How China's widening wealth gap caused the financial crisis

And how narrowing income inequality on the mainland, as reflected in numbers for household spending, is key to a more sustainable economy

PUBLISHED : Wednesday, 23 January, 2013, 12:00am
UPDATED : Wednesday, 23 January, 2013, 3:55am

Howls of derision greeted the official announcement last week that mainland Chinese income inequality peaked in 2008 and has since been falling.

The sceptics should think again. Not only is it feasible that China's wealth gap has narrowed since the financial crisis, it's excellent news. Widening income inequality not only dangerously destabilised China's own economy, it was also a major cause of the global financial crisis in the first place.

What riled observers last Friday was the publication by China's National Bureau of Statistics of a Gini coefficient for the first time since the year 2000.

If you are not familiar with it, the Gini coefficient measures a country's inequality on a scale of zero to 100. A score of zero would represent perfect equality, with everyone earning the same. In contrast, a score of 100 would see all the income generated by the entire country going to a single person, with everyone else getting nothing at all.

On this measure, the most equal countries in the world are usually reckoned to be the egalitarian social democracies of Scandinavia, which according to the World Bank get scores of around 25.

In contrast, the most unequal major economy is South Africa, with a score of 63. In general, any score above 40 is regarded as dangerously unequal. According to Beijing's statisticians, China's Gini number rose rapidly over the last decade to hit a high of 49 in 2008. Since then the wealth gap has narrowed, with the Gini falling to just over 47 last year (see the first chart). That's lower than either Hong Kong or Singapore, and roughly comparable with the United States.

In response, a whole legion of commentators complained that the official Gini number was far too low, massively understating China's wealth gap. What's more, they protested, income inequality was getting worse, not improving.

It's true that a number of studies have recently come up with Gini scores that are much higher than the official number. In December the Survey and Research Centre for China Household Finance, estimated that in 2010 China's Gini coefficient reached 61, almost on a level with South Africa.

But patchiness of income data in China means these studies have a huge margin of error. Working instead from data for household spending, last year Asian Development Bank chief economist Changyong Rhee calculated that China's Gini in 2008 should have been around 48, which is not far off the official figure.

It's also feasible that China's Gini is now falling, considering that over the last few years urban workers have won double-digit annual wage increases.

And if it is, that's excellent news, because rising income inequality in China was a major contributing factor in the global financial crisis.

Widening inequality meant a smaller share of national income went to ordinary households, which in turn meant that each year they were able to consume less of what China produced.

As a result, national savings - simply the excess of production over consumption - rose.

At the same time, the weakening share of domestic consumer demand eroded the opportunities to invest those savings productively. The consequences were misallocation of capital on an epic scale, a surge in speculative property investment, and a flood of capital abroad, where it forced down long-term interest rates and helped inflate the US housing bubble and the European debt boom.

As a result, narrowing China's wealth gap is an essential component of economic rebalancing.

Happily, that may now be happening. Last year urban real disposable incomes rose faster than China's real gross domestic product by a significant margin for the first time in 10 years (see the second chart).

If the trend continues, it means China's economy will be on track to become both more equal and more sustainable.