While aggregate measures
of economic growth and development paint a general picture of China’s
remarkable performance, they also conceal the distinct variations of growth and
development within the country. Since the
mid-1980’s income inequality in China has been rising. This suggests that while growth is
contributing to rising income averages, it may also be associated with the
deepening of inequality. Inequality in
societies can depress economic growth itself and erode the social capital that
contributes to the soundness of public institutions, political stability, and
stable policies—all of which facilitate economic growth.[1] The growing inequality in China implies that
economic growth undermines the achievements in economic development. Economic growth is driven in part by
economic policies adopted by the government.
China began its rapid expansion in 1978 with the introduction of
capitalistic markets into the domestic economy and the opening of international
trade. While an open trade regime
generally supports growth, its effect on the reduction of poverty often depends
on how trade liberalization affects the demand for the nation’s abundant factor
of production: namely the demand for unskilled labor.[2] The widening income gap and simultaneous
increase in the importance of trade to the Chinese economy suggest that trade
policy may in fact be debilitating to economic development in China.
China’s economic reforms
included the opening of trade in order to promote growth. Since entering the international market, the
value of Chinese exports has risen to over $232 billion in 2000, the GDP has
quadrupled, and per-capita incomes have risen above $3,600.[3] The positive relationship between trade and
growth suggest that in delivering growth, trade reforms have also contributed
to the rising average incomes.[4] Economic growth is important for improving
the incomes of the poor and reducing poverty, but for a “given rate of growth,
the extent of poverty reduction depends on how the distribution of income
changes with growth.’[5] Given the positive relationship between
trade and economic growth, trade theory predicts that the incomes of laborers
in China will increase, therefore reducing inequality and poverty.[6] For if economic growth increases the share
of income earned by the poorest section of the economy, the incomes of the poor
will rise faster than average incomes; and as the distribution of income
converges, poverty reduction occurs more dramatically than in those countries
where incomes diverge.[7]
The Stopler-Samuelson
trade theorem implies that trade facilitates income convergence, in that it
increases the real incomes of the owners of the abundant factor of production
while decreasing the real incomes of the owners of the scarce factor.[8] While an important implication of trade, the
Stopler-Samuelson theorem is derived from the conclusions of preceding
theories. David Ricardo predicted that
nations would trade in the presence of a comparative cost advantage, but neglected
to explain the source of such advantages.[9] A comparative advantage implies that one
nation is more efficient in producing a certain commodity than another due to
its internal factor endowments—efficiency implies that a nation can provide the
good on the world market at a relatively lower cost.[10] In attempting to explain the source of such
advantages and subsequent exporting decisions, the Heckscher-Ohlin theorem
first assumes that different nations have different relative factor endowments,
that technology is the same in both nations, and that different commodities
have different factor intensities, which are fixed for all factor price ratios.[11] Relative factor endowments are defined both
by physical quantity and price. With a
population of over 1.2 billion, China obviously has an abundant labor supply
relative to capital, and because of its large population the price of labor is
relatively low while that of capital is relatively high.[12] The Heckscher-Ohlin theory predicts that a
nation will export the commodity that uses its abundant factor of production
more intensively, because it will be able to produce relatively more of that
good at a relatively lower cost.[13]
See Graph 1 & 2.[14]
N w/r Relative
factor prices (w/r)I are represented by isocost line MN. Country I will produce S 1 units of steel at point
X and C 1 units of cloth at point Y. Since labor is relatively more abundant in country II, its
relative factor prices (w/r) II < (w/r)I; that is,
its isocost line M’N’is flatter than that of country I. It will therefore produce more at point
Q and at point T. Since C 2
represents a larger quantity of cloth for the same opportunity cost of
steel, S 1, the relative price of cloth must be cheaper in
country II than in country I. This
link between relative factor prices and relative product prices is shown
more directly in graph 2. An
increase in the wage rate relative to the price of capital will lead to an
increase in the price of the labor-intensive good, cloth, relative to the
price of the capital-intensive good, steel. If relative favor prices are placed on the horizontal axis
and the relative product prices on the vertical axis, this relationship
takes the form of an upward-sloping line.
With the opening of
trade, the price of the exported good will rise, signaling producers to
reallocate resources towards the production of that good. However, the resources released from the
production of other commodities with different factor intensities will be
inadequate in satisfying the increased demand for that particular factor of
production. If, for example, a labor
abundant country exporting cloth (a labor-intensive commodity) reallocates
resources away from steel production (a capital-intensive process) the factors
released will not contain an adequate supply of labor to meet the increased
demand. See Graphs 3 & 4.[15]
Graph 3 Graph 4 Cloth Steel As
the production of cloth (the labor-intensive good) expands and the
production of steel (the capital-intensive good) declines in Country II,
the price of labor increases and the price of capital decreases. This change in relative prices is
depicted above as the change from (w/r)0 to (w/r)1. The relative increase in the cost of
labor leads producers to substitute some capital for labor, that is, to
move along the relevant production isoquant in both industries. This factor substitution results in a
rise in the K/L ratio from (K/L)0 to (K/L)1 in cloth
production and from (K/L)’0 to (K/L)’1 in steel
production. Because of this increase
in cloth production, this factor-use adjustment takes place along a higher
isoquant, while the reduction in steel production causes this adjustment to
take place along a lower isoquant.
Assuming
fixed factor supplies, the excess supply of capital and the shortage of labor
will result in an increasing price of labor and a decreasing price of capital
until factor prices equalize between countries.[16] Because the price of capital falls as the
labor abundant country initiates trade, the price of labor must rise relatively
more than the price of the labor intensive good for the factor costs to equal
the increase in the price of the commodity.[17] Consequently, the real income of labor must
rise because the wage rate is increasing faster than the price of the
labor-intensive commodity.[18] As the wage rate rises, the price of capital
must fall even faster than the price of the capital-intensive commodity so that
the change in the price of that commodity is equal to the average change in the
factor costs used in its production.[19] Given that a nation exports the commodities
that use its abundant factor intensively, the Stopler-Samuelson theorem
predicts that the increase in price of the abundant factor will increase the
real income of those who own the abundant factor while decreasing the incomes
of those who own the scarce factor.[20]
As a labor abundant
country, China's participation in international trade should contribute not
only to economic growth but also economic development. According to the Stolper-Samuelson theorem,
increases in Chinese exports should increase the demand for labor, therefore
expanding employment opportunities and increasing the share of income earned by
the poor.[21] As incomes are more equally distributed,
poverty rates should fall, resulting in a more equitable distribution of income
and a dramatic fall in poverty rates.
Unfortunately however, what should be happening according to trade
theory is not occurring in reality.
Since the mid-1980's the Gini coefficient has been rising to its current
value of 40.3.[22] The Gini coefficient measures the extent to
which the distribution of income, or consumption expenditures, among
individuals or households within an economy deviates from a perfectly equal
distribution.[23] The positive relationship between trade and
income inequality, measured by the Gini coefficient, suggest that trade in
China may actually inhibit economic development by increasing income inequality
rather than decreasing it.
The divergent
conclusions made by trade theory and China's observed reality calls into
question the assumptions made in the theoretical model. While the Heckscher-Ohlin model, and its
corollary, assumes that technology is homogeneous among nations, the reality is
that technology and technological knowledge differ between nations. In entering
the international market, countries not only import and export commodities they
import and export technology.
Therefore, if trade makes a significant contribution to income
inequality, then one needs to consider the role technology plays in trade. Deng Xiopeng opened China's borders because
he recognized the importance of international trade as a source of modern
technology.[24] Participation in world markets provides
nations with access to a larger technological knowledge base, which can be
incorporated into domestic production processes.[25] Additionally, trade itself may help
technological dissemination “if foreign exporters suggest ways that their wares
can be used more productively or foreign importers indicate how local products
can be made more attractive to consumers in their country.”[26] Technological changes that favor skilled
laborers, or offers laborsaving production process violate the assumptions made
in the Heckscher-Ohlin model, and can therefore contribute to the positive
relationship between trade and income inequality in China.[27]
In modeling the
relationship between trade and income inequality it is important to account for
other factors that may contribute to the widening income gap. The sensitivity of poverty reduction to
growth, through increases in income, depends upon initial inequalities that
inhibit poor people's access to the opportunities fostered by economic growth.[28] The ability to participate in, benefit from,
and contribute to economic growth is linked with investments in human
capital. Human capital, reflected in
nutrition, health, and education, contributes to productivity. Because equilibrium wages are equal to the
productivity of the marginal worker in a competitive market, investments in
human capital that increase productivity also impact income.[29]
Beyond being a basic human need, nutrition
and health contributes to productivity. While distinct components of human
capital, nutrition and health both are essential for individuals to achieve
their full capability.[30] Inadequate nutrition at early stages of
development can impair the ability to learn and function, reduce the return
from investments in health and education, and consequently limit future labor
productivity and earning capacity.[31] Health too is essential to productivity and
earning capacity, in that healthier workers have fewer absences and greater
physiological capacities for work.[32] Because of the cyclical relationship between
nutrition and health, these two components will be aggregated for the purpose
of this model and measured by the percentage of babies born with a low birth
rate. The percentage of babies with a
low birth rate reflects the level of malnutrition at early stages of
development. As mentioned earlier,
inadequate nutrition during childhood diminishes cognitive abilities and
effects future health. The percentage of babies with low birth rates should be
negatively related to income inequality, in that increased nutrition and health
increase productivity and incomes.
In that nutrition and
health enhance cognitive abilities, they reinforce the benefits of
education. Education is the process by
which “human capital is enhanced through increases in knowledge and the
development of skills.”[33] Education not only enables individuals to
find employment in dynamic and growing sectors of the economy, it increases
their productivity.[34] Disparities in educational attainment often
mirror disparities in income.[35] The positive relationship between education
and income, suggest that differences in education level contributes to the
increase in income inequality. For this
model, education is measured by primary school enrollment. While education at higher levels is
important to increases in incomes, primary education is essential in laying the
foundation for secondary and tertiary education.[36]
Beyond human capital formation,
lie the geographic contribution to income inequality and the relationship
between unemployment and earning distributions. In China, rapid income growth has accompanied rising inequality
between urban and rural areas, as “poverty tends to be associated with the
distance from cities and the coast.”[37] Access to growing sectors of the economy
appears to be positively correlated with rising income. Therefore, in using urban population growth
as a proxy for access to employment opportunities, one would expect to find a
negative relationship between it and income inequality. Finally, unemployment impacts income
inequality—for “people earn wages only when they have jobs.”[38] The positive relationship between
unemployment and income suggests that changes in the percentage of total
unemployment should be inversely related to income inequality.
In modeling the impact
of trade on income inequality, income inequality becomes a function of trade,
health and nutrition, education, physical access to growing sectors of the
economy, and unemployment.
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Gene M., and Elhanan Helpman.
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