gap. According to several scholars’ estimation, had various hidden or gray incomes been added to the current statistics in 2008, the re-estimated per capita disposable income of urban residents would have been 3.19 times the statistics and furthermore, 80% of such incomes would have been owned by the 10% highest-income groups (Wang Xiaolu, 2011).

III. Deep-rooted Systemic Reasons for Income Inequality

It is an important judgment whether China has encountered the Kuznets’ inflection point. However, this problem is widely argued over in the academia and policy research circle and actually, there are some factors making us unable to make a conclusion of “yes” or “no.” According to official statistics released by the National Bureau of Statistics, we select the income gap between urban and rural areas and national residents’ Gini coefficient to delineate the change trend of income distribution structure. In general, the income gap has experienced a relatively-long-period widening. Only after China’s economy reaches the Lewisian Turning Point or encounters the shortage of laborers and salary hike, the widening of income gap will be restrained or the income gap will begin to narrow (see Figure 2).

However, given that the statistics show the above trend, the society of China widely pay great attention to the income distribution and people don’t sense the remarkable improvement of distribution status. To exactly depict and understand the actual change trend of income distribution, we can divide the existing income gap into two levels: first, the income gap of labor markets; second, the social income gap. According to the aforesaid description, the income gap of labor markets is narrowing, which is in line with the expectation of Kuznets inverted U curve. However, the social income gap doesn’t appear to be basically reversed.

Hence, the problem lies in the difference between income gaps of two criteria and mainly results from the uneven distribution of essences outside the labor. Almost all foresighted people believe that the inequality of income distribution is one of latent social risks in the future. Actually, according to Figure 2, we can raise two important questions on the income distribution system.

First, the trend in the Figure doesn’t include the distribution of gray incomes excluded by the statistics. Would the factor be added, it could be predicted the fundamental reversion hasn’t occurred. This special reason for the uneven distribution also indicates the key field of reform. Based on the nature of residents’ samplings, the samples in the statistics are mainly made up of labor income and legally obtained property and transfer incomes. However, the gray incomes are not covered by the statistics so we can add the anticipated gray incomes into the residents’ income (Wang Xiaolu, 2011) to observe the change trend of income distribution. Under the necessary and rational hypothesis, we can get a kind of symbolic and probable scenario according to the following methods.

Second, we take the statistical per capita urban income as the basis point and all gray incomes are added into different years according to their own growth speeds (mainly at least 10% and at most 10% groups are used here). Up to 2008, the proportions of gray income in different groups had been as same as those gained by Wang Xiaolu’s surveys, and were estimated according to the same growth rate by 2010. In the same way, we reevaluated the urban per capita disposable income calculated as per the unchanged price of 1978. As our goal is to observe the change trend of income distribution after the gray income is added and we don’t take into consideration the height of incomes of different groups, this hypothesis is reasonable. Then, we calculate the ratios of at most 10% income group and at least 10% income group and compare the results with those got through the statistics (see Figure 3).

It is worth noting that we don’t negate the accuracy of per capita incomes of statistics and needn’t agree with the specific quantity level regarding the gray income estimation. The said simulation will be meaningful only through clarifying two issues: first, there are a large number of hidden incomes affecting the actual income distribution in the case of excessively nontransparent, irregular and uneven allocation of resources and assets; second, according to the theoretical estimation, the inequality of income distribution should be exacerbated and there won’t appear a trend of income gap narrowing after the omitted gray incomes are added into the statistics.

IV. Fulfilling Uncompleted Supporting Reforms

If we theoretically consider the Kuznets’ inflection point reached and neglect the actually existing severe inequality and its ensuing social response and economic results, the research pertinence of policy will be downgraded. If we only see the reality of income gap’s existence but don’t understand the cause, we may also be led to the wrong policy direction. For instance, we can’t reveal that the main reason causing the widening of income gap is the uneven allocation of resources and assets, the policy may be misled to the wage equalization and excessively rely on the redistribution of labor remuneration-based regular incomes, which will not only fail to touch the groups who improperly possess a large number of resources but also impair the middle-income earners and ignore the disadvantages and latent risks caused by the severely uneven allocation of resources.

Since the main reason for the continual exacerbation of China’s income distribution lies in the severe inequality of allocation of incomes from properties and assets, the solution of income inequality should focus on three aspects of increment, stock and income flow. To address the inequality due to increment should concentrate on the legislature and law enforcement during the development of land and mineral resources in order to avoid the interference of power in system through standardizing the procedure. To prevent the exploitation of farmers’ interests during the urbanization of rural land, the ownership of contracted land and homestead should be identified as soon as possible in order to prohibit the infringement of farmers’ properties in any forms. To prevent state-owned assets from going to any individuals or groups, it is necessary to identify and strictly define the properties and standardize the transfer of properties. The more fundamental solution is to minimize the leaders and cadres’ individual resource allocation power and reinforce the supervision and anti-corruption. To resolve the irrational stock generated due to the irrational distribution should concentrate on the utilization of tax collection with an aim at promulgating legacy and housing property taxes regulating the income distribution as soon as possible. It is encouraged and urged to make employees hold shares, which may also equalize the assets to some extent. To resolve the income flow caused by the uneven possession of resources should phase out the China’s tax characteristics of overweight indirect taxes and excessively low direct taxes, raise the progressive nature of tax system and effectively regulate the excessively high incomes.

Furthermore, the system construction with long-term effects should be carried out in the following aspects. First, the change of labor market plays an important role in the improvement of income distribution. The arrival of Lewisian Turning Point creates the basic condition for narrowing the wage and salary income gap. It is an important approach for improving the income distribution to increase jobs, equalize the employment opportunities and raise the labor participation rate. However, the substantial narrowing of wage and salary income gap lies in a series of labor market system, including government’s labor law and regulation, such as establishment and improvement of minimum wage, labor union and collective bargaining systems.

In addition, the government’s redistribution policy on income allocation and people’s livelihood improvement will still play an important role in narrowing the income gap. The government pays great attention to the achievements of policy on people’s livelihood but some achievements will also be undermined by the inequality of resources allocation. Thus, the policy on improvement of income distribution should be substantially adjusted. It means that while continual efforts are made to boost the implementation of various policies equalizing achievements, more attention should be paid to the elimination of vested interest groups’ interference in the income distribution policy in order to make the resources allocation, possession and use free from the interference of power and achieve the equality of opportunity.

Third, the development of more tolerant and equalized education is the fundamental method to narrow the income gap and prevent the generation-to-generation poverty transmission. To improve the whole people’s quality and labor skills, more attention should be drawn to the equality and equalization by means of resolving the inequality of education opportunities between urban and rural areas, among different regions and within various interested groups. The globalization and technology progress potentially tends to repel the low-skilled laborers and thus, the all-round improvement of education level and continuous promotion of human capital of labor groups are the most effective method to prevent such repellence.

Last but not least, the government’s efforts in improving the income distribution should be focused on the proper balance between economic growth and redistribution policy. China’s excessively wide income gap and excessive debt in basic public services demand the great improvement of redistribution of government’s existing public services in the near future. Especially, the equalization of basic public services needs the government’s more active and leading role. However, it is an inevitable important target to keep the economic growth proper. The implementation of redistribution policy should effectively regulate the high-income groups, cultivate the middle-income groups and improve the living conditions of low-income earners according to law and meanwhile, great efforts should be made to prevent the randomness of policy, and avoid impairing labor employment, rational consumption, capital accumulation and investment enthusiasms.