Rising Inequality in China. What Are the Lessons from Brazil’s Success in Inequality Reduction?

List of Contents

List of Figures

Acknowledgments

1 Introduction

2 Inequality and Economic Development in China
2.1 Inequality on China’s Political Agenda
2.2 Conclusion

3 Inequality Reduction in Brazil and Lessons for China
3.1 Inequality and Economic Development in Brazil
3.2 Convergence of Labor Incomes
3.2.1 Educational Expansion in Brazil
3.2.1.1 Education in China
3.2.1.2 Lessons for China
3.2.2 Raising Minimum Wages and Unemployment Benefits in Brazil
3.2.2.1 Minimum Wages and Unemployment Benefits in China
3.2.2.2 Lessons for China
3.3 Non-contributory Social Assistance
3.3.1 Conditional Cash Transfers in Brazil
3.3.1.1 Minimum Living Standard Guarantee Scheme in China
3.3.1.2 Lessons for China

4 Concluding Remarks

List of References

List of Figures

Figure 1: GDP per capita and Gini index development in China from 1981-2012

Figure 2: Growth of rural and urban per capita income in China from 1978 - 2011

Figure 3: Total public social expenditure as a percentage of GDP in China, Brazil, and Russia, 2010

Figure 4: Average annual real income growth in Brazil by deciles, 2003-2011 (%)

Figure 5: Enrollment rates of 15-17 year olds by family income quintile in Brazil, 2001 and 2011

Figure 6: International comparison of China’s gross enrollment ratios for different education

levels, 2011-2012

Figure 7: Distribution of higher education among selected provinces in 2002

Figure 8: Main policy recommendations to converge labor incomes through education in China

Figure 9: Average monthly salaries and monthly minimum wages in selected Chinese regions

Figure 10: Comparison of Brazil’s and China’s unemployment schemes

Figure 11: Main policy recommendation to converge labor incomes through social legislation in China

Figure 12: Social development and health indicators in connection with Bolsa Familia

Figure 13: Average income, average Dibao benefit, and minimum living standard of urban Dibao households from 1999 to 2010

Figure 14: Average income and average Dibao benefit of rural Dibao households and comparison of minimum living standard in urban and rural areas from 2007 to 2010

Figure 15: Child mortality rates in Brazil and China, 1960-2010

Figure 16: Maternal mortality ratio and prenatal care in Brazil and China

Figure 17: Comparison of China’s health attainments in 2012

Figure 18: Main policy recommendations for non-contributory social assistance in China

Acknowledgments

I would like to thank the Department of Asian and International Studies at City University of Hong Kong for its general support and Dr. Ruben Gonzalez-Vicente for his extremely helpful and valuable comments, discussions, and suggestions. I would also like to acknowledge Thais Silva for her help in interpreting Portuguese literature and documents.

Abstract

This paper illustrates the main sources of income inequality in China and analyzes social policies and mechanisms that led to decreasing income inequality and pro-poor growth in Brazil in order to present lessons learnt for China to reduce income inequality. It explores how labor markets and social policies play a crucial role in directly or indirectly affecting inequality, suggesting a convergence of labor incomes through educational expansion and a constant rise of minimum wages, as well as effective non-contributory social assistance has contributed the most to the decline of income inequality in Brazil. These factors are evaluated not only from a monetary perspective but also from the perspective of people’s subjective wellbeing of enhanced capabilities and opportunities and its impact on social and economic development. This paper argues that Brazil’s experience offers solid policy recommendations for China to tackle rising income inequality and proposes interesting debates for social policy in China and other developing countries.

1 Introduction

While global poverty is falling, the world is becoming more unequal. Higher income concentration and restricted upward mobility for the poor can be observed in most countries across the world today.

China has achieved rapid economic development and may soon become the largest economy in the world. But there is a down side to China’s rise. Although China could highly reduce absolute poverty, China’s income inequality is rising to a daunting level and China now ranks among the world’s most unequal countries.

Brazil, on the other hand, is one of the few outstanding exceptions. Known for its traditionally high inequality levels, Brazil was able to significantly lower income gaps between the rich and the poor, reducing both inequality and poverty. This development pattern is conspicuously opposite of what is experienced in China and other BRICS¹ economies and a result of many good policy choices.

Brazil is an important case study for China because it was able to significantly reduce inequality while becoming the 7th largest economy in the world in 2012. Both countries are classified as upper-middle income countries today. China and Brazil are highly heterogeneous countries just taking into account the political sphere and size of the population alone. However, both countries have important features in common. Both economies experienced periods of rapid economic growth and large rural to urban migration, accompanied by a sharp rise of income inequality, characterized by a similar bias against low-skilled workers across a spatial, geographical and rural-urban divide.

The literature on social policies in developing countries is inconclusive. The descriptive rather than explanatory nature of research is limited in clarifying why certain policies are effective and determining the mechanisms at play.

The aim of this paper is to provide a comparative overview of the trends in inequality, economic development, labor market outcomes, and social policy in China and Brazil. The ultimate goal is to answer the question of whether there are lessons for China from Brazil’s social policies and inequality reduction experience. The study is interpretive research based on the case study of Brazil and China, bringing to bear theories of social policy in developing countries to tackle rising inequalities.

In preparation for this paper, I have done an extensive literature review of classical and contemporary work on inequality (e.g., Smith, 1884; Lewis, 1954; Kuznets, 1955; Wood, 1994; Stiglitz, 1996; Kawachi et al., 1997; Gallo, 2002; Sen, 2003; Goldberg & Pavcnik, 2004; Milanovic, 2011; Palma, 2011; Ferreira, 2012). However, I have decided not to include such review in the present paper due to space limitations.

This being said, this paper aligns with the work of Fajnzylber et al. (2002), Kharas (2011), the Asian Development Bank [ADB] (2012), and others in that it acknowledges that high inequality bears significant costs for a society by threatening social cohesion as well as economic and social development.

While it can be argued that some rise in inequality might be inevitable during the process of development and structural transformation (World Bank, 2009), historical data suggest that it would be naïve to assume that inequality in China will automatically decrease with economic growth and remain low in the future² - underlining the importance of social policy reforms.

In the first section, I present China’s economic development and change in income inequality and explain how inequality is addressed on China’s political agenda. In the second section, I discuss the key drivers of Brazil’s inequality reduction and compare them with China’s current situation, which allows for a discussion of appropriate policies in China for tackling income inequality. For a discussion of the limitations of this paper and further considerations, see the last section of this paper.

2 Inequality and Economic Development in China

With average GDP growth rates of almost 10% per year since 1980, China has become the second largest economy in the world. From 1980 to 2012, combined with the slowing population growth, GPD per capita grew annually by an average of almost 9% and China was “promoted” from “lower income” to “upper middle income” status by the World Bank (2014c). Although China’s real GDP growth forecast is estimated to be significantly lower than in the past, with steady economic growth, China may soon become the largest economy in the world (World Bank, 2013).

The transition from a planned to a market-oriented economy was one of the main reasons for China’s rapid economic growth. Thanks to the economic transition and reforms that have directly supported rural incomes in particular, China has effectively reduced the number of people living in absolute poverty (World Bank, 2009). The percentage of people living on less than US$1.25 per day (PPP) decreased from 69.4% in 1984 to 11.8% in 2009. Although tremendous, this still leaves over 157 million living in absolute poverty and many more just above the poverty line (World Bank, 2013).³

According to Ravallion and Chen (2007), poverty reduction was by far higher in the coastal than in the inland provinces. Most poor people live in western and central provinces and poverty is most severe in mountainous and minority areas. However, around 20% of the poor are still found in coastal and northeast provinces and the share of non-mountainous and non­minority population accounts for around 50% of the poor (World Bank, 2009).

Real household income for the bottom 20% in the 1990s increased by an average of 3.6% and by 8.5% in the 2000s. During the same period, the income of the middle 20% increased by 6.4% and 11.4%. The income of the top 20%, on the other hand, increased by 8.7% and 15.1%, respectively. Consequently, the income share of the bottom 20% and the middle 60% decreased whereas the income of the top 20% increased (OECD, 2010, pp. 40-41).

Thus, despite high reductions in absolute poverty, income inequality in China skyrocketed. Figure 1 illustrates the GDP per capita at current US$ prices and the Gini index development.⁴

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Figure 1: GDP per capita and Gini index development in China from 1981-2012 (World Bank, 2014c; Xinhua News, 2013)

While China’s GDP per capita increased from US$195 to US$6,188, its Gini index rose from 29.11 in 1981 to 42.06 in 2009, and reached 47.4 in 2012, overshooting the UN warning level of 40.0. Due to China’s method of measuring income, inequality estimates are likely to be even higher (World Bank, 2009).

Reflecting Kuznets’ theory, without verifying it, inequality in China increased as labor moved from low-productivity agriculture to higher-productivity manufacturing.⁵ In 1978, 71% of the workforce was engaged in agriculture. By 2010, the number of agricultural workers declined to 37% (World Bank, 2014c). Since the 1990s, the number of rural-to-urban migrants has increased to 145 million and is expected to increase by another 300 million in the upcoming decades (Meng, 2012).

The movement of labor from the low-productivity agricultural sector to the high-productivity urban sector is one of the main reasons for China’s overwhelming economic growth (Meng, 2012). However, China’s development model exploits the stark divide between rural and urban citizens, promoting proletarianization of the poor by advocating a business environment in which the working poor are mobilized to the cities and exploited for work (Gallagher, 2014). The downward pressure of Chinese manufacturers on expenditures in order to sustain comparative advantages together with the vast supply of labor has increased income inequality and informal employment.

The OECD (2010, p. 29) estimated that 85% of migrant workers in 2005 worked informally. Public and industrial policies continue to focus on coastal provinces leading to further geographical inequality and large scale rural to urban labor migration. Official data state an increase of unemployment from 2.9% in 1995 to 4.5% in 2005. However, the unemployment rate is assumed to be much higher than official statistics claim (Vodopivec & Tong, 2008).

Inequality in China has not only increased with respect to income but also with health and education. Baeten et al. (2013) highlight that health attainments on the basis of average income have slowed down. Their study found that health disparities in China relate to rising income inequality, mostly affecting elderly rural women who lack pension entitlements and income support. The state Council’s Development Research center published in 2005 that around 45% of urban residents were not covered by medical insurance programs, thus turning healthcare service into an exclusive privilege for the rich (Leung, 2006).

With regards to education, in 2009, over 89% of the migrant workers were employed in low­skill/salary jobs (Meng, 2012). Furthermore, only about 5% of the total migrant workforce in cities holds a college or university degree and compared to their urban counterparts, migrants work an average of almost 20 hours longer per week (Meng, 2012).

In the context of China’s household registration system (Никои), Chinese citizens are categorized into urban and non-urban citizens, treating migrants as second-class citizens deprived of social welfare and public services (Kennett et al., 2013, p. 255).⁶ The Никои system prevents migrant workers from accessing public services outside their place of birth. A large share of migrant workers and the rural population are generally not covered by any formal social security system and excluded or deprived of access to public services, such as education and healthcare (Naughton, 2007). As a result, the Никои system is often stated as one of the main drivers behind these inequalities, creating deep and rigid divisions and exclusions, reinforcing social stratification, widening the rural-urban divide, and fostering regional inequalities, discrimination, and injustice (Wang, 2005).⁷

Figure 2 clearly shows an increase of the gap between rural and urban income since 1978. Rural per capita increased from RMB500 in 1978 to RMB6,977 in 2011 whereas urban income rose from RMB1,701 to RMB23,979 over the same period.

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Figure 2: Growth of rural and urban per capita income in China from 1978 -2011 (Naughton, 2007, p. 210; National Bureau of Statistics [NBS], 2012)

The income gap between rural and urban households illustrates that inequality in China is mainly a rural-urban phenomenon. The World Bank (2009, p. 37) estimated that in 2003 rural­urban differences were responsible for about 40% of the overall income inequality. Although both rural and urban income significantly increased, taking into account productivity growth, the labor share in relation to GDP growth actually went down (ILO, 2013b).

However, statistics regarding urban and rural income differences need to be interpreted with care. Migrant workers with rural Никои have been excluded from official statistics until 2002 and even after their inclusion, are widely underrepresented albeit accounting for over 20% of the urban population. Moreover, the NBS urban household survey excludes urban residents living in townships and suburbs of province-level cities. These exclusion errors are likely to create over-estimation of urban incomes (Park, 2008, p. 44; OECD, 2010, p. 117).

However, overall income inequality did not only increase because of the rural-urban gap. Equally important is the rise of income inequality within both urban and rural areas (World Bank, 2009).

Income inequality of workers with urban Никои is larger than income inequality of migrant workers (OECD, 2010, p. 120). This, inter alia, indicates that the vast supply of low-skilled migrant workers puts pressure on urban wages of low-skilled labor which increases income disparities between low and high income workers in cities.

Golley and Meng (2011) highlighted the deteriorating positions of low-skilled and in particular of migrant workers compared to skilled urban workers. From 2000 to 2009, their study found that while unskilled workers’ income was about 20% less than skilled urban workers’ in 2000, the gap widened to 75% less by the end of the period. Therefore, despite rising nominal urban unskilled income, low-skilled migrant workers’ relative income depreciated, widening the income gap of low- and high-skilled workers.

The next section highlights China’s policy priorities and explains why social policies have been widely neglected or subordinated to economic policies in the past and why this is likely to change or is already in the process of changing.

2.1 Inequality on China’s Political Agenda

According to Ravallion (2009), China’s level of poverty used to be so high that inequality was not a major concern, leading to the fact that direct redistributive interventions were predominantly absent. Furthermore, profound economic growth, having a great impact on poverty reduction, made comprehensive social policy redundant.

Since the mid-1980s, the government has introduced a series of social security reforms. However, despite continued expansion, coverage and benefits for these schemes remain low (Kennett et al, 2013).

In many developing countries, inferior social policy may only go to such lengths as long as social welfare services are still underdeveloped and considered residual. Thus, it is often argued that economic growth is primarily needed to provide the resources to expand public social expenditures. This is particularly evident in the case of China (see Figure 3).

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Figure 3: Total public social expenditure as a percentage of GDP in China, Brazil, and Russia, 2010 (ILO, 2013c)

China’s social expenditure as a percentage of GDP is significantly lower than in other emerging economies such as Brazil and Russia. In 2011, the share of social expenditure actually decreased to only 3.7% (ILO, 2013c). Moreover, social spending on education, health, or social protection is unequal and significantly higher for the urban population (World Bank, 2009).

A study by Xie et al. (2012) revealed that Chinese see high inequality as an indicator of economic development and consider countries with low inequality as less developed. This partially implicates that the majority of Chinese tolerate current inequality levels to a certain extent as it is considered part of development. Whyte’s (2010) findings coincide with this statement. His survey found that most Chinese accept the market-generated inequalities and are sanguine regarding a better future through hard work thus implying that equality of opportunity is more relevant. The low resistance of the Chinese population could be seen as a reason why the government has primarily neglected tackling rising inequality and continued to promote economic growth.

However, we have to consider that inequality increased during economic boom and is therefore associated with sanguine attributes. This positive perception is fragile in the long run if economic growth fails to meet the aspirations of all citizens. As Huntington (1968) states, economic development and modernization raise a gap between aspirations and expectation which, if left unsatisfied, leads, in the absence of strong adaptable political institutions, to social movements and mobilization.

This phenomenon is increasingly evident in China. Rising inequality, in particular the exploitation of domestic migrant workers and their exclusion from social welfare in the urban society but also issues concerning ethnic minorities, environmental degradation, corruption, and land grabbing, have led to unprecedented growth of social unrest and violence in China (see Young, 2010; The Atlantic, 2012; Gallagher, 2014; Wall Street Journal, 2014). Friedman (2013) points out that the rise of labor conflicts in China are best explained by the relative material deprivation of migrant workers and the fact that things did not actually improve for them.

Increased resistance and conflicts of the deprived segments of the population may promote institutional moments, where class conflict is institutionalized in economic and political spheres. However, despite its overarching goal of maintaining social order and peace, the Chinese government seems to not be capable of fully resolving political tension - all together calling for profound social policy reforms.

Nonetheless, after years of making economic growth a top priority, the Chinese government seems to increasingly acknowledge the importance of more equal income distribution and inclusive growth.

Key policy initiatives include the Western Region development strategy, poverty alleviation investments, and the development of urban social security systems (World Bank, 2009). Further efforts to reduce the wealth gap in China include a blueprint published in February 2013 by the central government containing several populist points for addressing inequality such as to cut down on senior manager’s salaries and to eliminate sources of illegal income without presenting novel initiatives (Economist Intelligence Unit [EIU], 2013; Buckley, 2013).

One of the main responses to the new challenges of inequality and social protection has been the expansion of the Minimum Living Standard Guarantee Scheme (Dibao), a means-tested, non-contributory social assistance program to assist the poor and vulnerable households (Kennett et al., 2013, p. 252), to be discussed in more detail later on.

Further major reforms include medical assistance schemes in rural and urban areas as well as free compulsory education (World Bank, 2009). Moreover, the Chinese government is gradually attempting to unify the various pension programs, and to extend coverage to all urban workers. However, despite growing coverage, most informal and migrant workers as well as the rural population are de facto not covered by any formal statutory social security and the fragmentation of existing schemes limits risk pooling and the redistributive impact (OECD, 2010, p. 266; Luo, 2012, pp. 104-106).

In December 2013, the central government announced removing or easing the Никои system to provide migrant workers access to public services and promote further urbanization (South China Morning Post, 2013). According to the report, the plan will be gradually implemented in smaller and medium cities but omits the large main cities.

Whalley and Zhang (2004) calculated that with the abolition of the Никои system, existing income inequalities will disappear. The argument is based on the premise that the income gap is lowered through rural-urban migration and the following convergence of the marginal productivity of agricultural and non-agricultural labor. There is indeed evidence that regional disparities have declined since 2003, which implies that the increase in inequality can be attributed to a rise of earning differences between unskilled and skilled workers (Goh et al., 2009; OECD, 2010, p. 113). As Golley and Meng (2011) point out, China has still a large stock of under-employed, low income rural workers, which, with the reduction of institutional barriers, provides a large stock of low-skilled migrant workers possibly doubling the number of migrant workers in the cities.

As a result, the challenges still remain. The additional surplus workforce of low-skilled occupations will put pressure on wage levels leading to emerging income inequality between low-skill and high-skill occupations. Abandoning a smaller share of the population in remote rural areas may lower regional income disparities but does not solve the issues of increasing wage gaps between skilled and unskilled workers in urban centers and the rural population left behind.

Nonetheless, these policies are a clear indicator that inequality has become an important item on the government’s agenda. Yet, the commitment towards these policies and the plain intention of the central government remain to be seen. Moreover, as Meng (2012) points out, social policy implementation is extensively decentralized, giving local governments large autonomy, indicating that the central government solely passing a law is often of limited significance. The EIU (2014) noted that China’s national urbanization plan disappoints and is already delayed by over a year. Further, the report states that while the plan talks of settling 100 million migrants to the cities with equal access to public services, it omits the reforms of the Никои system that are required to facilitate this.

2.2 Conclusion

China’s economic growth and its impact on poverty reduction have been remarkable. However, it has also led to an unprecedented surge of income inequality, challenging the constricted view that income growth is a desired end in itself.⁸

The World Bank (2009) found that while China’s economic growth has been critical to reducing poverty in the past, its responsiveness to poverty reduction is decreasing. Thus, in the absence of persuasive social policy, China will fail to eradicate poverty and inequality will exacerbate which endangers social justice, in turn, leading to increased social unrest and hampering inclusive economic and social development.

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¹ The BRICS consist of the emerging economies of Brazil, Russia, India, China and South Africa.

² In many high-income countries income inequality is high and rising as well (see OECD, 2011a; World Bank, 2014c).

³ In developing countries, poverty is measured as the share of the population living on income below the minimum level of subsistence. For the purpose of comparing levels of poverty across countries, the international poverty line refers to the share of the population living below an ascertained USS amount a day at 2005 purchase power parity (PPP). The international poverty line typically ranges between USS1 and USS2.5, depending on the country’s income level or chosen approach. The PPP conversion rate is retrieved from the World Bank (2014c). For more information on PPP conversion factors, data issues, and their limitations, see United Nations (2014) and World Bank (2011b).

⁴ The Gini index is a commonly used measure for income inequality, indicating the income distribution among individuals or households within an economy (World Bank, 2014c). The index varies between 0 (perfect equality) and 100 (perfect inequality).

⁵ The Kuznets curve implies that during the transition from a low-income agricultural economy to a middle- income industrial economy, income in urban areas increases because of higher industry productivity. In contrast, income in rural areas remains low resulting in a wider income gap between rural and urban residents despite overall income growth. However, as the society in sum becomes richer, social transfers to the poor reduce these income inequalities. Thus, the Kuznets curve follows an inverted “U” shape indicating that inequality is low at the initial stage of development, rises during industrialization, and equalizes when an economy reaches a high income bracket (Kuznets, 1955). His hypothesis, however, has been criticized and refuted by several economists (see, e.g., Stiglitz, 1996 and Palma, 2011)

⁶ Hereafter, this paper generally understands migrants as the urban workforce with rural Никои as opposed to urban dwellers with urban Никои.

⁷ For further in-depth discussions of the Никои system, see, e.g., Chan & Zhang (1999) and Tang & Yang (2008).

⁸ The notion of moving away from utilitarian welfare economics is expanded upon by Amartya Sen’s capability approach which challenges the correlation of GDP growth and development. Monetary approaches do not capture other aspects of deprivation such as access to health and education, intra household distribution, or civil rights. In order to assess the quality of life, the evaluation should be based on what a person manages to achieve and a person’s freedom to choose between different ways of living reflecting the person’s capability. In Sen’s view, commodities are merely means to wellbeing and do not reflect the value of a desired end.