China’s war on inequality

China’s war on inequality

A new target in the “Five-Year Plan for Economic and Social Development" that China unveiled recently is to boost the growth rate for household (disposable) income so that it equals the growth rate of the country’s gross domestic product (GDP). The reason: 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 structural problems have resulted from this trend. Lagging household income has held back private consumption, 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 faster than overall GDP). That may cause higher investment or asset bubbles, as businesses seek to reinvest their savings. And lagging household income contributes to the trade surplus, because low domestic consumption tends to keep exports higher than imports.

But there are more problems related to China’s small household income, particularly growing income disparity. Not all of China’s “households" have benefited alike from rapid GDP growth. Some groups, such as skilled workers, engineers and financial sector employees, have seen their wages rise strongly. People with formal registration as urban residents have recorded income gains as well, owing to 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, such as migrant workers and farmers, however, have fared much worse. The former earn an annual salary (including fringe benefits) totalling $2,000; the later may get 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 labour force was composed of farmers. While that figure is down 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 favourable to urban and industrial sectors may also be to blame.

The most fundamental problem is that development does not take place overnight. It takes 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 farmers (about 200 million people) into the industrial or service sectors, where their wages doubled. But at least another 150 million farmers are still coming into the labour market, competing for higher-paying jobs.

The old generation of farmers may stay put, but younger generations will continue to leave the land, creating a seemingly infinite supply of labour, which suppresses wages in all industries and services for lower-educated workers. As a result, the income of almost 70% of the labour force cannot increase as fast as their labour productivity, and average household income thus cannot grow as fast as the economy as a whole. Given China’s massive stock of “surplus labour", this trend will not reverse itself soon. 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 programmes, 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 for 2% of the labour 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 labour 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 programme is economic growth is all the more applicable. All the lessons from developing countries from the 1950s through the 1980s, and recent ones from some advanced developed countries, tell us that over burdening social schemes 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. Continued growth and job creation is the only real solution for lifting millions 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, and secretary general of the China Reform Foundation

©2010/Project Syndicate

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