Labor Market Distortions, Rural-Urban Inequality, and the Opening of China's Economy

The authors evaluate the impact of two
key factor market distortions in China on rural-urban
inequality and income distribution. They find that creation
of a fully functioning land market has a significant impact
on rural-urban inequality. This reform permits agricultural
households to focus solely on the differential between farm
and non-farm returns to labor in determining whether to work
on or off-farm. This gives rise to an additional 10 million
people moving out of agriculture by 2007 and lends a
significant boost to the incomes of those remaining in
agriculture. This off-farm migration also contributes to a
significant rise in rural-urban migration, thereby lowering
urban wages, particularly for unskilled workers. As a
consequence, rural-urban inequality declines significantly.
The authors find that reform of the Hukou system has the
most significant impact on aggregate economic activity, as
well as income distribution. Whereas the land market reform
primarily benefits the agricultural households, this
reform's primary beneficiaries are the rural households
currently sending temporary migrants to the city. By
reducing the implicit tax on temporary migrants, Hukou
reform boosts their welfare and contributes to increased
rural-urban migration. The combined effect of both factor
market reforms is to reduce the urban-rural income ratio
dramatically, from 2.59 in 2007 under the authors'
baseline scenario to 2.27. When viewed as a combined policy
package, along with WTO accession, rather than increasing
inequality in China, the combined impact of product and
factor market reforms significantly reduces rural-urban
income inequality. This is an important outcome in an
economy currently experiencing historic levels of
rural-urban inequality.