Inequality and economic growth in China

Purpose – The purpose of this paper is to study the long‐run relationship between economic growth and income inequality in China during the pre‐reform (1952‐1978) and post‐reform (1979‐2007) periods, this will be done via cointegration analysis. Design/methodology/approach – The aim of this paper is to offer a proper answer to the issue of the inequality‐growth nexus by using a cointegrated VAR‐setting approach, in this way, the study can cope and avoid the problems of parameter heterogeneneity, omitted variable bias and endogeneity, from which the model of macroeconometric analysis suffers. Findings – The cointegration analysis shows that, for both periods the relationship is positive and the inequality‐growth elasticity has grown in the second period. In addition, a more robust test of Granger‐causality suggested by Toda and Yamamoto indicates that whereas in the first period there is unidirectional causality from inequality to growth, there is no directional causality in the second period. Practical implications – The pre‐reform period going from 1952 to 1978 is characterized by the adoption and implementation of a Soviet‐type economy. The economy showed a modest annual economic growth rate of 2.33 percent and very low levels of inequality, with an average Gini coefficient of 0.27. The post‐reform period tried to combine central planning with market‐oriented reforms to increase productivity. In fact, the economy has grown at an annual growth rate of 7.07 percent since 1979 and also the inequality with an average Gini coefficient of 0.33. Originality/value – The paper studies the relationship between income inequality and economic growth in China during the pre and post reform periods. A significant and positive long‐run relationship between inequality and economic growth in both periods was found. The inequality‐growth elasticity is greater in the post‐reform than the pre‐reform period. Using a more robust Granger causality test the authors find a unidirectional predetermination between the variables for the whole period and for the pre‐reform period. However, there is not causality in the post‐reform period. Except the urban‐rural disparity which explains the unidirectional causality from inequality to growth, pre‐reform China was basically an egalitarian society. In the pre‐reform period, the low inequality was identified as a strain on economic growth. However, the reform period has seen remarkable growth. Although regional inequality and the rural‐urban gap declined from the late 1970s to the mid‐1980s, both have increased rather dramatically since the mid‐1980s.