Globalization Reduces Inequality in China

"Those cities that have had a greater increase in the trade-to-GDP ratio have also tended to witness a reduction, rather than an increase, in the urban-rural income inequality."

Does globalization worsen income inequality or reduce it? In recent years, this simple yet stubborn question has spawned countless studies examining the link between economic openness and income gaps. However, these analyses typically use cross-country regressions and encounter two key problems. First, data on relevant indicators -- such as national income-distribution measures -- are often not compatible internationally because of differences in the definition of the variables and data collection methods. Second, researchers often have a hard time accounting for variations in legal systems, political institutions, and culture that may affect economic growth and income inequality but may not be directly measurable. Indeed, some of these variables may interact with openness in affecting inequality and growth. As a result, evidence on the impact of globalization on inequality remains ambiguous.

In Globalization and Inequality: Evidence from Within China (NBER Working Paper No. 8611), co-authors Shang-Jin Wei and Yi Wu seek to overcome these obstacles by studying the connections between openness and inequality within a single country, where data disparities as well as institutional and cultural differences are less likely. Wei and Wu examine data for about 100 Chinese cities between 1988 and 1993, focusing on the gap between urban and rural incomes as a measure of income inequality. (They limit the study to cities that encompass urban areas plus adjacent rural counties.) Total income inequality in China can be decomposed into inequality between urban and rural areas, inequality within urban areas, and inequality within rural areas. A number of other studies have shown that the first component - the inequality between urban and rural incomes - explains 75-80 percent of the overall inequality in China in the last two decades.

It is sometimes asserted, based on China's aggregate statistics, that it is an example in which greater openness has led to an increase in inequality. Wei and Wu suggest that this is wrong because other factors, such as inflation, could account for the increase in inequality. A within-country study such as theirs can hold constant these nationwide factors. Wei and Wu find that "those cities that have had a greater increase in the trade-to-GDP ratio have also tended to witness a reduction, rather than an increase, in the urban-rural income inequality." In other words, openness to the global economy is associated with a reduction, not a worsening, of income disparities.

China is indeed a good case study: First, China offers "a quasi-natural experiment on the consequences of embracing globalization." Because of Deng Xiao-Ping's 1978 decision to open the Chinese economy to the rest of the world, the country's overall trade as a percentage of GDP skyrocketed from 8.5 percent in 1977 to 36.5 percent 22 years later. Second, China's size allows Wei and Wu to amass data from a large number of intra-national observations. This means that it would be more difficult to implement a similar study on economies such as Argentina, Bangladesh, or Costa Rica, three countries that also have increased their openness dramatically in the last two decades.

In addition to its economic lessons, China has geographic features that provide a methodological advantage. China is semi-landlocked with a coast on its Eastern and Southeastern sides. The differences across Chinese cities in terms of participation in international trade are, to a large extent, attributable to their varying distance from a major seaport. This is confirmed by the data. Thus, the Chinese geography offers a plausible "instrumental variable" for local exposure to globalization. It would be more difficult to carry out a similar study on economies such as the United States or Indonesia whose access points to international trade are more diffused.

Through what channels has China's trade openness helped rural residents to narrow their income gap relative to the urban residents? Wei and Wu hypothesize that globalization has offered an opportunity for rural areas to industrialize. More specifically, the industrial firms in rural areas of China (often referred to as "township-and-village enterprises," or TVEs) have a better chance to emerge, expand and succeed in more open areas. As a consequence, the residents in these areas catch up with their urban counterparts faster.

-- Carlos Lozada

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