Corruption and Income Inequality in China

ABSTRACT

We investigate the intricate relation between corruption and income inequality in China based on provincial panel data of 1996–2014. Our analysis shows that lower corruption is associated with higher income inequality. This seemingly counter-intuitive result, however, is consistent with findings from countries with a large informal sector, particularly those in Latin America. Institutional reform reduces corruption but also imposes additional costs on the participants in the informal sector. The latter effect, at least initially, exacerbates inequality, giving rise to the negative correlation. After the informal sector in China is considered, that negative relation vanishes. Moreover, when reform is accompanied by measures protecting the poor (such as those taken in the agricultural reform occurring in early 2000s), its perverse impact on inequality is significantly reduced. Lastly, public investment is positively associated with income inequality as the former, generally financed by taxation, may transfer income from the taxpayers to the business elites.

KEY WORDS:

• China
• corruption
• income inequality
• informal sector
• reform

JEL:

• C23
• H0
• O15
• O53

Acknowledgments

We are indebted to Jie Li, Naihua Gu, and Priscilla Tam for comments on an earlier draft.

Notes

1. Informal institution (or system of social values and norms) also plays a key role in perpetuating corruption. The analysis of this important element, however, is beyond the scope of this paper.

2. Rose-Ackerman (1978) defined corruption as “the abuse of public offices for private gains”.

3. The data source is Quan Guo Zan Zhu Ren Kou Tong Ji Zi Liao Hui Bian, 1996–2015.

4. To avoid repetition, we present the results from one-step GMM estimation. The results from two-step estimation are similar and available on request.

5. A small value of ε is assumed here, without the loss of generality, to avoid the complicated boundary-value issue of zero and infinity.

6. The regression analysis in the text shows a positive effect of public investment on income inequality. Moreover, from the World Wealth and Income Database (www.wid.world) compiled by Piketty (2015) and others, the income share of the top 10% and 1% in China increased by, respectively, 60% and 120% between 1986 and 2003.