Comments on
Decentralization, Inequality
and Poverty Relief in China
by Li, Tao, and Yang
Xiaobo Zhang
Peking University and IFPRI
Extremely Important Topic
• Rising inequality is a top concern.
• Decentralization is a defining feature of
Chinese economy. It has shaped China’s
growth and income distributional patterns.
• This paper makes a contribution to
understanding the impact of decentralization
on rural-urban income gap.
China’s Fiscal Structure
 Fiscal decentralization
Expenditures tie more closely to revenue
 Horizontally, inter-judiciary competition.
Page 3
China’s Political Structure
Page 4

Organizational form.
 Replicate, vertical hierarchical structure
 Irrelevant of economic size and local needs.

Strong central mandates.
 Family planning
 Social stability and occupational safety (no major
accidents)
 Other central tasks
Hierarchical
Structure
Central
Province
Prefecture
County
Township:
Village:
Page 5
Page 6
Uneven Fiscal Dependent Burden
Page 7
Zhang, JCE (2006)
Regressive Tax Rate
Page 8
Zhang, JCE (2006)
Two Spirals
 Tax burdens are extremely high in poor regions
with agriculture as the major means of production.

Downward spiral: small tax base, more extraction from
limited agricultural surplus and nonfarm activities,
worsening investing environment, and lowering public
goods provision.
 They are low in developed regions initially with a
large nonfarm sector.

Page 9
Virtuous cycle: light tax burden for each enterprise,
more public inputs, better investing environment.
Coastal Region: Race to the “Bottom”
 Less tax on capital
 Small governments and better investment
environment,
 but sometime under provision of public
goods (such as crime problem)
Page 10
Poor Region: Race to the “Top”

Big government and predatory investment environment.

Devote most energy to obtain transfers from the upper
level government.

Keep the “poverty county” status partly by
underreporting income. This is probably why in the
poverty regressions, transfer is always negative for rural
income (a key finding of the paper).
Page 11
Decentralization and Overall Regional Inequality
Page 12
Fan, Kanbur, and Zhang, RDF (2011)
Tax Sharing Rate and Rural-Urban Income Ratio
Page 13
Drawn based on Tables 1 and 2 of Li, Tao, and Yang (2013)
Heavy-Industry-led Development Strategy
and Rural-Urban Inequality
Page 14
Fan, Kanbur, and Zhang (2012)
Problem of using Rural-Urban Gap in
Regressions
• Local rural-urban income gap is not equal to
national rural-urban inequality.
– It doesn’t take the within-rural and within-urban
inequality in a prefecture into account;
– Cross-regional migration is not accounted.
An Example
30
Inland
Coast
25
20
Poor
15
Rich
10
5
0
Rural
Urban
Rural
Income
Urban
An Example
50
Coast
Inland
45
40
35
30
Poor
25
Rich
20
15
10
5
0
Rural
Urban
Rural
Income
Urban
Alternative method:
regression-based decomposition
• Suppose y is income per capita (each region
has two observations, one for rural and one
for urban):
Alternative method:
regression-based decomposition
Zhang and Zhang (2003)
Mapping Findings to Policy Options
• “It is necessary to introduce local
accountability from the bottom up, through
both democratic elections and information
transparency.”
• Election is just one way to hold local officials
accountable.
Challenges of Promoting Local
Democracy
• Both political and economic decentralization
may jeopardize national unity.
• Local elite capture/ clientelism can become a
problem (See Mu and Zhang, JDE
forthcoming).
Indigenous Reforms on the Ground
• Cut the prefecture-level government (Hubei);
• Merge townships;
• Borrow police officers from regions.
• Pairwise-aid (from rich to poor province)
strategy (Sichuan and Xinjiang)
Other Suggestions
• For the poverty part, it is better to use
outcome variable from census, agricultural
census, or economic census, which are less
manipulated by local officials.
• Split the paper into two papers.
• Take logs for economic and population
variables.