Introduction

After the mid-1980s income inequality in China increased markedly and has now reached a level that is relatively high by international standards. Underlying this increase was China's transition from a planned to a market economy. Prior to the transition a wide array of policies and programs had depressed income differentials. Wage differentials in urban areas were compressed and based largely on seniority and the ownership classification of the enterprise. In rural areas collective farms distributed earnings in an egalitarian fashion, and income inequality was mainly the result of differences among collective farms in resource endowments. Opportunities for households and individuals to engage in private income-generating activities were severely restricted.

With economic reforms the government has allowed, if not encouraged, some people to get rich first. In urban areas wage differentials and bonuses have increased; in rural areas farming is now household-based, and income differences reflect variation in household resources, abilities, and effort. Restrictions on private economic activities have been lifted, permitting diversification in sources of income and allowing returns to entrepreneurship. Such changes have naturally contributed to greater inequality.

The transition has led not only to a higher level of inequality, but also to a change in the underlying determinants of incomes and inequality. Markets now play a much enlarged role in the determination of incomes. As the scope of markets expands, one would expect incomes, and therefore inequality, to reflect differences in underlying productive characteristics and endowments such as land and labor endowments, education, and so on.