Rural Income Volatility and Inequality in China

Current literature based on analyses of rural income volatility in China decompose poverty into chronic and transient components using longitudinal survey data and assesses the fraction of the Foster, Greer, and Thorbecke poverty gap attributable to mean income over time being below the poverty line. Resulting estimates of 40--50% transient poverty point to the policy conclusion that poverty may be a less serious social problem than it appears in annual data due to rural income volatility. Here, we instead use a direct method to adjust rural income for volatility using a certainty equivalent income measure and recomputed summary statistics for the distribution of volatility corrected incomes, including the urban--rural income gap on which much of current poverty debate in China focuses. Available data indicate a growing urban--rural income gap (the ratio of mean urban to rural incomes) with a significant increase from around 1.8 in the late-1980s to over three today. These estimates do not take into account the higher volatility of rural incomes in China. Since an uncertain income stream is worth less in utility terms than a certain income stream, we argue that heightened rural volatility increases the effective urban--rural income gap and intensifies not weakens poverty concerns. Using Chinese longitudinal rural survey data for which current decompositions can be replicated, we make adjustments for certainty equivalence of rural household income streams, which not only widen the urban--rural income gap in China but also increase other distributional summary statistics. Depending upon values used for the coefficient of relative risk aversion, the measured urban--rural income gap increases by 20--30% using a certainty equivalent measure to adjust rural incomes for volatility. We also conduct similar analysis using consumption data, for which similar (but slightly larger) increases occur. (JEL codes: D00, D31, D81,G11, N55, O12; O15; R20) Copyright The Author 2009. Published by Oxford University Press on behalf of Ifo Institute for Economic Research, Munich. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.