Comments onDecentralization, Inequality and Poverty Relief in

Chinaby Li, Tao, and Yang

Xiaobo ZhangPeking University and IFPRI

Extremely Important Topic

• Rising inequality is a top concern.

• Decentralization is a defining feature of Chinese economy. It has shaped China’s growth and income distributional patterns.

• This paper makes a contribution to understanding the impact of decentralization on rural-urban income gap.

Page 3

China’s Fiscal Structure Fiscal decentralization

Expenditures tie more closely to revenue

Horizontally, inter-judiciary competition.

Page 4

China’s Political Structure Organizational form.

Replicate, vertical hierarchical structure Irrelevant of economic size and local needs.

Strong central mandates. Family planning Social stability and occupational safety (no major

accidents) Other central tasks

Page 5

Hierarchical StructureCentral

Province

Prefecture

County

Township:

Village:

Page 6

050

000

0 100 200 300 0 100 200 300

1993 2000

Size of Bureaucracy Fitted values

Siz

e of

bur

eauc

racy

Total population

Graphs by year

Page 7

Uneven Fiscal Dependent Burden

-20

24

6 8 10 12 6 8 10 12

1993 2000

Fiscal burden Fitted values

Fisc

al b

urde

n

Economic development level

Graphs by year

Zhang, JCE (2006)

Page 8

Regressive Tax Rate -6

-4-2

0

6 8 10 12 6 8 10 12

1993 2000

Industrial tax rate (in log form) Fitted values

Indu

stria

l tax

rate

Economic development level

Graphs by year

Zhang, JCE (2006)

Page 9

Two Spirals Tax burdens are extremely high in poor regions

with agriculture as the major means of production. Downward spiral: small tax base, more extraction from

limited agricultural surplus and nonfarm activities, worsening investing environment, and lowering public goods provision.

They are low in developed regions initially with a large nonfarm sector. Virtuous cycle: light tax burden for each enterprise,

more public inputs, better investing environment.

Page 10

Coastal Region: Race to the “Bottom”

Less tax on capital

Small governments and better investment environment,

but sometime under provision of public goods (such as crime problem)

Page 11

Poor Region: Race to the “Top”

Big government and predatory investment environment.

Devote most energy to obtain transfers from the upper level government.

Keep the “poverty county” status partly by underreporting income. This is probably why in the poverty regressions, transfer is always negative for rural income (a key finding of the paper).

Page 12

Decentralization and Overall Regional Inequality

Fan, Kanbur, and Zhang, RDF (2011)

Page 13

Tax Sharing Rate and Rural-Urban Income Ratio

Drawn based on Tables 1 and 2 of Li, Tao, and Yang (2013)

Page 14

Heavy-Industry-led Development Strategy and Rural-Urban Inequality

Fan, Kanbur, and Zhang (2012)

Problem of using Rural-Urban Gap in Regressions

• Local rural-urban income gap is not equal to national rural-urban inequality. – It doesn’t take the within-rural and within-urban

inequality in a prefecture into account;– Cross-regional migration is not accounted.

An Example

Rural Urban Rural Urban0

5

10

15

20

25

30

PoorRich

Inland Coast

Income

An Example

Income

Rural Urban Rural Urban0

5

10

15

20

25

30

35

40

45

50

PoorRich

Inland Coast

Alternative method: regression-based decomposition

• Suppose y is income per capita (each region has two observations, one for rural and one for urban):

Alternative method: regression-based decomposition

Zhang and Zhang (2003)

Mapping Findings to Policy Options

• “It is necessary to introduce local accountability from the bottom up, through both democratic elections and information transparency.”

• Election is just one way to hold local officials accountable.

Challenges of Promoting Local Democracy

• Both political and economic decentralization may jeopardize national unity.

• Local elite capture/ clientelism can become a problem (See Mu and Zhang, JDE forthcoming).

Indigenous Reforms on the Ground

• Cut the prefecture-level government (Hubei);

• Merge townships;

• Borrow police officers from regions.

• Pairwise-aid (from rich to poor province) strategy (Sichuan and Xinjiang)

Other Suggestions

• For the poverty part, it is better to use outcome variable from census, agricultural census, or economic census, which are less manipulated by local officials.

• Split the paper into two papers.

• Take logs for economic and population variables.