A March 2015 IMF working paper focuses on modern China as an example of how economic and fiscal policy can lead to the development of income inequality.

Authors Serhan Cevik and Carolina Correa-Caro study income inequality in China and a panel of BRIC+ countries from 1980–2013, focusing on on the redistributive contribution of fiscal policy. The study finds an inverted U-shaped relationship between income inequality and economic development both in China and in the set of BRIC+ countries. In China, the results make it clear that government spending and taxation have opposite effects on income inequality. Government spending seems to have a worsening on income inequality whereas taxation improves income distribution.

Cevik and Correo-Caro note that even though the redistributive impact of fiscal policy in China is greater than that seen in the BRIC+ panel, it is not large enough to compensate for the impact of other influential factors, resulting in a growing income inequality in the country.

Rapid growth has led to major income inequality in China

Since the economic reforms of the late 1970s, China has grown at the amazing rate of almost 10% a year, lifting 660 million people out of poverty. Per capita income was up from $320 in 1980 to nearly $5,500 in 2012, according to the World Bank. However, the riches created by the transition from socialism to a market-oriented economy are not being shared across the society. Income inequality (measured by the Gini coefficient for pre-tax market income) has increased dramatically from 0.28 in 1980 to 0.44 in 2000 and 0.52 by 2013.

The authors note: “This widening in the gap between rich and poor shows China’s transition from a relatively egalitarian society to one of the most unequal countries in the world.”

Rich rapidly becoming super rich in China

The big move up in income inequality over the last 30+ years is a result of China’s investment and export-led development model. The growth incidence curve (the extent to which each quintile of households benefits from growth in real terms) illustrates a total increase of 331% for the lowest-income quintile between 1980 and 2012, compared to 1,042% for the highest-income quintile. That means the top 20% now captures 47% of total income (an increase from 38% in 1980), while the lowest quintile accounts for only 4.7% (down from 8.7%). The data male it clear that China’s widening income inequality is directly related to more rapid income growth among the rich, rather than slipping incomes for the poor.

Cevik and Correo-Caro argue that he Chinese economic reform strategy “aimed for high aggregate growth rates at the expense of an increase in income inequality.” That said, they also note there is “mounting evidence that income disparities become detrimental to economic growth over the long term, with significant social consequences, especially in a country like China aiming to move beyond the “middle income” status.”

They go on to say that Berg and Ostry (2011) (others) have shows that income inequality is a key determinant in the rate and sustainability of economic growth, even when compensating for other economic and institutional factors.