1. Title of the submission:
Foreign Direct Investment and Regional Income
Inequality in China
2. Name(s) of the author(s):
3. Affiliation (s) of the author (s)
Sumei Tang, 1 Saroja Selvanathan 2
1. School of International Business and Asian Studies,
Griffith University Nathan, Queensland, Australia
2. Economics and Business Statistics Discipline,
Department of Accounting, Finance and
Economics Griffith University Nathan, Queensland,
Australia
4. Mailing address:
Associate Professor Saroja Selvanathan
Department of Accounting, Finance and Economics
Griffith University, Nathan Campus, Kessells Road,
Nathan, Queensland, 4111, AUSTRALIA
5. E-mail address(es):
[email protected], [email protected],
1
Foreign Direct Investment and Regional Income
Inequality in China
Sumei Tang*
School of International Business and Asian Studies,
and
Saroja Selvanathan
Department of Accounting, Finance and Economics
Griffith University
Nathan, Queensland
AUSTRALIA
January 2005
Abstract China is the largest foreign direct investment (FDI) recipient country in the
world, which aggravates concerns over the impact of FDI on rising inter-regional income
inequality in China. This paper examines the relationship between FDI inflows and
regional income inequality using data for the period 1978 to 2002 at national, rural and
urban levels. We find that FDI inflows as one of the main factors have led to increasing
of regional income inequality at national level, as well as rural and urban regions of
China. In addition, the empirical evidence also suggests that the level of economic
development, education, trade, the economic reform in the State-Owned-Enterprises
(SOE), the agricultural transformation, the level of domestic investment and the direct
role of government are some of the other crucial determinants of regional income
inequality in China.
* Email: [email protected], [email protected]
* I am grateful to Professor G. H. Wan, World Institute for Development Economic Research, United
Nations University, and professor E.A. Selvanathan, SIBA, Griffith University, Australia for helpful
comments.
2
Foreign Direct Investment and Regional Income
Inequality in China
1. INTRODUCTION
Foreign direct investment (FDI) in China has set a new record high, reaching U$52743
million dollars in 2002. This has led to China becoming the largest FDI recipient country
in the world replacing the United States (US). The annual growth rate of utilized FDI in
China has also showed a remarkable achievement at 21% over the last quarter of this
century. Coupled with this persistent strong growth of FDI inflows, China has achieved
its highest average annual economic growth rate of about 10%, while the distribution of
growth rate is extremely skewed. This is probably due to the average annual growth rate
of GDP in the coastal regions of China, where most FDI inflows flowed in, has been
traditionally always higher than that of the inland regions. Has FDI influenced China’s
regional inequality? If it has, how are the FDI and regional inequality related? The
relationship between FDI and inequality has been under hot debate and has been an
important subject of interest in the field of international economics and economic
development. On the one hand, some researchers argue that FDI, in general, should not
cause any significant variation in income inequality and even it reduces the income
inequality in developing countries in particular (Mundell 1957). On the other hand, others
argue that FDI does attribute to the rise in income inequality (Tsai 1995). In this paper,
under a regression analytical framework, we seek answers to the above debate using time
series and cross-regional Chinese data for the period 1978 to 2002. While we identify the
principal forces that affect regional income inequality, we also explore alternative
policies that may promote more rapid economic growth in China’s poorer regions. Such
an analysis on FDI and the regional income inequality in China is important not only
because China is the largest FDI recipient country in the world but also, China, as a
developing nation, needs to feed 13 billion people - one quarter of the world population.
Therefore, an increase in the regional income inequality could not only undermine the
social stability but also disrupt political stability, spur secessionist activities, which would
3
eventually destroy the very foundation of China’s emergence as a major world economic
power and consequently the high economic growth that China currently enjoys.
The remainder of this paper is organized as follows. Section 2 reviews a number of
theoretical and empirical studies on FDI and income inequality. Section 3 presents an
overview of the FDI inflows and regional income inequality in China. The following
section applies econometric methodology to investigate the causal relationship between
FDI and regional income inequality in China and determines the other factors which
influence China’s regional income inequality. The last section of the paper presents the
implications and conclusion.
2. A REVIEW OF STUDIES ON FDI AND INCOME INEQUALITY
Most FDI theories are fairly straightforward, from the multinational enterprises (MNEs)
aspect, focusing on determinants of FDI. These theories seek the analytical framework to
address questions in relation to firm engagement in international production. The wellknown FDI theories include the classical industrial organization theory, the product cycle
theory, the internationalization theory, the dynamic comparative advantage theory and the
eclectic theory etc. (A detail review of such theories can be found in Dunning, 1993).
Most of these theories by no means directly and logically discuss the macroeconomic
effects of FDI on both investing and host countries, especially on developing host
countries. However, by analyzing these theories, the number of major impact of FDI on
host country’s economic development can be concluded. These include (1) technology
transfer and management know-how; (2) increases foreign capital investment; (3)
increases openness and economic activities; (4) increases exports (trade-oriented FDI,
only), or destroys the balance between economic development in developing countries
and international trade balance (anti-trade-oriented FDI); (5) creates employment,
upgrade of the labor force and increase productivity; (6) GDP contribution and increase
tax revenues; and (7) repatriation of profit and pricing transfer.
4
In contrast to the above well-known FDI theories, dependency and modernization
theories addressed the macroeconomic effects of FDI on developing host countries.
Dependency theorists viewed that the predatory behavior of the MNEs creates a neocolonial economy through FDI. This means that more FDI in a country means more
foreign control in that country and as a consequence the greater the degree of income
inequality in that country (Bornschier and Chase-Dunn, 1985; Gowan, 1999). It is also
argued that FDI not only creates employment opportunities for “local labor elites” with
higher wages, but also it leads to production that are more capital-intensive. As a
consequence, unemployment rate increases in the traditional sectors and income
inequality becomes greater (Tsai, 1995). However, modernization theorists describe FDI
as an ideal mechanism for the diffusion of capital, markets and knowledge that would
lead to development for the newly independent countries of the world (King and Varadi,
2002). Although modernization hypothesis rarely directly and explicitly addresses the
relationship between FDI and income inequality, the implication was extended - as FDI
stimulates economic growth and its benefits eventually spread throughout the whole
economy, thus, in the long run a more even income distribution would be achieved. Like
dependency theorists, the modernization theorists also acknowledge that FDI does create
local employment with higher wages, but once the labor share rises, the total amount of
income distribution would be improved.
Obviously, theories regarding the impact of FDI on income inequality are different in
principle and the empirical findings of FDI effects on income distributions are divided.
Using cross-country data, Tsai (1995) examined the relationship between FDI and
income inequality in 33 less-developed countries (LDCs) and found that FDI does give
rise to more unequal income distribution in the host LDCs. The findings of Tsai (1995)
are generally consistent with the argument of the dependency theorists. Apart from FDI,
the study supports Kuznets hypothesis1 but suggested that trade has no correlation with
inequality, an improvement in human capital does not help achieve greater equality while
high proportion of agricultural labor force is positively correlated with higher inequality.
However, the study may have several defects, for instance, a large number of countries
may be too diverse to be pooled together so that the comparison of data on inequality in
5
different countries is doubted, as well as the different countries’ culture and legal system
may interacts with FDI and openness. In the case of China, Fu (2004) investigated the
spillover and migration effects of exports and FDI and their impact on regional income
inequalities in China applying panel data covering the years of 1990s to a log-liner
dynamic panel model. This study also produced a result supporting the dependency
theorists that FDI does increase the inequality between the inland and the coastal regions
in China. In addition, this study also found that while exports and interstate labor
migration from the inland to the coastal regions have played an important role in
increasing regional disparities, urbanization in the inland regions help to reduce the
regional income inequalities and leads to a more balanced regional growth. The
limitations of this study are that a number of most important variables such as the role of
the Chinese government and the economic growth are omitted from the analysis. Such
variables may have significant effect on income distribution as China has had remarkable
rapid economic growth during the 1990s and the Chinese government indeed has heavily
intervened in the foreign and domestic investment markets in order to reduce regional
income inequality.
In contrast to the studies of FU (2004) and Tsai (1995), the study of Wan, Lu and Chen
(2003) provided empirical evidence from China in support of the modernization
hypothesis by estimating an income generating function and incorporating trade and FDI
variables. The study found that while capital input and infrastructure are the largest
contributors to regional inequality, FDI and trade exert a decreasing impact on regional
inequality in China and privatization helps equalize income across regions. Similar to Fu
(2004), this study also has a number of shortcomings which may cast doubt on the results
presented in the study. The shortcomings include the failure to convert values of trade
and FDI from US dollars into the Chinese currency to maintain consistency with other
variables, the measurement of a few variables such as human capital and reform are not
appropriately defined and omitting the important GDP determinant of income
distribution. Feenstra and Hanson (1997) also reported findings in favor of the
modernization theory that FDI does not induce income inequality in developing
countries. However, it is worth pointing out that their finding is merely based on Maxican
6
data and failed to compare the explanatory powers of the competing hypotheses (Mah,
2003).
3. AN OVERVIEW OF THE FDI INFLOWS AND THE REGIONAL INCOME
INEQUALITY IN CHINA
In 1978, China finally opened its door to the world after almost 30 years self-imposed
isolation. Attracting FDI has been a key pillar of China’s “opening up” policies and
economic reforms. The policies adopted to attract FDI were basically preferential ones,
which provided tax concessions and special privileges to foreign investors. In Table 1, we
present the timeline of China’s FDI and regional preferential policies during 1979 to
2002. The experiment of economic and social reforms, as indicated in Table 1, started
with the establishment of 3 Special Economic Zones (SEZs) in southeast coast province
Guangdong, next to Hongkong and Macao; subsequently 1 additional SEZ in Fujian, next
to Taiwan. During 1984 and 1986, there were 27 additional FDI zone established in
Shanghai, Tianjin, Liaoning, Hebei, Shandong, Jiangsu, Zhejiang, Fujian, Guangdong
and Guangxi. However, the amount of FDI entered in China was small during this period
and obviously most of the FDI was located in the coastal region2. During this period the
Chinese government also promulgated FDI legislations and policies such as “Equity Joint
Venture Law” and changed China’s FDI regulatory regime from “permitting” to
“encouraging” FDI. Further, in 1990, the Chinese government provided a more complete
legal structure to facilitate the operations of the foreign-invested enterprises (FIEs) by
issuing “Amendments to the Equity Joint Venture Law and Wholly Foreign-Invested
Enterprise Implementing Rules.” Figure 1 shows the FDI inflows into China during the
years 1978 to 2002. As can be seen from Figure 1, FDI inflows continuously grew in
China, as more and more economic zones and opened cities developed. FDI inflows were
quite low ranked from 0.03 to 0.64 billion US dollars per year from 1978 to 1983, but
from 1984 till the early 1990’s, FDI increased at an average rate of over 30% per annum.
However, the total amount of FDI was still small (less than US$5 billions) until 19923.
7
Table 1. Timeline of China’s FDI and regional preferential policies: 1979-2002
Year
Number and type of opened zones
Location
Or specific events and FDI policies
1979
1980
1984
3 Special Economic Zones (Equity Joint Venture Law)
1 Special Economic Zone
14 Coastal Open Cities
10 Economic and Technological Development Zones
1985
1986
1988
1990
1992
1 Economic and Technological Development Zone
3 Coastal Open Economic Zones
2 Economic and Technological Development Zones
Open Coastal Belt
1 Special Economic Zone
1 Economic and Technological Development Zone
Pudong New Area
13 bonded areas in major coastal port cities
(South Tour)
10 major cities along the Yangtze River
13 Border Economic Cooperation Zones
All capital cities of inland provinces and autonomous
regions
5 Economic and Technological Development Zones
1993
1994
12 Economic and Technological Development Zones
Guangdong
Fujian
Liaoning, Hebei, Tianjin, Shandong
Jiangsu,Shanghai, Zhejiang, Fujian,
Guangdong and Guang
Liaoning, Hebei, Tianjin, Shandong,
Jiangsu, Zhejiang, and Guangdong
Fujian
Pearl River delta, Yantze River delta, Fujian
Shanghai
Liaoning, Shandong, Guangxi and Hebei
Hainan
Shanghai
Shanghai
Tianjin, Guangdong, Liaoling,
Shandong, Jiangsu, Zhejiang Fujian, Hai
Jiangsu, Anhui, Jiangxi, Hunan, Hubei,
and Sichuan
Jilin, Heilongjiang, Inner Mogolia,
Xinjiang, Yunnan, and Guangxi
Fujian, Liaoning, Jianxi, Shandong, and
Zhejiang
Anhui, Guangdong, , Hubei, Liaoning,
Sichuan, Fujian, Jilin, and Zhejiang
Beijing and Xinjiang
2 Economic and Technological Development Zones
(foreign exchange system reform &decentralize FDI
policies)
1995
Encourages greater geographical dispersion of FDI
inflows and promotes FDI inflows into export-oriented,
high technology, agriculture and infrastructure sectors
1996
Encourages more FDI flowing into western area of the
Northwest and Southwest provinces
inland regions
1998
Abolished the FDI projects approval requirement
2001
A new era of FDI liberalization (China became the
143 rd member of WTO)
Sources: Almanac of China’s Economy, varies issues and Démurger et al. (2002).
In 1992, the famous “South Tour” by former President Deng Xiaoping pushed ahead
further economic reforms in China and led to a new phase of FDI liberalization. In the
same year, after 14 years of opening up in the coastal region, China finally extended the
economic zones to some selective inland provinces and open cities to all capital cities of
the inland region. In the meantime, FDI and ownership laws, property rights and contract
laws were developed during this period to improve investment condition and business
environment in order to attract more FDI. As a result, as clearly can be seen in Figure 1,
China’s FDI entered into a stage of high-speed growth during the 1990’s and placed
8
FDI inlows (billions of US dollars)
60
50
40
30
20
10
0
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
Year
Figure1. FDI inflows into China 1978 - 2002
China as the largest FDI hosting country in the developing world since 1993. While new
economic zones were created across the country, the distribution of FDI was continued to
be favored into the coastal region. During 1996, the Chinese government encouraged
foreign investors to invest in the western areas of China in order to facilitate the
economic development in the inland region so that the income inequality between the
coastal and the inland regions can be reduced. In 1998, during the Asian financial crisis
period, the Chinese government further liberalized its FDI policy. One such liberalized
policy is to abolish the FDI project approval requirement. However, these new liberalized
policies did not make a significant improvement as the impact of the Asian financial
crisis was very strong and hence the FDI inflows into China during the years of 1999 and
2000 has fallen below the previous year’s level (see Figure 1). In December 2001, China
joined the World Trade Organization (WTO), which marked the FDI liberalization
entering into a new era. In the same year, China’s FDI inflows increased dramatically, as
can be seen in Figure 1, from U$40.72 billions in year 2000 to U$46.88 billions in 2001.
By 2002, China became the largest FDI host country in the world attracting US $52.74
billions of FDI. Indeed, China has successfully attracted the enormous amount of FDI
inflows but the FDI inflows are highly geographically distributed unevenly. Table 2
presents the regional distribution of FDI inflows into China during 1984 and 2002.
Column 1 presents the names of the regions and sub-regions; columns 2 and 4 show the
9
amount of FDI in 1984 and 2002, respectively; and columns 3 and 5 express the FDI in
percentages for the two years. As indicated in Table 2 that FDI inflows in the coastal
region were much higher than the inland region in both years of 1984 and 2002. The
Table 2. Regional distribution of FDI inflows in China (millions of US dollars and %)
(1)
Region
Coastal region
Metro cities
Beijing
Tianjin
Shanghai
Coastal provinces
Hebei
Liaoning
Jiangsu
Zhejiang
Fujian
Shangdong
Guangdong
Guangxi
1984
(2)
Amount
2575.8
655.2
118.7
105.7
430.8
1920.5
11.2
44.1
56.5
31.5
236.2
104.9
1409.3
26.7
(3)
%
94.9
24.1
4.4
3.9
15.9
70.8
0.4
1.6
2.1
1.2
8.7
3.9
52.0
1.0
(4)
Amount
45362.7
7578.9
1724.6
1582.0
4272.3
37783.8
782.7
3411.7
10189.6
3076.2
3838.4
4734.0
11334.0
417.3
2002_____________
(5)
%
87.3
14.6
3.3
3.04
8.2
72.7
1.5
6.6
19.6
5.9
7.4
9.1
21.8
0.8
Inland region
136.6
5.1
6596.7
12.7
Central
62.1
2.3
4408.9
8.5
Shanxi
1.1
0.0
211.6
0.4
Anhui
3.6
0.1
383.8
0.7
Jiangxi
6.9
0.3
1082.0
2.1
Henan
6.0
0.2
404.6
0.8
Hubei
9.9
0.4
1426.7
2.8
Hunan
34.6
1.3
900.2
1.7
Northeast
6.6
0.2
599.8
1.2
Jilin
1.4
0.1
244.7
0.5
Heilongjiang
5.2
0.2
355.1
0.7
Northwest
34.7
1.3
686.5
1.3
Mongolia
3.0
0.1
177.0
0.3
Shaanxi
1.6
0.1
360.1
0.7
Gansu
0.3
0.0
61.2
0.1
Qinghai
23.5
0.9
47.3
0.1
Ningxia
3.0
0.1
22.0
0.04
Xinjiang
3.3
0.1
19.0
0.04
Southwest
33.3
1.2
901.5
1.7
Sichuan
28.9
1.1
751.6
1.5
Yunnan
1.5
0.1
111.7
0.2
Guizhou
2.9
0.1
38.2
0.1
Total
2712.4
100
51959.4
100
___________________________________________________________________________________
Sources: Almanac of China’s Economy various issues, China Statistical Yearbook 2003.
10
amount of FDI inflows were US$2576 millions in 1984 and US$45363 millions in 2002
into the coastal regions while the corresponding FDI figures for the inland regions are
US$137 millions and US$6597 millions. In percentages, the FDI inflows were 95% and
87% into the coastal regions against 5% and 13% into the inland region in 1984 and
2002, respectively.
Table 3. Various forms of contribution of FDI in China, 1985, 1990 – 2002
FDI inflows/
FDI stocks/
Exports by FIEs export/
FIEs induNumber of
total domestic
GDP
FIEs(billtotal export
strial output/
employees
investment
(%)
ion dollars)
(%)
total industrial in FIEs
(%)
output (%)
(millions)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
1985
2.0
1.5
0.3
1.1
0.06
1990
3.9
5.2
7.81
12.6
0.66
1991
4.4
5.6
12.1
17.0
5.0
1.65
1992
8.0
7.1
17.4
20.4
6.0
2.21
1993
13.1
10.2
25.2
27.5
9.0
2.88
1994
18.1
17.6
34.7
28.7
11.0
4.06
1995
17.2
18.8
46.9
31.3
13.0
5.13
1996
16.8
24.7
61.5
40.7
5.40
1997
16.6
23.5
75.0
41.0
18.6
5.81
1998
14.4
81.0
44.0
5.87
1999
12.0
88.6
45.5
6.12
2000
10.7
119.4
25.2
27.4
6.42
2001
10.7
133.2
26.1
28.5
6.71
2002
10.2
170.0
27.4
7.58
Sources: World Investment Report, various issues; Almanac of China’s Economy, varies issues; China
Statistical Yearbook, various issues
Year
FDI, as expected by the Chinese government, has played a significant role in China’s
economic development. It has transferred technologies and management know-how. It
has also expanded China’s export sector, improved total factor productivities and
contributed to GDP growth significantly through the establishment of FIEs and the
spillover effects on domestic enterprises. Table 3 presents various forms of significant
contribution of FDI to China’s exceptional economic performance during 1985 and 1990
to 2002.Ccolumns 2 and 3 of Table 3 provide the shares of FDI inflows in the total
domestic investment and the percentages of FDI stocks in GDP, respectively. Columns 4
and 5 show the exports by FIEs and the share of exports by FIEs in the total exports,
respectively. The last two columns present the share of the industrial output by FIEs in
the total industrial output and the number of employees in FIEs, respectively. The FDI
11
inflows have provided sufficient foreign capital investment flows and were accounted for
over 10% of the total domestic investment per year since 1993 (see column 2). The ratio
of FDI stocks to GDP in 1985 was 1.5% and has increased to 23.5% in 1997 (see column
3). FDI has assisted China to access new export markets. The exports by FIEs was 0.3
billion US dollars which accounted for 1.1% of China’s total exports in 1985 while in
1997 it has increased to $75 billion US dollars and accounted for 41% of China’s total
exports (see columns 4 and 5). The share of industrial output by FIEs in total industrial
output also demonstrated great strength. This share has increased from 5% in 1991 to
29% in 2002 (see column 6). With 208056 FIEs4 operating in China’s battlefield of
almost every single sector, FDI has created local employment opportunities and the
number of employees in FIEs have increased from a very low level 0.06 millions in 1985
and reached 7.58 millions in 2002 (see column 7).
While FDI had a strong impact on China’s overall economic development, the
unbalanced distribution of FDI among the different regions has undoubtedly created a
skewed regional economic development. This can clearly be evidenced in Table 4, where
we present the impact of FDI on two regional economies of China, coastal and inland
regions. Table 4 demonstrates that FDI has had a much greater contribution to economic
development in the coastal region than the inland provinces in 2001. The exports by FIEs
in the coastal region was about US$130 billion which accounted for 53% of the region’s
total exports, whereas the inland provinces had only $3.3US billion dollars which is 16%
of the region’s total export. The exports of the coastal and the inland regions in 2001
were US$244 billion and US$21 billion, respectively, which accounted for 92% and 8%
in the national total exports, respectively. For the two regions, the average annual growth
rates of total exports between 1978 and 2002 were about the same at 13%, despite the
fact that the export induced by FIEs was much higher in the coastal region than in the
inland region. Undoubtedly, opening up to the world economy does not only benefit the
coastal region, it also indeed stimulates the demand for increasing export in the inland
region through the enhanced competition in whole China. This occurs despite the fact that
the FDI policies have been in favor of the coastal region that resulted in much more of
FDI flowed into the coastal region. Similarly, the industrial output by FIEs in the coastal
12
Table 4. The impact of FDI in regional economy in China: 2001
Type of variable
(1)
Coastal Region
(2)
Inland Region
(3)
1. Export by FIEs (US billion dollars)
130
3
2. Share of export by FIEs
In regional total export (%)
53%
16%
3. Regional total export (US billion
dollars)
244
21
4. Regional total export average
annual growth rate: 1978-2002 (%)
13%
13%
5. Share of export by region
in national total export (%)
92%
8%
6. Industrial output by FIEs
(RMB billion Yuan)
2469
249
7. Share of industrial output by
FIEs in regional total industrial
Output (%)
36%
9%
8. Regional industrial total output
(RMB billion Yuan)
6815
2706
9. Share of industrial output by
Region in national total industrial
Output (%)
71%
28%
10. Number of employees in FIEs
(10 000 Persons)
583
85
Sources: Calculated from China Statistical Yearbook 2002.
and the inland regions, respectively, were RMB 2469 billions (see row 6) and RMB 249
billions and are accounted for 36% and 9% (see row 7) in the respective regions’ total
industrial output. This led to the share of industrial output of the coastal and the inland
regions in national total industrial output to be 71% and 28%, respectively (see row 9).
Moreover, FDI also has created much higher local employment in the coastal region than
in the inland region. The number of employees in the FIEs, as shown in the Table 4 (row
10), in the coastal region reached 5.83 million compared to only 0.85 million in the
inland region.
13
In terms of earnings, it is widely observed, that the employees in FIEs are much better off
than in the comparable domestic sectors, especially, in the state-owned enterprises. Thus,
the average wage in all sectors in the coastal region was pulled up5. As a consequence of
the extremely unbalanced economic development in the two regions, the regional income
inequality has been widening with the deepening of economic reforms and FDI
movements in the regions became more and more pronounced. Figure 2 shows the per
capita income in the coastal and the inland regions from 1970 to 2002. As can be seen,
the income inequality between the two regions increased gradually since 1978. From mid
1980s, a visible widening surged and the difference in per capita income between coast
and inland population became more and more divergent.
45000
40000
RMB/Per Capita
35000
30000
25000
20000
15000
10000
5000
0
2002
2000
1998
1996
1994
1992
Year
Inland
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
Coast
Natoinal
Figure2. Regional Income Inequality in China: 1970-2002
Facing the issue of growing regional inequality in the country, the Chinese government
has taken steps to bridge the widening gap between the inland and the coastal regions
throughout the economic reform period. During the mid 1980s, a new emphasis on the
economic development plan in the poorer areas was introduced, adopted in the 7th Five
Year Plan (1986 – 1990) and further strengthened in the 8th Five Year Plan (1991 – 1995)
(World Bank, 1992). The whole plan includes special programs to improve the education
and health status; a Food-for-Work-Program to assist with the building of roads,
irrigation works and other capital constructions; price reform to decontrol distorted raw
14
material and agricultural prices and subsidized bank loans for development (World Bank,
1992). Also, as the Chinese government viewed the widening economic gap between the
coastal and the inland regions as mainly a result of the decline in the performance of the
rural enterprises, thus, a domestic investment plan to support the rural enterprises in
inland region (excluding of northeast provinces) was particularly emphasized. For
example, a large amount additional bank loans and a special state council loan, RMB 10
billion, were planned for years 1993 – 2000 for the growth and development of the inland
region6. In addition, a three-year exemption from income tax for all newly established
rural enterprises in central provinces, as well as the new tax policy of exemption of all
items of export from value-added tax and consumer tax were introduced.
The Chinese government, in 2000, further addressed the concerns about the widening of
regional inequalities and planned to narrow the regional inequalities as one of its
principal objectives. In 2001, RMB 205.4 billion was transferred to poor provinces and
cities to finance social security cash-flow7. Meanwhile, the social security system was
under reform by transferring the social security responsibility from enterprises to the state
at the provincial and municipal prefecture levels. Beside the social security reform, in the
10th Five-Year Plan (2001–2005), the Chinese government aimed at increasing
productivity in agriculture and industrial state-owned enterprises, developing collective,
private and individual businesses, promoting labor-intensive activities in service sectors,
investing in human capital and protecting natural capital. Moreover, the Chinese
government has also emphasized the need for establishing economic development zones
in the inland provinces by attracting foreign investors to invest in strategic physical
infrastructure for transport, water resources management, energy and mining.
4. THE MODEL AND EMPIRICAL RESULTS
In this section, we use a regression framework to empirically analyze the relationship
between FDI and regional income inequality in China. We specifically attempt to find
answers to the following questions: (1) Has FDI influenced China’s regional inequality?
15
(2) If yes, how are FDI and regional inequality related? (3) What are the other principal
factors affecting regional income inequality in China?
The conceptual framework adopted to analyze the causality between FDI and regional
income inequality is based on the argument between the modernization and dependency
theories developed in Section 2 of this paper. The Kuznets hypothesis will be used to
guide the study on the relationship between economic development and regional income
inequality. Other variables which are used to explain regional income inequality include
(i) the variables the Chinese government used for its intervention to reduce regional
income inequalities; and (ii) the variables commonly used in past income inequality
studies and could be defined and measured. Thus, the following three basic models are
considered for national, urban and rural studies, respectively:
GINItn = a1 + b1 FDItn + c1 PCGtn + d1 PCG2tn + e1 AGRtn + f1 HCAPtn + g1 GOVtn
+ h1 TRADEtn + j1 DINVtn+ utn
(1)
GINItu = a2 + b2 FDItu + c2 PCGtu + d2 PCG2tu + e2 SOEtu + f2 HCAPtu + g2 GOVUtu
+ h2 TRADEtu + j2 DINVtu+ utu
(2)
GINItr = a3 + b3 FDItr + c3 PCGtr + d3 PCG2tr + e3 RUEtr + f3 HCAPtr + g3 GOVRtr
+ h3 TRADEtr + j3 DINVtr+ utr
(3)
Where the variables denote
GINI
Gini coefficient
FDI
Share of FDI inflows in GDP
PCG
Logarithm of real per capita GDP
PCG2
Squared PCG
AGR
Ratio of the agricultural labor force of the total labor force
SOE
Ratio of the employment of State-Owned Enterprises (SOE) of the total
urban employment
16
RUE
Ratio of the rural enterprises employment of the total rural employment
HCAP
Human capital
GOV
Share of total government expenditure in GDP
GOVU
Share of government expenditure for urban in GDP
GOVR
Share of government expenditure for agriculture in GDP
TRADE
Share of trade in GDP
DINV
Share of domestic investment in GDP
u
Normally distributed disturbance term.
Gini coefficient is used as the dependent variable because it is the most popular measure
for income inequality. In this study, a newly developed method by Wan (2001) was used
to decompose the aggregate value of the Gini coefficient for rural, urban and national. In
brief, the Gini ratio, denoted by Gk, can be obtained via simple matrix manipulation:
Gk = Pk Q Ik
where Pk is a row vector of the shares of income-receiving units, Q is a square matrix
with appropriate dimensions whose elements qij, such that
qij
0

= 1
1

and I is a column vector of income shares (Yk/Y) based on the k-th income data. Both
are ranked by increasing values of per capita income Yk. Y is total income composed of
K sources or components, i.e., Y = Y1 + Y2 + …+ Yk.
Columns 2-4 of Table 5 presents such calculated Gini ratio for rual, urban and national
from 1978 to 2002. The decomposition for rural, urban and national Gini coefficient is
based on the data of rural, urban and national household disposable income in terms of
Chinese currency RMB, respectively. Thus, the provincial level time series panel data
and the national time series data for 1978 – 2002 are needed and these data are compiled
from Comprehensive Statistical Data and Materials for 50 years of New China and
17
various issues of China Statistical Yearbook, both published by the National Bureau of
Statistics (NBS). The independent variables of models 1, 2, and 3 are also collected from
the same resources and all variables are measured in Chinese currency RMB.
Table5. Calculated rural, urban and national Gini ratio 1978 – 2002
Year
(1)
National
(2)
Urban
(3)
Rural
(4)
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
0.1463
0.1311
0.1292
0.1116
0.1127
0.1130
0.1214
0.1261
0.1372
0.1520
0.1549
0.1615
0.1530
0.1698
0.1767
0.1971
0.1977
0.1930
0.1853
0.1832
0.1808
0.1881
0.1945
0.1974
0.1833
0.0888
0.0757
0.0784
0.0766
0.0751
0.0789
0.0846
0.0905
0.0856
0.0894
0.0994
0.1044
0.1046
0.1130
0.1212
0.1362
0.1554
0.1470
0.1421
0.1386
0.1404
0.1454
0.1459
0.1436
0.1290
0.1142
0.1040
0.1025
0.0933
0.1008
0.1060
0.1154
0.1101
0.1261
0.1370
0.1506
0.1536
0.1393
0.1616
0.1672
0.1820
0.1846
0.1872
0.1814
0.1785
0.1757
0.1778
0.1827
0.1867
0.1768
Sources: Calculated from various China Statistical Yearbooks.
The view on the expected sign of the coefficient bi is divided. Dependency theorists
believe that greater regional income inequalities associated with increasing FDI inflows,
thus, the expected sign of the coefficient bi should be positive. However, if modernization
hypothesis holds, that is, FDI does not cause any significant variance in income
inequality, the expected sign of the coefficient bi would be negative. According to the
18
Kuznets hypothesis, PCG and PCG2 are used to measure economic development and the
coefficients ci and di are expected to be positive and negative, respectively.
Agricultural transformation has been widely acknowledged and practically recommended
by many researchers and developing countries as a force of convergence toward regional
income equality. Thus, AGR has been used to estimate the national regional income
inequality. In general, a high ratio of agricultural labor force of total labor force indicates
divergence toward regional income equality. In the urban regional income inequality
estimation, SOE is used to measure the changes of economic structure as SOE is a well
reflection of economic reforms in urban areas and any changes in SOE would
significantly affect income distributions in urban areas. According to dependency theory,
a low ratio of the employment of SOE of the total urban employment is regarded as
divergence of regional income equality. However, the opposite result will occur if
modernization hypothesis holds. In the estimation of rural income inequality, RUE is
used to measure agricultural transformation in the rural areas. The rural enterprises have
played a great role in China’s rural economic development and the Chinese government
viewed that the successful development of the rural enterprises could effectively reduce
regional income inequality. More people are employed in the sectors other than in the
agriculture sector means better income prospects. Thus, a high ratio of the rural
enterprises employment of the total rural employment indicates an even income
distribution in the rural regions.
Human capital (HCAP) is measured by ratio of secondary school enrolment of the
population, which was commonly used in income inequality studies (e.g. Tsai 1995 and
Sylwester 2000). It is widely believed that improvement of education could effectively
reduce regional income inequality. The Chinese government has attempted to narrow
regional income inequality throughout the whole economic reform period. The role of
government in income redistribution certainly is crucial. Thus, it is expected a high share
of government expenditure in GDP would narrow regional income disparities. Trade is
generally used to measure the degree of openness of an economy. According to
modernization hypothesis, trade enhances competition, fosters economic growth and
19
leads to better income distribution. Thereby, a negative sign of hi is expected if
modernization hypothesis holds. One of the important strategies used by the Chinese
government to narrow regional income inequality is domestic investment through bank
and state loans as discussed in section 3, and consequently, the expected sign of ji is
negative.
Table 6 provides a summary on the expected signs of all the coefficients on the variables
for national, urban and rural equations, respectively. The observed signs of all the
coefficients noted from the estimated results for the three equations also are presented in
the same table.
The least squares estimation results corresponding to the equations (1) to (3) of national,
urban and rural are contained in Table 7. Overall, the results are encouraging with 97%,
96% and 98% of the variation in the Gini coefficient is explained by the right-hand side
independent variables. The Durbin-Watson statistics for the three equations indicate no
serial correlation in the error terms.
The estimated coefficients of FDI for the three equations are positive, statistically
significant at the 1% level and indicate that increasing FDI inflows in China has
accelerated regional income inequality. The findings lend some supports to the
dependency hypothesis and are consistent with what were reported by Tsai (1995) and
FU (2004). The coefficients of PCG and PCG2 both are significantly at 1% level in the
three models, national, rural and urban. The signs of these coefficients are all consistent
with an inverted U-shaped curve. That is, the Kuznets hypothesis is generally supported
by the empirical analysis. The estimated AGR coefficient in the national model is
20
Table 6 Expected signs of the coefficients on the variables
National Eq. GINItn Urban Eq. GINItu
Variable Coefficient Expected Actual
Expected Actual
Sign
Sign
Sign
Sign
(1)
(2)
(3)
(4)
(5)
(6)
FDI
PCG
PCG2
AGR
SOE
RUE
HCAP
GOV
GOVU
GOVR
TRADE
DINV
bi
ci
di
e1
e2
e3
f
g1
g2
g3
hi
ji
 or *















 or 















Rural Eq. GINItr
Expected Actual
Sign
Sign
(7)
(8)
 or 















* If dependency theory holds, the expected sign of bi is “+”, if modernization hypothesis holds, the
expected sign is “-” .
positive at 1% significant level. The positive sign of AGR coefficient confirms that
agricultural transformation toward industrialization can effectively narrow the regional
income inequality. This also confirms the findings in Tsai (1995) and FU (2004). The
RUE and SOE coefficients are negative and statistically significant at the 1% level. A
negative sign associated with the coefficient of SOE confirms that dependency
hypothesis holds for the urban areas and is consistent with those obtained in other
research on the Chinese economy (e.g. Xu and Zou ,2000). This finding also supports the
argument that the continuing collapse of SOE in the recent decades has forced
considerable increasing number of XIA GANG (layoff) workers, which significantly
worsens income inequality in the urban areas. Similarly, the RUE coefficient is negative
and statistically significant confirms that transformation of rural agricultural labor force
to manufacturing and service industries is an effective strategy to narrow income
inequality.
21
Table7. Estimates of the regression models for FDI and regional income inequality
Variable
(1)
CONSTANT
FDI
PCG
PCG2
AGR RUE SOE
HCAP
GOV GOVR GOVU
TRADE
DINV
Adj. R2
National Equation
(2)
Rural Equation
(3)
Urban Equation
(4)
-245.93
-212.95
-78.267
(-7.570)
(-4.428)
(-3.318)
0.9068
1.0725
1.3476
(5.512)
(3.750)
(7.211)
121.57
130.88
61.581
(7.671)
(4.486)
(4.192)
-16.956
-18.489
-9.8491
(-7.530)
(-4.340)
(-4.319)
0.6109
-0.3346
-0.0818
(4.599)
(-2.246)
(-3.793)
3.2616
2.3124
1.1638
(7.528)
(2.476)
(3.599)
-0.1451
-0.2704
-0.1367
(-1.373)
(-0.338)
(-1.362)
-0.0880
-0.1295
-0.0278
(-1.991)
(-1.899)
(-0.8215)
-0.0026
-0.0787
-0.1370
(-0.0499)
(-1.196)
(-3.402)
96.87%
96.35%
97.69%
D. W.
2.0812
2.2486
The numbers in parentheses are t-statistics; all tests are two-tail tests.
2.0303
Surprisingly, the coefficients of HCAP in all three national, rural and urban equations are
associated with a wrong positive sign. This is obviously in contradiction to the wide
believes that improvement in education could effectively reduce income inequality (Wan,
Lu and Chen, 2003; Tsai, 1995). However, this could be an indication that the educated
“labor elites” from the inland region have been attracted to the high income coastal
region which has led to worsening of regional income inequality (FU, 2004). It is wellknown that interstate labor migration from the inland region to the coastal region has
been an important phenomenon in China over the last two decades. Another striking
22
result from Table 7 is that the great commitments of Chinese government on narrowing
regional income inequality at national, urban and rural level have not had any influences
on regional income inequalities, as the three coefficients are all negative and statistically
insignificant. Perhaps, this could be due to the fact that given the large population and the
massive areas of the inland provinces are still underdeveloped and the efforts of the
Chinese government to narrow the regional income inequality may not be strong enough.
Interestingly, the coefficient estimates of TRADE variable for national and rural regions
are negative and statistically significant indicates a negative relationship between
openness and regional income inequality as expected. This lends some supports to the
modernization theory that openness to the world economy could enhance competition and
improve efficiency in resource allocation hence leading to economic development with
better income distribution. Indeed, the rich resources of the inland provinces have been
well explored for trade, which, no doubt, has helped the poor, especially, those in the
rural regions, to gain power fighting for a better income distribution8. However, the
urban coefficient for TRADE is statistically insignificant. This may reflect the facts that
the inland provinces relatively have weak comparative advantages in production of
manufactured and finished goods, whereas, the manufacture enterprises mainly are
located in urban areas, thus, trade in the urban areas did not play a significant role to
narrow income inequality.
The sign of the coefficient for DINV variable for the national level and rural region are
negative and are statistically insignificant but the coefficient for urban is significant at
1% level indicating that more domestic investment would reduce the differential between
the coastal and the inland regions. This result, in fact, is not surprising despite the great
effort that the Chinese government attempted to invest in the rural enterprises in the
inland provinces.
The courses of increasing regional inequality are not only the
continuing decline of the rural industries in the inland provinces, some other factors such
as the preferential FDI policies and appropriate long term economic development policies
could play a great role in influencing regional income inequality.
23
5. IMPLICATIONS AND CONCLUSIONS
In this paper we analysed the impact of FDI on regional income inequality in China by
estimating three separate equations for national, urban and rural and using time series and
cross-sectional data for the period 1978 to 2002. The results show that the FDI inflows
are one of the major factors that have led to an increase in regional income inequality at
national, rural and urban levels in China. Other factors that have caused regional
inequality to increase include the level of economic development, human capital and the
economic reforms in SOE industries. The factors have narrowed the regional income
inequality are agriculture transformation toward industrialization in the case of rural and
urban, trade for achieving a better income distribution in the rural areas and at national
level and domestic investment in the urban areas. The Chinese government has failed to
reduce the level of income inequality in rural, urban and at national level. Trade and
domestic investment have had no significant impact on urban and rural income
distributions, respectively.
Concerning the impacts of FDI on the host developing countries economy, the results of
this study evidently demonstrate that FDI does come with both benefits and costs. It is
clear from the analysis that while FDI has fostered Chinese economic rapid growth, it is
also true that FDI has also led to an increase in the regional income inequality. Thus, in
order to reduce the income inequality a sustainable long-term geographical dispersion
and selective FDI policy should be implemented to encourage foreign investors investing
in the inland region of China, and to promote FDI inflows into export-oriented, high
technology, agriculture and infrastructure sectors.
Our analysis also shows that the unbalanced economic development in the regions has
increased income inequality. Consequently, to promote economic development in the
inland regions, as important as FDI, further liberalization and reforms on domestic
sectors are urged. The following recommendations may provide helpful hints:
(1)
Reforms and development in domestic manufacturing and tertiary industries to
produce manufactured and finished goods in the inland regions should be
24
encouraged as it enables trade and improves efficiency in using rich and cheaper
production resources.
(2)
While encouraging the domestic investors to invest in the inland regions, any
discrimination and unfair policies against its own domestic enterprises, especially,
the Non-State-Owned Enterprises (NSOE) must be abandoned.
(3)
Further research and development of appropriate government policies are also
important to reduce regional income inequality. In particular, the policy of
exemption of all items of export from value-added tax and consumer tax must be
reviewed as this tax policy further increases regional income inequality. Because
the export from the coastal region has been much higher than the export from the
inland region, the larger the export the greater the benefits.
As far as human capital and the reforms in the SOE industries are concerned, effective
support programs and preferential policies in the inland regions are required. For
instance, education programs could be designed with incentives to encourage educated
“local elites” to contribute to the local economic development. With the increasing
number of XIA GANG (layoff) workers, an integrated set of fiscal reforms of the
Chinese security system should be considered which should be linked with re-education
and re-training programs.
Finally, it should be acknowledged that there are a few limitations to this study. First, the
difference in price levels across regions and inflation effects are problems which remain
unresolved, although a very few studies have paid attention to this possible problem.
Second, the relatively poor quality and inconsistency of the Chinese data may have
resulted in incorrect conclusions. Third, some important variables, for instance, political
democracy and geography variables are not included.
Overall, further research on
income distribution effects from different types of FDI, the impacts of FDI on the income
inequality – not by regions but based on average incomes of different percentiles for
urban and rural residents in different provinces would be interesting and helpful for
China’s economic development.
25
NOTES
1. Kuznets (1955) hypothesis describes that the relationship between income inequality
and the level of economic development is just like an inverted -U-shaped curve.
2. In this study, the geographical regions of China were divided into two major regions,
the coastal and inland regions, for comparison. The coastal region includes the metro
cities (Beijing, Tianjin and Shanghai) and the eight coastal provinces (Hebei,
Liaoning, Jiamgsu, Zhejing, Fujian, Guangdong, Guangxi and Shangdong). The
inland region includes six central provinces (Shanxi, Anhui, Jiangxi, Henan, Hubei
and Hunan), two northeast provinces (Jilin and Helongjiang), six northwest provinces
(Inner Mongolia, Shanxi, Gansu, Qinghai, Ningxia and Xinjiang) and three southwest
provinces (Sichun, Guizhou and Yunnan). Hainan and Tibet provinces are excluded
from the study due to incomplete data issue while the newly established metro city,
Chongqing was combined with Sichuan where it was originally separated from. This
design is in accordance with the Chinese experiment economic reform geographical
plan.
3. Calculated from various China Statistical Yearbooks.
4. China Statistical Yearbook 2003.
5. The statement is based on the calculation from China Statistical Yearbook 2003. For
instance, the average annual wage in the richest metro city Shanghai was 2.52 times
higher than in the poorest province Guizhou.
6. The State Statistical Bureau of China (SSBC) online information in Chinese.
7. The China Internet Information Centre (The State Council of China official website):
www. org.cn.
8. The trade in the inland regions mainly is primary goods and services as the inland
provinces are rich of resources, whereas, those natural resources mainly are located in
rural area. This may well explain why the rural area can gain from trade hence
achieving a better income distribution (sources: Almanac of China’s Economy and
The China Internet Information Centre: www. org.cn).
26
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