Friday, March 03, 2006

High Inequality Necessary in China During Industrialization

In his latest column, Stephen Roach discusses what he argues is the rising inequality both between and within countries as a result of globalization. His claim that inequality between countries is rising is dubious as poor countries as a group have far higher growth than richer countries. For now, I will leave aside his discussion on income inequality in America and instead focus on his discussion of income inequality in China.

While some ignorant American conservatives stuck in cold war thinking insist on refering to China as "communist China" or "Red China", China is now a basically capitalist country. Not surprisingly, the end of communism in China have meant that it have started to catch up with the prosperous majority Chinese countries -Hong Kong, Taiwan, Singapore- that have had capitalism since the end of WW2.

In order to achieve a higher level of prosperity and economic development, it is necessary to get the rural population of farmers into the cities and thus into industrial-,construction- and service activities, all of which have a far higher marginal productivity than farming.

But in order to get farmers to move into the cities it is necessary to have a strong economic incentive to move into the cities-which is to say urban income levels must be much higher than rural income levels.

Any attempts to try to reduce urban-rural income disparities through increased government spending for the rural population will only serve to slow down the necessary migration from rural to urban areas and thus not only slow down growth but also slow down the reaching of the long-term equilibrium population balance between urban and rural areas when the large gaps won't be necessary anymore. Thus, attempts to reduce social tensions in the short-term through government redistribution will only serve to increase inequality and thus social tensions in the short-term: The Chinese government must keep its cool and avoid short-sighted measures to reduce the urban-rural income gap.

This is not to say that there aren't measures it can undertake to reduce inequality and social tensions without reducing the incentive for migrating to urban areas. First of all, they should scrap (a measure which have been discussed but not yet undertaken) the formal restrictions on internal migration. These restrictions are in practice almost never enforced, but they greatly weaken the bargaining position for workers who have moved into the cities. Secondly, by allowing the yuan to appreciate and by scrapping capital outflow restrictions, the Chinese central bank can end the large build-up of foreign reserves which have created high money supply growth which in turn have redistributed from the poor (both rural and urban poor) to the rich.

The latter measure, scrapping capital outflow restrictions, are also being increasingly likely to be implemented as it is advocated in government run news papers.


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