Top incomes, inequality in China ‘massively underestimated,’ new study reveals

Shanghai, China (Credit: Jakob Montrasio / Flickr)

China’s economic miracle has long been hailed as one of the biggest contributors to the fall in the global rate of extreme poverty. But now that growth is slowing and the country is working its way out of the “middle income trap,” economists have turned their focus toward the sharp inequality that latched onto China’s stunning growth. According to a new study, it’s far worse than previously estimated.

December 1978 marks a turning point in China’s development, when the Communist Party led by Deng Xiaoping began to institute reforms that opened up China’s economy to the global capitalist market. This is where economists Thomas Piketty, Li Yang and Gabriel Zucman begin their re-evaluation of China’s inequality in a new paper published this week, which compares levels of inequality from 1978 to 2015.

According to the study, China in 1978 was as equal as the most egalitarian Nordic countries. However, China in 1978 was also utterly poor.

Home to 22 percent of the world’s population, it held less than 3 percent of global gross domestic product (GDP). This was partially due to the economic regression, three-year famine and systematic violence that killed tens of millions of people during the ultra-left Great Leap Forward, which preceded Deng’s economic reforms.

By 2015, China’s share of global GDP had risen to about 20 percent, appropriate for its population that was now about 19 percent of the world’s population. Its rapid rise stunned the world. However, it had also become more unequal than France, which is broadly representative of European inequality levels, and was approaching U.S. levels.

More specifically, the poorest 50 percent of France’s population earns about 22 percent of the country’s total income. In China, the poorest half earns about 15 percent, while the poorest half of the U.S. earns only 12 percent of total income. Wealth inequality estimates similarly placed China between France and the U.S.

Capital Accumulation, Private Property and Rising Inequality in China, 1978-2015:
Thomas Piketty, Li Yang, Gabriel Zucman

These comparisons are based on figures that the authors compiled from official and non-official sources, including national accounts, household surveys, wealth rankings and tax data, particularly on high-income individuals.

“To our knowledge, this is the first time that income tax data on high-income individuals is used to correct inequality measures in China,” the authors wrote.

Previously, studies of income inequality in China were based almost entirely on self-reported data in household surveys. But when the authors applied income tax law to self-reported income levels and income tax law, they found that the simulated income tax revenues were smaller than observed revenues. This indicated to them that the wealthy were grossly underreporting income, not unlike in other countries.

Capital Accumulation, Private Property and Rising Inequality in China, 1978-2015:
Piketty, Yang, Zucman

The authors noted that their revised estimates are imperfect – their estimates of top income share should be viewed as lower-bounds. Still, these numbers revealed that income inequality in China is far worse than previously estimated, and largely because the reported income share of the the top 1 percent was only about half of what it should have been.

Capital Accumulation, Private Property and Rising Inequality in China, 1978-2015:
Piketty, Yang, Zucman

Much of the wealth – and inequality – came from the housing system. In 1978, only about 50 percent of the housing stock was privately owned. But in the 1990s, the government began to sell its share at low prices. As real estate values quickly climbed, so did the wealth of those who initially invested, and so did inequality. By 2015, 95 percent of the housing stock was private.

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Although the government has given up nearly all of its housing share, they did not do the same with equity ownership of corporations. Almost 60 percent of it today is public, with about 30 percent of it in private Chinese ownership and 10 percent of it foreign ownership.

Today the total share of public property in China is around 30 percent – vastly different from most developed countries whose 15 percent to 25 percent shares in the 1960s and 1970s have now dropped close to zero percent, even negative in some countries like the U.S., U.K. Japan and Italy where public debt exceeds public assets.

“To put it differently: China has ceased to be communist, but is not entirely capitalist; it should rather be viewed as a ‘mixed economy’ with a strong public ownership component,” the authors wrote.

Though the subject is understudied, the structure of private versus public property has large implications for economic development, according to the report.

“For less developed countries, such as China, that often have weaker institutional capacities to collect taxes, it can be good if the government controls a certain amount of properties, so that the it can generate stable non-tax revenue to support its development,” Yang wrote in an email to Humanosphere.

But many studies also show that “for pre-communism counties, such as China, developing property right protection and private ownership is critical for its economic development,” Yang said.

The optimal mix, Yang said, is still unknown though certain sectors, especially the ones prone to monopoly like oil, are more suited for public ownership than private.

Norway – one of the most equal countries in the world – is one such mixed economy with a large public share in oil. Unlike China’s public share of property, which dropped from about 70 percent in 1978 to about 30 percent in 2015, Norway’s rose from 30 percent to 60 percent.

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However, China’s public share – which strengthened after the 2008 financial crisis – mostly has an “industrial/control dimension,” according to the authors. In contrast, Norway’s large public wealth is being used to generate more capital, which should in the long-run lower taxes for households and finance more public spending and welfare payments. Such public spending and welfare transfers are much more difficult for countries with negative public wealth.

But at the end of the day, if China’s poor were lifted up along with the rich, isn’t inequality a necessary evil?

China’s bottom 50 percent absolutely benefited from the country’s miraculous growth. According to the report, the average income of the poorest 50 percent multiplied by five between 1978 and 2015.

However, growth in that bottom 50 percent was still less than the average per adult national income, which multiplied by nine in that time. Even greater was growth among the top 10 percent, and even more so among the top 1 percent. Income among the top 0.001 percent in China multiplied by almost 40.

In China, the inequality is not just a disparity of wealth and income between urban and rural populations, either. Although the urban-rural gap in China has always been large and is growing, the study found that the rise in inequality had more to do with inequality within rural China and within urban China. In fact, inequality in rural China, they found, is even higher than within urban China.

Economists often cite Vietnam as proof that a country can develop quickly without sharp increases in inequality, and according to the World Bank, eradicating extreme poverty will be impossible if the level of inequality stays as it is today.

“I totally agree that to a certain extent, inequality is good/necessary for economic development,” Yang said. “The question is how much inequality in China is too much?”

Although the study emphasized that more transparency and data, particularly on high-income individuals, is critical to better answer that question, Yang said, “I think China is not the worst case regarding the increase of inequality,” given its high growth rate and compared to other countries like the U.S.

China’s inequality rose the fastest during the mid-1980s to the mid-2000s and has actually since stabilized in recent years. However, this should not necessarily be taken as a good sign, the study noted, as it may not stay this way in the future and also means inequality is not improving.

Of course, inequality can lead to social instability – a major concern for the Chinese government – but Yang also pointed out that it can hinder economic growth. A 2014 study by the Organization for Economic Cooperation and Development (OECD) found that not only does inequality hurt growth, but reducing it can boost growth.

As China attempts to work its way out of the middle income trap, that’s worth considering.

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About Author

Joanne Lu

Joanne Lu is a South Carolina-based writer and editor dedicated to global development, poverty alleviation and social justice. After a year in Rwanda, she now covers the Asia-Pacific and economics. Find her on Twitter @joannelu or email joanne@humanosphere.com.