July 21, 2008 / 10:09 AM / 11 years ago

China's inequality looms large as policy challenge

BEIJING (Reuters) - When French cosmetics retailer L’Occitane en Provence eyes Hong Kong for a share listing because Asia is the fastest-growing market for its fig-scented soaps, it speaks volumes about the rise of the region’s middle class.

China, in particular, with its 1.3 billion consumers, has marketing men salivating. Brands from Pizza Hut (YUM.N) to Rolls Royce (BMWG.DE) are increasingly counting on China, where retail sales rose 21.4 percent in the first six months, to drive growth.

At the tonier end of the discretionary spending spectrum, Richemont CFR.VX, the maker of Cartier jewellery and Mont Blanc fountain pens, last week cited strong demand in China and Hong Kong for forecast-beating quarterly sales.

Alongside swelling ranks of super-rich, there were still 204 million Chinese in 2005 living on less than $1.25 a day, according to the World Bank. The result is a gulf in incomes that is one of the country’s greatest social and political challenges.

Which makes a new essay by the World Bank’s chief economist, Justin Yifu Lin, intriguing reading.

Before his recent appointment, Lin was a prominent Peking University professor who frequently advised the government on development issues.

In “China’s Dilemma”, a collection of papers co-published by Australian National University and Asia Pacific Press, Lin argues fundamental flaws in China’s economic model are partly to blame for the yawning gap between rich and poor.

Lin criticizes a basic Communist Party economic tenet that puts, in the name of “efficiency”, the interests of corporations before those of workers and leaves it to government redistribution policies to tackle the ensuing inequalities.

“It is our task to ensure that in the course of development, the income of the poor grows faster than that of the rich, but it should not be accomplished by redistribution,” Lin writes.

STABILITY RISKS

Firms may be raking in high profits thanks to the emphasis on “efficiency”, but it is only because the state shields them from market competition and lavishes subsidies on them, Lin argues.

“Essentially, however, these profits are a kind of wealth transfer that will inevitably lead to social instability,” he warns.

Lin’s recommendations for a more equal share-out of China’s wealth add up to a radical manifesto:

— China must promote smaller banks to help small firms grow. He attacks the current set-up whereby big firms receive loans for capital-intensive projects from state-owned banks that would never dream of lending a peasant money for a new hen house.

— Resource companies should pay significantly more tax. Low taxes and fees — just 1.8 percent in China against 12 percent in America, Lin says — have generated fabulous wealth for some mining and petroleum firms, further skewing income inequality.

— Where possible, China should scrap monopolies and introduce competition, which would lower profits and prices.

“Income differences between urban and rural regions will decline once a complete market system is fully in place,” Lin predicts.

These differences have been widening, not narrowing.

According to an Asian Development Bank report last year, the Gini coefficient for China soared to 47.3 in 2004 from 40.7 in 1993, putting it at a level more typical of Latin America.

In a society where income was perfectly distributed, the Gini coefficient would be zero; if all the income was in the hands of one person, it would be 100. The figure for India is 36.2.

By a different measure, when China embarked on market reforms in 1978, urban disposable incomes were 2.6 times greater than rural net income. By 2006 they were 3.3 times bigger, forming what Lin says is one of the biggest income gaps in the world.

“As the old adage suggests, ‘shortage is not a problem, but inequality really matters’,” he writes.

FOOD PRICE RISES

For policy makers, the task of tackling inequality is complicated by rising food prices. The urban poor, who spend a lot of their disposable income on food, are obviously hit hard.

Yet higher food prices are a boon for those among China’s 737 million rural population with spare produce to sell, said Wang Dewen, a researcher at the Institute of Population and Labor Economics with the Chinese Academy of Social Sciences in Beijing.

With heavy government spending on rural health, education and infrastructure also kicking in, rural incomes jumped 19.8 percent in the first six months from a year earlier, outstripping a 14.4 percent rise in urban incomes.

“As you can see, the income growth of Chinese farmers was higher than inflation, and that means an improvement in the standard of living,” Wang said.

But he added: “Inflation always hits poor people more than rich people, and China is no exception.”

A recent study by Asian brokerage CLSA found that 54 percent of households earning 1,000 yuan ($147) a month or less had cut back on meat consumption due to rising prices.

In the same vein, the World Bank said inequality in Vietnam was likely to increase, even though a lot of peasants near the poverty line are net sellers of rice and are benefiting from higher prices.

“The complexity of poverty and distributional impacts of rising food prices warns against sweeping ‘one size fits all’ responses,” the bank concluded.

($1=6.816 Yuan)

Additional reporting by Zhou Xin; Editing by Mathew Veedon

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