Rural and Urban Dynamics and Poverty: Evidence from China and India

The rural and urban sectors of an economy are interconnected economically, financially, and socially. Ideally, resources such as capital and labor should move freely between these two sectors. In an undistorted economy, marginal returns to production factors should be equal. As a result, labor productivity and consequently per capita income should be the same. Many have argued that there should not be any distinction between rural and urban sectors. Indeed, there has been a growing interest in the development literature on the linkages between rural and urban development (DfID 2003). However, the relationship between urban and rural sectors in many developing countries is still characterized by an economic dualism, in other words, by the coexistence of a modern urban sector and a traditional rural sector. This duality arose because many developing countries, including China and India, pursued a heavy industrialization development strategy based on the transfer of resources and labor surpluses from the traditional (or rural) sector to the modern (or urban) sector. This development strategy largely favored the development and growth of the urban sector at the expense of rural areas. China initiated its reform in agriculture in the late 1970s and India began its macroeconomic reforms in the early 1990s. In both countries, these reform policies have corrected the urban bias to some extent. But the urban bias still persists. Whether measured in terms of income, literacy, or access to social services, a large gap is present between the rural and urban areas. The framework we used in this analysis is based on the equalization of returns to factors between rural and urban areas. Within this framework, any distortions that affect the free movement of resources should be removed. Government policies should be designed to correct market failures in order to achieve higher efficiency and also better income distribution. Under this circumstance, both efficiency and equality can be achieved, and greater synergies can be obtained between the two sectors. Our hypothesis is that further correcting urban bias would lead to higher growth in agriculture and therefore larger poverty reduction in both rural and urban areas, as a result of better rural-urban linkages. To test this hypothesis, panel data are used from China and India to measure (1) the contribution of rural growth to the reduction of both rural and urban poverty and (2) the impact of urban growth on rural and urban poverty reduction. For China, the results showed that agricultural growth has contributed to poverty reduction in both rural and urban areas. But the effect on rural poverty is larger than the effect on urban poverty. On the other hand, urban growth contributed to only urban poverty reduction and its effect on rural poverty reduction is negative or statistically insignificant. The results for India show that rural growth helps to reduce rural poverty, but its effect on urban poverty reduction is statistically insignificant. On the other hand, urban growth contributes to urban poverty reduction and its contribution to rural poverty reduction is not statistically robust. For both China and India, poverty rates are higher in rural than in urban areas. In addition, rural areas are still home to most of the total population. Poverty is thus concentrated in rural areas. Therefore, any policy that leads to higher growth in rural areas will also lead to greater poverty reduction. China and India both implemented development policies biased in favor of the urban sector. The terms of trade for agriculture have improved as part of the reform process, leading to some correction in urban bias. But other types of biases still exist. Among these, government investment has been one of the most important. To achieve greater poverty reduction, both governments need to correct this bias urgently by investing more in rural areas. Infrastructure such as transportation and communication, for example, is crucial for achieving better rural-urban linkages as it facilitates mobility and therefore access to markets, employment, and services for the rural population. Moreover, empirical evidence on the economic returns to public investments from both countries has shown that more investment in rural infrastructure as well as in agricultural research and development, and education will yield the largest returns in terms of both growth and poverty reduction. In poor areas such as western China and Eastern India, the poverty reduction effect from these investments is particularly high, and therefore deserves more investments from the government. The government should also reform its policies to nurture the further development of rural industries and small towns that play a key bridge role between rural farming communities and urban centers.