Figure 1: Chinese Share of Wealth and Income Accruing to Top 10%
Source: World Wealth and Income Inequality Database, Continuum Economics
Political economist Karl Polanyi in 1944 authored a book called the Great Transformation, the title referring to the process of the rise of the market economy. Prior to this great transformation, economies were based on reciprocity and redistribution, but competitive markets undermine the latter and replace them with formal institutions, which characterize a self-regulating market economy. While China was well-engaged into this great transformation, as is illustrated by the debt-fueled capitalism that Evergrande now stands for, Xi has clearly decided to take a step backward, refusing markets’ self-regulation and returning to tight controls, which is effectively a system based on central planning and orders, plus a greater emphasis on redistribution. The quantitative targets issued by this system are often met, yet the side effects of their achievement are often problematic.
Take the latest power crisis, which seems to have distracted the market’s attention from the troubles of Chinese property developer Evergrande. Behind the major power shock, three factors are at work: an emphasis on meeting targets to cut CO2 emissions ahead of the November COP; the inability of power suppliers to pass rising coal prices onto the electricity prices they charge industries and consumers, due to regulations and social stability considerations; and coal scarcity. Chinese industrial growth is now at risk, resulting in rising demand for electricity and a surge in coal and gas prices. China is now paying the most on record for the dirtiest type of coal from Indonesia at $120/ton, which weakens the emissions target explanation. Of course, it can be argued that the power crisis is global and attributable to tight global energy supply, as a post-COVID recovery in activity and consumer demand hits the market as investment has not recovered.
Meanwhile, the Evergrande crisis also holds great significance for China’s long-term outlook. Considering that the impact of real estate-related activities amounted to 28.7% of Chinese GDP in 2016, compared with 18.9% of U.S. GDP in 2005 at its pre-crisis peak, the scale of the consequences of the Evergrande debacle is evident. Not only has China’s growth been boosted by the construction of an excess supply of housing units, but this construction has also been financed by an unsustainable mountain of debt. China expert Michael Pettis notes that ‘China’s official debt-to-GDP ratio has soared by nearly 45 percentage points in the past five years, leaving it with among the highest debt ratios for any developing country in history’. We have highlighted the nature and risks from this debt build-up. While the government will most likely ensure that a relatively orderly restructuring takes place and that Evergrande is turned into a counter-example for other companies, Evergrande’s legacy may be less a financial crisis than a macroeconomic one, as it threatens a key ingredient of growth, i.e. the property sector. In this perspective, even the IMF’s 2023 projection of 5.4% growth might be optimistic.
More important in our view, the authorities’ clampdown on Evergrande and the property sector is also significant because it is a manifestation of their overarching emphasis on income and wealth inequality.
Figure 2: Top 10% Wealth Share According to the World Inequality Institute
Source: World Inequality Database, Continuum Economics
So do the clampdown on technology and private tuition, or the Evergrande and power debacles, mark the end of the argument that China will soon take over from the U.S. as the richest economy in the world? Niall Ferguson certainly thinks so. He compares this idea to the assertion in the Cold War that Russia would outpace the U.S. in the late 80s to mid-90s, a prediction which never came to pass. To be sure, China is resembling Soviet Russia more by the day in terms of centralized control. Yet there are two reasons that Ferguson’s assertion is not necessarily correct. For one thing, the advent of capitalism in China has changed society to the extent that redistribution and reciprocity, while not extinct, are coexisting with capitalist values, which will not go away that easily, repression and all. Capitalism’s animal spirits have been unleashed and are unlikely to vanish altogether in our view. Recently, Chinese officials have sought to clarify that the eradication of these animal spirits is not the objective of Common Prosperity: ‘Common prosperity means doing a proper job of expanding the pie and dividing the pie. … We will not kill the rich to help the poor’. Similarly, the recent announcement of a new Beijing stock exchange sends the same signal.
Hence a more pertinent question is whether China is merely on the way toward a transition to a capitalism with Chinese characteristics, where a greater space for redistribution and reciprocity exists. The steep rate of increase in the wealth of the top 10% since the 1990s (Figure 2) certainly justifies the authorities’ attempt to put a lid on income and wealth inequality. Inequality increased substantially after the economic liberalization of the 1980s. While the official data has many limitations, researchers at the London School of Economics and World Inequality Lab have made some adjusted estimates of inequality, suggesting that the share of national income earned by the top 10% of the population has increased from 27% in 1978 to 41% in 2015, while the share earned by the bottom 50% has dropped from 27% to 15%. (2015 is the latest data point available from the World Inequality Lab but there is no particular reason to believe the trend has ended.) The bottom 50% of the population used to have about the same income share as the top 10%, while their income share is now about 63% lower. Consequently, this set of research concludes that while the level of inequality in China in the late 1970s was less than the European average — closer to that observed in the most egalitarian Nordic countries — it is now approaching a level that is almost comparable with the U.S. China is also more unequal than post-communist Eastern Europe but on a par with post-communist Russia, especially at the very top.
Data from the World Bank, which also has the drawback of only being available until 2016, is less negative, in that it puts the share of the top 10% at 29.4% compared to the World Inequality Lab’s 41%, and it shows a slight decline in the share from 2010 to 2016 from 32.6% to 29.4%, while the World Inequality Lab sees the share as flat in this period. World Inequality Lab data combines national accounts, fiscal and wealth data, and surveys to correct for the fact that most official inequality measures, including those of the World Bank, mostly rely on self-reported survey data, which tend to underestimate top income levels. Yet regardless of which data on income inequality is correct, the wealth inequalities emphasized by the World Inequality Lab have risen faster than income inequalities and they are at the core of this debate. As noted by the Brookings Institution, ‘the fact that a poor population nearly twice the size of the full population of the United States lives alongside a wave of first-generation billionaires and millionaires who consume nearly half of all luxury goods sold globally creates complexities for social cohesion in China’.
Hence one way of looking at this is not to examine whether China is losing the race toward becoming the world’s richest economy, but rather to ask whether it is leading the world toward a new social economy where income distribution is a primary macroeconomic, and not just political, consideration, from being a second thought at the moment. To be sure, Xi’s income distribution agenda is partly politically motivated: As he recasts himself from princeling to populist leader, it is convenient for him to champion greater equality and present himself as the one who will correct the excesses of Deng Xiaoping’s decision to ‘let some people get rich first’. In general, Xi is also keen to place more segments of the economy under government control. At the same time, given his competitive streak with the U.S., Xi is eager to demonstrate the superiority of an alternative Made in China development model. Soothing economic inequalities behind China common prosperity would be well-understood in EZ and Nordic countries where social balance is more important than the U.S./UK.
But does it matter if Common Prosperity is driven by political posturing? Ironically, the experience of DM economies, which we describe below, shows that even if it is political posturing, the pursuit of the reduction of income inequality is economically rational, as it has an impact on the natural rate of interest. Considering that low natural rates are the biggest economic challenge of the 2010s/early 2020s, if they amplify inequality by increasing wealth faster than income, then achieving common prosperity can only become a central aspect of macroeconomic stability and policy, and that will perhaps be Xi’s greatest political victory if it is achieved.
Figure 3: Income Share Held by Highest 10% in BRICS According to the World Bank
Source: World Bank, Continuum Economics
Meanwhile, as a development model for EM, China’s experience is relevant to none more than South Africa. The inequality issue is salient there, permeating both the income and wealth dimensions (see Figure 2). The experience of the July riots has brought home the significant risks to macroeconomic stability implied by extreme inequality. The top 0.01% concentrate 15% of household net worth, more than the bottom 90%. Inequality is driven by the concentration of all forms of assets at the top end. It is higher than in any other country for which comparable estimates exist: In particular, the South African top 10% wealth share fluctuated between 80-90% from 1993 to 2017, while it remained below 70% in Russia and China and 65% in India. There has been no sign of decreasing inequality since the end of apartheid. If anything, during South Africa’s recent history of positive growth and despite ambitious policy frameworks from 1993 to 2017 whose objectives included reducing inequality, the wealth share held by the top 1% and 0.01% even increased. Inheritance of asset allocations before apartheid still shapes wealth inequality in recent years. Interestingly, a recent report by the World Inequality Institute finds that any decline of racial inequalities between Black and White South Africans since the end of apartheid has been largely driven by the boom of top Black income groups and is only marginally reduced by taxes and transfers. Despite being enabled by a high-performance developmental state that South Africa could only dream of, if China makes some headway in addressing inequality, it could at least provide evidence that patterns of inequality can be shifted and that it is a worthwhile and attainable political pursuit. At the moment, South African institutions are not succeeding in shifting these patterns and their attempts lack conviction. The introduction of a permanent basic income grant, which is likely to be adopted by the South African government, is a drop of water in the context of long-entrenched wealth inequality.
Figure 4: The Decline in r* in the U.S.
Source: Kansas City Fed, Continuum Economics
Ignoring income inequality is not advisable in DM either, where it is as pressing a concern as it is in China, due to its correlation with the natural rate of interest. In the U.S., the labor share fell in the first decade of the 21st century and has been moving sideways since 2010, remaining much lower than at the turn of the century. Because capital ownership tends to be concentrated among individuals in the top of the income distribution, the fall in the labor share deepens overall income and wealth inequality. In addition, COVID has intensified inequality as those with lower wages or who participated less in the labor market have been hurt the most. Hence the issue has become a centerpiece of DM public policy, especially in the U.S. via the debate on physical and human infrastructure bills and the associated redistributive tax agenda. More significantly still, it is becoming incorporated into mainstream macroeconomic models used for policy analysis, on the premise that rising income inequality is causing a low natural interest rate. A paper presented at Jackson Hole by the Kansas City Fed shows that as the savings rate of high-income U.S. households is higher than that of low-income ones, the shift in income to high-income households has led them to save 3-3.5% more of national income compared to the pre-1980 period, and the resulting savings glut has caused the natural interest rate to fall, resulting in high-income households becoming even wealthier. Goodhart and Pradhan reach the same conclusion: In the past 30 years, the insertion of China into the labor market and favorable demographics have created a positive shock to global labor supply, which has caused the bargaining power of labor to decline. The consequence is that the share of labor income in GDP has fallen, the natural rate of interest has fallen, asset prices have risen and inequality has increased, because the wealthy with more assets benefit more from lower rates. Who says inequality is just a social policy afterthought? If even DM are getting serious about it as an economic issue, albeit for different reasons than China, maybe Xi is on the right track indeed.