From Poverty Reduction to Common Prosperity: Challenging Reforms, Big Upside

January 07, 2022

The beginning of the 2020s marks an important threshold for China’s economic development. In the coming decade China will very likely cross the threshold to high income. In 2020, the Chinese authorities announced that extreme poverty had been eliminated, China had become moderately prosperous. Shortly thereafter, Chinese policy makers launched a series of important initiatives, including a renewed emphasis on the objective of achieving common prosperity, indicating concern for the large domestic imbalances in levels of development and continued high levels of economic inequality. In short, as China is setting its sights on high income, its leaders no longer target growth at all cost, but aim for quality and balanced development.

This objective is commendable. Imbalances in China’s development are notoriously high. Inequality, with a GINI coefficient of 0.46, is much higher than in the advanced economies. The urban-rural income gap remains large (with a ratio of around 2.7:1 in 2019, albeit down from a peak of 3.1 in 2009). Perhaps more importantly, as Scott Rozelle documents in his recent book Invisible China, there are persistent difference in access to quality public services and economic opportunities between those with an urban hukou and those registered as rural residents. This has led relative intergenerational mobility in China to decline since the early reform period: it matters more today for your personal prospects what family you are born into than it did a couple of decades ago.

What could China’s policy makers do to address these challenges? Inequality in the disposable income of households is the result of two factors: the inequality of market incomes – wages and capital incomes – and the extent of redistribution through taxes, government transfers and (far less importantly) private donations. The distribution of market incomes in China is roughly comparable to that in the average OECD country. In fact, wage inequality has been falling over the past decade, as labor markets have tightened including for low skilled workers. While China today has more billionaires than the United States, the distribution of wealth in China is not particularly unequal either. Nonetheless, better access to quality education for kids from rural households could help reduce inequality of opportunity and narrow wage gaps. The complete abolition of China’s hukou system would allow workers to move to where the best jobs are, while labor market reforms could help reduce informality, once again reducing wage inequality.

On the other hand, the redistribution of income through taxes and government transfers in China is low. According to research by Lustig and Wang, the total impact of redistribution through the government in China as of the mid 2010s was to lower the Gini coefficient of final household income by around 8 points, similar to Chile and Mexico, but only two thirds of the impact in Turkey, half that in Brazil and only around one third of the impact in EU countries such as Poland and Spain. China collects far less than other countries through personal income taxes, raising the bulk of its revenues through taxes on goods and services. These taxes represent a proportionally higher burden on poor households and are thus unequalizing. China could collect more progressive taxes, for instance by introducing an inheritance tax, a property tax, or reforming the personal income tax.

Direct transfers to poor households, including social welfare payments under the dibao and non-contributory rural pensions, have increased substantially in recent years, but benefit levels are still very low. Raising them and integrating multiple welfare benefits in one social registry would increase the level of protection offered to the most vulnerable while improving targeting and efficiency. In-kind transfers such as health and education spending contribute to lowering inequality because of intergovernmental transfers from richer to poorer regions. However, much larger inter-governmental transfers, alongside more rigorous performance-based monitoring systems, would be needed to close the gap in access to quality services.

None of the above is easy. Government advisors have thus been quick to manage expectations and insist that the path towards common prosperity would still rely centrally on “growing the cake” rather than redistributing it. Global evidence suggests that it is growth that drives sustained improvements in living standards. However, the evidence also suggests that reducing inequality of opportunity is good for growth. Giving all rural children the chance of a quality education is vital for growth to continue as China’s workforce ages and declines in the coming decades. Rising incomes among the less well-off will add to the dynamism of China’s consumer market and could drive the next wave of innovation and entrepreneurship.

The next decade will show whether China’s aim to shift to a new development paradigm is successful. A shift from growth at all cost to creating equal opportunities for all Chinese citizens would make success more likely.

By Martin Raiser, World Bank’s Country Director for China and Mongolia, and Director for Korea

Martin Raiser is the World Bank’s Country Director for China and Mongolia, and Director for Korea since March 1, 2019. Mr. Raiser is leading a team that is managing an evolving partnership with China, a growing program of support to Mongolia, and a deepening knowledge partnership with Korea focused on innovation and technology.

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