Development strategy, economic transformation and income distribution

Income inequality will affect China’s economic growth over the long term. It is also one of the important factors determining whether China can avoid the middle-income trap. Different from the ‘equality of outcome’ perspective, this paper analyses the causes of China’s income distribution from the perspective of equality of opportunity. The inequality of opportunity in China is mainly caused by distorted institutional arrangements in the financial markets, labour markets, and product markets, involving e.g. restrictions on interest rates, the household registration (hukou) system, price controls on industrial and agricultural products, and privileges of state-owned enterprises. All of these distorted institutional arrangements are attributed to the heavy-industry-oriented development strategy in the recent history. Although this strategy was gradually abandoned, it has generated some institutions which have long-run impacts on the income distribution in China. Transforming government functions through institutional reforms is necessary to improve equality of opportunity and income distribution.