China’s new goal for income distribution: Some insights from survey data back to 1981

Martin Ravallion, Shaohua Chen 15 November 2021

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Beyond the popular goal of ending poverty, national leaders rarely articulate a goal for the national distribution of income. In an exception, at a prominent and widely reported meeting in August 2021 of the Chinese Community Party’s Central Committee for Financial and Economic Affairs, President Xi Jinping argued that the goal of “common prosperity” for China required an “olive-shaped distribution structure of large middle and small ends” (as reported by the Xinhua News Agency 2021). In short, the proposed aim of the Chinese leadership is to “expand the proportion of middle-income groups” (Xinhua News Agency 2021), or what The Economist dubbed “fleshing out the olive” in an article reporting on President’s Xi’s speech. 

President Xi was clearly not saying that this is the only policy goal for China, even among goals related to the distribution of income. (Xi has often emphasised the goal of ending poverty.) So, the question naturally arises as to what trade-offs might exist with respect to other goals. That is a difficult question. Trade-offs can be hard to identify ex-post in observable data, which also reflect past shocks and policy choices (given trade-offs faced at the time). To see what historical experience suggests about trade-offs with regard to this new goal requires that we quantify attainments of the multiple distributional goals, including defining and measuring the idea of “fleshing out the olive” (Economist 2021). 

China’s well-documented success in reducing absolute poverty came, of course, with a rising share of its population living above official poverty lines (Chen and Ravallion 2021). Many of those who escaped absolute poverty joined China’s middle-class. Naturally, what this means depends on the setting. The prevailing definition of a middle-income group can be expected to change over time with rising living standards; what was considered a middle income in the China of the 1980s is clearly not the same today. “Fleshing out the olive” can be interpreted as reducing the spread of incomes relative to the current median, which may provide a more relevant reference point than a fixed absolute level of real income. 

This perspective suggests that the concept of polarisation as found in economics is relevant to monitoring China’s performance in “fleshing out the olive” and identifying potential trade-offs against other goals. And there is a measure available in the literature, namely the Foster-Wolfson (FW) polarisation index (Foster and Wolfson 2010). The greater the spread of incomes relative to the median (in either direction), the higher the FW index. What trade-offs might be found between this concept of polarisation and other goals for the distribution of income? And what does the time-series evidence suggest? 

Trade-offs

Our new paper (Ravallion and Chen 2021) points to some theoretical arguments about potential trade-offs between reducing income polarisation – interpreted as the spread of incomes relative to the median – and other valued goals, including poverty reduction. Some policies that are good for fighting poverty and inequality could well be polarising. Policymakers need to be aware of these potential trade-offs. How much they matter in practice is an open question. 

An obvious concern is how the process of economic growth impacts the extent of polarisation. One can make theoretical arguments either way. A growth process that only raises incomes (relative to the median) for the upper half of the distribution will clearly be polarising, while a growth process that only raises incomes for the poorest half (relative to the median) will be de-polarising.  On the other hand, a distribution-neutral growth process – whereby all income levels increase by the same proportion – will leave the polarisation index unchanged. Yet such a growth process can be effective in reducing absolute and weakly relative poverty, as well as enriching the middle class in absolute terms (Ravallion 2016). 

While it is not something that has attracted much attention in the literature, one might expect that the process of economic development through structural transformation in a country like China can have a de-polarising effect, as the poorest move closer to the middle. Nor is this an aspect of the potential distributional changes with development that is likely to be captured by the standard inequality indices. Potentially de-polarising gains among the poorer half may, however, come hand-in-hand with polarising gains among the (primarily urban) upper half, comprised of elite, skilled workers and those who own capital stock and/or rental properties.

Counterarguments to the idea that a less polarised distribution will yield lower economic growth can also be drawn from the literature on growth economics.  One strand of that literature has argued that a larger middle-class share (by various measures) can promote economic growth and poverty reduction (our paper cites various papers on this topic). We need not find any aggregate trade-off over time.

Also relevant in the context of China is the evolution of the large disparities found between mean incomes in urban and rural areas. This reflects long-standing inequalities in social policies (health, education, and social protection) as well as impediments to internal migration (notably through the hukou registration system) and administrative land allocation processes (our paper provides references to the literature on these points). Given the large mean income gaps between China’s urban and rural areas, the degree of urban-rural sectoral fractionalisation – the extent to which people live in different sectors – can also matter to both income inequality and polarisation. 

These observations suggest that a focus on polarisation begs some new policy questions that will need further thought. A prominent example in contemporary China is the central government’s goal of eliminating the hukou registration scheme – the internal ‘passport’ system in China that restricts access by rural migrants to urban services and markets. While ongoing reforms to the hukou system would undoubtedly help reduce poverty, the impact on polarisation is unclear because the bulk of both the personal benefits and the costs of relaxing hukou restrictions may fall on the lower side of the median, suggesting that these reforms could be polarising. The potential for such polarising effects of relaxing hukou restrictions would need to be balanced against other considerations, including poverty reduction. 

What the time-series evidence suggests

In addition to arguing that the Foster-Wolfson index is a close match to the spirit of the idea of “fleshing out the olive” – and so provides a valuable tool for monitoring progress in attaining that goal – our new paper looks for signs of trade-offs in the aggregate time series data for China following Deng Xiaoping’s growth-promoting reforms, which were launched in the late 1970s. To take our estimates back to the early 1980s, we have no choice but to rely on published tabulations of the distribution of income in China, as produced by the National Bureau of Statistics (NBS). Though the micro data from NBS surveys are not publicly available, we use the data available to estimate parameterised Lorenz curves separately for urban and rural areas. We then aggregate these into a national Lorenz curve, allowing for the higher cost-of-living in urban China while factoring in differences between the rates of price inflation in urban and rural areas (our methods are described more fully in Ravallion and Chen 2021). 

Figure 1 summarises our estimates of the FW polarisation index over time. We see an overall upward drift in the extent of polarisation nationally, though with two distinct turning points: a brief one in the mid-1990s and another starting in 2009. The TPs are less pronounced within each urban and rural area, suggesting the presence of some strong between-sector effects.

Figure 1 Income polarisation indices for China

Source: authors’ estimates, as documented in Ravallion and Chen (2021).

We little evidence in the time-series data of any negative co-movement between polarisation (on the one hand) and economic growth or reducing poverty and inequality (on the other). We find that polarisation rose with rising average incomes up to 2009, but this appears to be spurious, reflecting common time trends. Periods of higher poverty reduction or higher economic growth did not typically see more rapid polarisation. And we find strong co-movement between the Gini index and the Foster-Wolfson polarisation index. Nor do we find that periods of a more rapid rise in the urbanisation of the poorer half of the population (who started off almost only in rural areas) tended to be more polarising. 

To the extent that reducing polarisation is a new policy goal for China, the historical record does not point to any serious trade-offs going forward, including with economic growth, poverty reduction, and overall social welfare. The recent reversal in the generally upward path for polarisation in China has been driven almost entirely by attenuated median-normalised incomes among the upper half. 

Of special relevance to future policy options for reducing polarisation is our finding that the rise and fall in China’s national polarisation index in Figure 1 is largely accountable to the evolution of the gap between urban and rural mean incomes. Here too, the historical record provides little support for the idea that reducing urban-rural disparities would be polarising; indeed, the data we have assembled suggest the opposite. However, potential trade-offs would need to be considered further in the context of specific policy efforts, such as expanding social service coverage in rural areas, as well as taking account of how those efforts are financed.

References

Chen, S and M Ravallion (2021), “Reconciling the Conflicting Narratives on Poverty in China”, Journal of Development Economics 153 (November), forthcoming.

The Economist Magazine (2021), “Fleshing Out the Olive”, 28 August.

Foster, J and M Wolfson (2010), “Polarization and the Decline of the Middle Class: Canada and the U.S.”, Journal of Economic Inequality 8: 247–73.

Ravallion, M (2016), The Economics of Poverty: History, Measurement, and Policy, New York: Oxford University Press.

Ravallion, M and S Chen (2021), “Fleshing Out the Olive? On Income Polarization in China”, NBER Working Paper 29383. 

Xinhua News Agency (2021), “Xi Jinping Report Collection”, Beijing, 17 August.

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Topics:  Poverty and income inequality

Tags:  China, Income distribution, income polarisation, poverty reduction, absolute inequality

Edmond D. Villani Chair of Economics, Georgetown University

Professor, School of Economics, Xiamen university

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