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Fleshing out the Olive? Income Polarization in China

Beyond the popular goal of “ending poverty,” national leaders rarely articulate a reasonably well-defined goal for the national distribution of income. In an exception, at a prominent and widely-reported meeting in August 2021 of the Chinese Community Party’s Central Committee for Financial and Economic Affairs, President Xi Jinping argued that the goal of “common prosperity” for China required an “olive-shaped distribution structure of large middle and small ends” (as reported by the Xinhua News Agency, August 17). In short, the proposed aim of the Chinese leadership is to “expand the proportion of middle-income groups” (Xinhua News Agency)—what the Economist magazine dubbed “fleshing out the olive” in an August 28 article reporting on President’s Xi’s speech.

President Xi was clearly not saying that this is the only policy goal for China, even within the gamut of goals related to the distribution of income. (Xi has often emphasized the goal of ending poverty.) So, the question naturally arises as to what trade-offs might exist against other goals. That is a difficult question. Trade-offs can be hard to identify ex-post in observable data, which also reflect past policy choices (given the trade-offs faced at the time) and shocks. Nonetheless, it is of interest to see what the historical experience suggests about trade-offs with regard to this new goal. This requires that we can quantify attainments of the multiple distributional goals, including defining and measuring the idea of “fleshing out the olive.”

The well-documented success of China in reducing absolute poverty came (of course) with a rising share of the population living above the absolute poverty line, many of whom joined what can be thought of as China’s “middle-class.” Naturally, what this means depends on the setting. The prevailing definition of a “middle-income group” can be expected to change over time with rising living standards; what was considered a “middle” income in the China of the 1980s is clearly not the same as today. “Fleshing out the olive” can be interpreted as reducing the spread of incomes relative to the current median, which arguably provides a more relevant reference point than a fixed absolute level of real income.

This perspective suggests that the concept of “polarization” found in economics is relevant to monitoring China’s performance in “fleshing out the olive,” and identifying potential trade-offs against other goals, including poverty reduction. And there is a measure available in the literature, namely the Foster-Wolfson (FW) polarization index. This measures the spread of incomes relative to the median.

While much has been written about poverty and inequality in China, rather little has been said about polarization. A new paper, “Fleshing out the Olive,” with Shaohua Chen, provides polarization measures for China spanning the post-reform period after 1980. This allows us to identify some key sub-periods when polarization was stable and even falling. The variance in the time-series allows us to explore the covariates of polarization. For example, we will be able to see whether there are signs in the historical record that less polarizing periods saw lower rates of economic growth.  

Conceptually, polarization is not the same thing as inequality, which suggests the possibility of a trade-off between the two. While it is not something that has attracted much attention in the literature, one might expect that the process of economic development through structural transformation in a country such as China may have a de-polarizing effect, as the poorest move closer to the middle. Nor is this an aspect of the potential distributional changes with development that is likely to be captured well by the standard inequality indices. These potentially de-polarizing gains among the poorer half may, however, come hand-in-hand with polarizing gains among the (primarily urban) upper half, comprising an elite of skilled workers and those who own the capital stock and/or rental properties.

Also relevant in the context of China is the evolution of the large disparities found between mean incomes in urban and rural areas. This reflects long-standing inequalities in social policies (health, education and social protection) as well as impediments to internal migration, notably through the hukou registration system, and administrative land allocation processes. (Our paper provides references to the literature on these points.) Given the large mean income gaps between China’s urban and rural areas, the degree of urban-rural sectoral fractionalization—the extent to which people live in different sectors—may also matter to both income inequality and polarization.

Our new paper points to some potential trade-offs between reducing income polarization and other valued goals. Some policies that are good for fighting poverty and inequality could well be polarizing. Policy makers need to be aware of these potential trade-offs. In addition to arguing that the Foster-Wolfson index is a close match to the spirit of the idea of “fleshing out the olive”—and so provides a valuable tool for monitoring progress in attaining that goal—the paper has looked for signs of such trade-offs in the aggregate time series data for China since 1981.

A focus on polarization begs some new policy questions that have so far been largely ignored. A prominent example in contemporary China is the Central Government’s goal of eliminating the hukou registration system—the internal “passport” system in China that restricts the access of rural migrants to urban services and markets. While ongoing reforms to the hukou system would undoubtedly help reduce poverty, the impact on polarization is unclear, given that the bulk of both the personal benefits and the costs of relaxing hukou restrictions may well fall on the lower side of the median, suggesting that these reforms could be polarizing. The potential for such polarizing effects of relaxing hukou restrictions would need to be balanced against other considerations, including poverty reduction.

However, our paper finds rather little evidence in the time-series data we have assembled of any negative co-movement between polarization (on the one hand) and economic growth or reducing poverty and inequality (on the other). Granted, polarization rose with rising average incomes up to 2009, but this appears to be spurious, reflecting common time trends. Periods of higher poverty reduction or higher economic growth did not typically see more rapid polarization. And there is strong co-movement between the Gini index and the Foster-Wolfson polarization index. Nor do we find that periods of a more rapid rise in the urbanization of the poorer half of the population (who started off almost only in rural areas) tended to be more polarizing.

To the extent that reducing polarization is a new policy goal for China, the historical record does not point to any serious trade-offs with past goals going forward, including with economic growth and poverty reduction. The recent reversal in the generally upward path for polarization in China has been driven almost entirely by attenuated median-normalized incomes among the upper half.

Of special relevance to thinking about the policy options in reducing polarization is our finding that the rise and fall in China’s national polarization index is largely accountable to the evolution of the gap between urban and rural mean incomes. Here too, the historical record provides little support for the idea that reducing urban-rural disparities would be polarizing—indeed, the data suggest the opposite. However, potential trade-offs would need to be considered further in the context of specific policy efforts, such as in expanding social service coverage in rural areas, also taking account of how those efforts are financed.