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The Household Registration System Is a Major Challenge in Crossing Over the Middle-income Trap


A prominent scholar at the Chinese Academy of Social Sciences argues that addressing barriers to social mobility is key to curbing rising income inequality in China and avoiding the middle income trap. He promotes hukou reform as a potential remedy, advocating for a change in “the method where the supply of public goods treat[s] people differently based on household registration status.”

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In 2019, China’s per capita gross domestic product (GDP) exceeded U.S. $10,000, which is already significantly higher than the average level of upper-middle-income countries. For some time to come, China will be in a critical stage in its transition to a high-income country. Looking at the development experience of various countries, the crucial importance of this stage of development can be recognized from several aspects.


First, although the World Bank sets a per capita GNI (or GDP) standard for high-income countries (currently $12,235 and above), when determining whether a country has qualitatively entered a stage of development that differs in both quantity and quality, it is not enough to measure only by economic indicators such as per capita GDP. In addition, many indicators, especially social development indicators, are more important because such indicators not only reflect the purpose of economic development itself but are also the sources of sustainable growth in higher stages of development.


Second, the experience of various countries shows that the closer you approach the high-income threshold from the upper end of the middle-income range, the more the economic growth of most countries shows a deceleration trend, and the economic performance between countries tends to diverge. Those countries that fail to cope with the challenge of slowing growth and that perform poorly in social development are often caught in a vicious cycle of stagnant economic growth and widening income gaps, preventing them from actually entering the ranks of high-income countries for a long time. Economists call this state the “middle-income trap.”


Third, with the weakening growth momentum from “low-hanging fruit” and narrowing space for reforms of a Pareto-improving nature, not only is it more difficult to maintain a reasonable rate of economic growth, but this also has an adverse effect on social mobility. This poses a challenge to the continuous improvement of the level of social development. To deal with these challenges, we must break down the obstacles of vested interests and promote continued reforms in order to better obtain economic growth momentum based on innovation and rationally enhance the government’s redistributive policies.


In 2010, China’s per capita GDP exceeded U.S. $4,000, making it an upper-middle-income country. At the same time, fundamental changes have taken place in the population transition stage. The working-age population aged 15-59 is now in a stage of negative growth, and the corresponding population dependency ratio is increasing rapidly. Correspondingly, labor shortages, slower improvements in human capital, lower returns on capital, less room for labor reallocation, and the resulting slower rate of productivity gains, have resulted in a decline in potential growth rates and slower real growth rates.


Sharing in the gains of economic development not only depends on the speed at which the pie grows, but also on the mechanism for dividing the pie. If the distribution pattern of the pie remains unchanged, the slowdown in the expansion of the pie means that sharing is weakened. China’s reality already displays this tendency. For example, since 2009, the Gini coefficient of resident income has seen several years of decline, from 0.491 in 2008 to 0.462 in 2015, before it began to increase again.


In fact, the middle-income trap refers to the fact that in the upper-middle-income stage, countries face both the challenge of maintaining a reasonable economic growth rate to make the pie bigger and the challenge of maintaining sufficient social mobility in order to correctly divide the pie.


Traditional growth theory usually regards economic development as a homogeneous process, with each country achieving an expansion in the total economy and an increase in per capita income according to certain general laws. The convergence or conditional convergence hypothesis of neoclassical growth theory links the initial per capita income level to economic growth performance. It expects that, once the necessary endowments, institutions, infrastructure, and other conditions are in place, it will be possible for those countries at a lower stage of economic development to achieve faster economic growth than countries at a higher stage of development. In this way, convergence occurs between countries. However, such research does not pay particular attention to the differences in the growth patterns that countries at different stages of development follow to achieve economic growth. It is precisely these types of differences that drive growth performance at different stages of development and the social development performance associated with it.


Many low- and lower-middle-income countries are still trapped in the low-level equilibrium trap, lacking the most basic critical conditions for an economic takeoff. As a result, there are many countries stacked up around the lower-middle income threshold and just below the upper-middle income threshold. However, at such stages, the rate of growth varies greatly between countries. There are not only some fast-growing stars but also many failed cases of stagnant growth.


Relatively speaking, after entering the upper-middle income stage, countries enter onto a normal growth track. Such countries and those with low-income starting points and string growth performance usually experience Lewis-style dual-sector economic development. Thanks to low-hanging fruit sources of growth such as demographic dividends, their economic growth is able to catch up. However, based on the meaning of convergence, these countries show a moderate deceleration trend starting from this stage.


When a country is in the late upper-middle-income stage, especially when it is approaching the high-income threshold, growth sources, such as the driving force of production factors, the effect of resource reallocation, and late-mover advantages in technology that these countries have relied on in the past, have declined or even disappeared. These countries generally experience slowdowns, and divergences among countries due to the appropriateness of policy responses reemerge. It is from here that individual countries either enter the ranks of high-income countries or fall into the middle-income trap.


At a specific stage of development (here, we mainly refer to the period after entering the upper-middle-income stage), redistribution policies need to intervene in the income distribution process and the supply of basic public services. In the upper-middle-income stage or even when approaching the high-income threshold, the decline of traditional sources of growth leads to a serious decline in return on capital. Under normal circumstances, a country’s economic growth rate will accelerate the pace of its regression to the mean. When the speed at which the pie expands slows down, it becomes more important to divide the pie correctly. However, the very same reasons for the slowdown in growth also lead to the failure of the labor market’s primary distribution function and a decline in social mobility. At the same time, imperfect redistributive policies make this stage vulnerable to widening income gaps.


The truth is that the redistributive tendencies and actual policy measures seen at this stage of development are not necessarily intended to truly improve income distribution. In fact, when the pie is no longer growing, the practice of redistributing the pie is often affected by vested interests and the relative policy negotiating power of each group. The result of this game further widens the income gap in some countries. However, this phenomenon also shows that this is a stage of development where we must pay attention to redistributive policies themselves and the appropriate choice of redistributive methods.


Since reform and opening up, the achievements of China’s rapid economic growth have been widely shared, mainly through the mechanism of the labor market. The shared nature of this development and the mechanisms that made it possible are closely related to the specific development stage and type of development.


As China’s 30-year demographic window of opportunity (1980-2010) rapidly closed, the most significant feature of the dual economic development stage, the infinite supply of labor, also seems to be disappearing. Specifically, as the transfer of surplus agricultural labor slows down, the expansion of urban and rural employment and the reallocation of resources are no longer proceeding at the same pace as before. China’s comparative advantage in labor-intensive manufacturing has also weakened rapidly, and the feature of its international trade where it mainly targeted developed countries is also becoming weaker.


These changes are also reflected in the field of social development, where not only has the rate of improvement in income distribution slowed, but social mobility is decreasing. We can observe social mobility and its changing trends from both horizontal and vertical perspectives. Social mobility is a complex issue concerning changes in the social identities of various groups and involving the social class structure, residents’ well-being and recognition of social justice, and whether society is cohesive. Usually, through the choice of migration space by workers in the labor market, i.e., horizontal mobility, individuals, and families realize vertical mobility in themselves, between population cohorts, and through intergenerational occupational changes.


Since reform and opening up, China has experienced a Lewis-style dual-sector economic development process, mainly manifested in large-scale population flows centered on the transfer of agricultural surplus labor. This resulted in great changes to industrial structures and regional patterns. From 1978 to 2018, the proportion of the agricultural labor force fell from 70.5 percent to 26.1 percent, and the urbanization rate increased from 17.9 percent to 59.6 percent. However, as a result of large-scale labor transfers and demographic changes, the rate of this labor transfer has already entered a period of significant slowdown in recent years. The deceleration of the horizontal mobility of labor across urban and rural areas, regions, and sectors will inevitably have an adverse impact on vertical social mobility as manifested in terms of occupation, income status, and social identity.


Generally speaking, in a development stage of high-speed economic growth, rapid changes in the industrial structure, substantial improvement in education level, and large-scale and wide-range horizontal flow of labor, the occupational structure tends to improve to a higher level of human capital content and social status. The corresponding changes are also relatively rapid, so the mobility of the whole society is relatively strong. At the same time, while society creates more opportunities for upward mobility, there is not the same probability that another part of the population will be pulled downward (that is, there is more upward mobility than downward mobility). This means that economic development is shared, while social mobility is of a Pareto-improving nature.


We can grasp two important factors that affect the change in occupational structure and use them to observe the trend of social mobility: The first is the upgrade and optimization of the industrial structure, which is a demand-side factor in the change in occupational structure. The second is the increase in the educational level of the working-age population, which is a supply-side factor in the change in the occupational structure. The rapid improvement of these two factors promoted the transition of the occupational structure to a higher level and, accordingly, led to the enhancement of vertical mobility in society.


Generally, based on the stage of development or environment a society is in, social mobility can be divided into two types by its nature. First, in the process of rapid growth and structural change, social mobility occurs as a positive-sum game (so it is Pareto-improving). During the period of reform and opening up, Chinese urban and rural residents shared the fruits of development. To date, this has been the main method of social mobility. Second, under the condition of a relatively static total economic size and industrial structure, higher-level occupational positions become increasingly limited. The upward mobility of some groups along the social ladder can lead to a decline in the social position of others. Upward and downward movement are the two sides of the coin of social mobility and occur with equal probability.


Social mobility is close to a zero-sum game, and in response, a “synthesis paradox” (合成悖论) of social mobility arises. That is to say, when every person and family is striving to come out on top, we see the following situation: The efforts of the groups at the lower end of the social mobility ladder to break the existing pattern and the efforts of the groups at the upper end of the social mobility ladder to maintain their vested interests act in opposite directions, creating conflicts and reducing social cohesion and harmony. In turn, this synthesis paradox strengthens the zero-sum nature of social mobility, resulting in the deterioration of the income distribution situation and the solidification of the current pattern and leading to a lack of a sense of gain or security among all social classes.


Rapid population expansion, economic growth, and changes in the industrial structure are phenomena that are only observed at a specific stage of development, but social mobility must be maintained in all eras. Therefore, the method to maintain and improve social mobility should not remain unchanged but needs to evolve with the times. While it is true that development is the fundamental way to solve problems in development and it is undoubtedly correct to try to maintain the continued growth of the pie in response to the problem of economic slowdown, at the same time, as we will see later, the removal of various existing institutional obstacles in China through reforms can significantly improve social mobility and distribute the pie more rationally.


A lack of social mobility is not only the fundamental reason for the continued widening of income gaps but also allows this gap to be passed on from generation to generation. This results in the solidification of social stratification, which in turn leads to a decline in social cohesion. Therefore, government policy efforts aimed at reducing income disparities should include both implementing redistribution systems such as progressive taxation and transfers, as well as broader social policies that facilitate the promotion of social mobility. In China at present, the biggest institutional obstacle to social mobility is the difference in the enjoyment of basic public services between urban and rural areas, between regions, and between groups. The root cause of this systematic difference remains the current household registration system.


China established the household registration system in the early days of the planned economic system. It was originally intended to prevent rural-to-urban and cross-regional population flows through the strict registration of population residence locations and the provision of segmented and exclusive basic public services. After the official introduction of the household registration system in 1958, apart from limited opportunities such as attending university, joining the army, and planned worker recruitment, there were very few other channels that allowed residents to migrate across regions, and the restrictions on migration between urban and rural areas were particularly strict. The blockage of career change channels and the urban-rural income gap formed by the system made China have extremely low social mobility in the planned economy period.


Since the mid-1980s, with the advancement of reforms and the acceleration of economic growth, controls on the flow of labor across urban and rural areas and different regions have been gradually relaxed, and these flows have continued to expand in degree and scope. However, although the original intention of the household registration system to restrict population migration and labor mobility has broken down, no fundamental breakthroughs have been made in the system that originally served this purpose and divided the supply of basic public services. This continues to retain the dual social structure formed over a long period, which not only hinders the thoroughness of horizontal population flows but also creates a special population group, solidifies the structure of interests, and has the effect of inhibiting social mobility. This special group is the migrant workers who live and work in cities but have not obtained urban residence permits (户口, hukous). In 2018, a total of 173 million migrant workers left the towns and villages where they had residence permits, and the vast majority when to work and live in cities. However, this group still fails to enjoy equal treatment in the labor market and equal access to basic public services.


Just as we can still achieve a relatively slow but still reasonable rate of sustainable growth through a shift in the growth model despite the deceleration at higher stages of development by reasonably regulating the initial distribution process and following the principle of “do your best with what you have” in the same way, starting from the equalization of access to basic public services to implement a redistributive policy with Chinese characteristics, we can also maintain social mobility and expand the sharing of economic development in order to continuously improve the well-being of residents. The special challenge facing China is that the more ample mobility and integration of labor are hampered by the delay in the reform of the household registration system.


First, we must enhance the inclusiveness of the supply of basic public services, gradually stripping and then completely cutting off the connection between the household registration system and the supply of public services. Changing the method where the supply of public goods treated people differently based on household registration status will help break down the systemic barriers that hinder social mobility.


Second, we must strengthen the central government’s responsibility for expenditures related to the reform of the household registration system and improve the compatibility of incentives between the central and local governments in promoting reform. In view of the huge positive externalities that the reform of the household registration system would bring to China’s economic development, the central government’s payment of the bill is the key to breaking the deadlock. This is also in line with the internal logic of policy formulation and institutional arrangements.


Finally, we must improve the public finance system and transform the motivation of local governments to promote economic development into incentives to promote social development. We must reasonably delineate the functions and boundaries of public finance and improve the division of government financial resources and expenditure responsibilities between the central and local governments as well as give local governments the necessary abilities, responsibilities, and autonomy to provide public services, while also avoiding profit-seeking and malicious competition in the supply of local public goods.


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Cite This Page

蔡昉 (Cai Fang). "The Household Registration System Is a Major Challenge in Crossing Over the Middle-income Trap [户籍制度是跨越中等收入陷阱的重大挑战]". CSIS Interpret: China, original work published in Aisixiang [爱思想], June 19, 2020

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