Government expenditures and equity of opportunity in China.

Author:Guo, Shen
Position::Report
 
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  1. INTRODUCTION

    Achieving and maintaining social equity is one of the fundamental objectives of a government. The concept of equity not only means equity of outcomes but also includes equity of opportunities. In general, equity of outcomes focuses on the skewness of income distribution rather than reasons of income gaps. As long as income gap is large, a society is believed to lack outcome equity. Equity of opportunity emphasizes the sources of income gaps. If it is mainly due to family endowment instead of individual's effort that generates income gaps, the society lacks equity of opportunities. On the other hand, if income gaps among individuals are mainly caused by the degree of efforts, the society is regarded to be equal in opportunities, even if income gaps may be large.

    The majority of the literature on equity of opportunities focuses on the study in intergenerational income mobility, which could be defined as the correlation between children's income in their adulthood and parent's income. Parental income is a proxy of endowment that affects their offspring's income. A large and positive correlation of income between two generations indicates that children's income gaps are mainly determined by their differences in endowments but not by individual's efforts. In such a society, income mobility is low between different income layers. The offspring from low income families finds hard to move to high income hierarchy in the society even through working harder. This leads to the immobility of social hierarchical system, which exasperates misallocation of resources in the whole society and impedes social progress and productivity improvement.

    A government could use fiscal instruments to improve opportunity equity. For instance, the government could help children from low income families obtain better education by public investment in education, which eventually will help them move to an income tier higher than their parents' tier. However, not all kinds of government expenditures are capable of improving intergenerational mobility. The presumption of such an improvement is that the offspring from low income stratum should benefit more from the public services than their counterparts from high income stratum. Thus, the disadvantage of low endowment faced by the offspring in the low income stratum can be reduced. On the other hand, if the public services provided by the government make higher income group benefit more, government expenditures will make intergenerational mobility even worse.

    A large body of studies in the literature concentrates on estimating the relationship between fiscal policies and outcome equity in China (Lin, 2005; Wang et al, 2007; He, 2007; Wu 2011). However, it is astonishing that few attempts have been made to examine whether fiscal policies promote equity of opportunity. Admitting the important effects of government expenditures in improving outcome equity, some scholars believe that evaluating whether government expenditures can enhance opportunity equity is even more important (Rosen and Gayer, 2013). Anticipating that their children are very likely to move to higher social status through efforts, people may believe that it is acceptable to be in a low income group currently.

    In this paper, we examine the effect of public expenditures on opportunity equity by linking subnational public expenditures to intergenerational income mobility in China. (2) The dataset we use is China Health and Nutrition Survey (CHNS). We find that subnational government expenditures, particularly expenditures on education, health and social security, can effectively increase intergenerational income mobility and enhance opportunity equity. Our empirical analysis shows that public spending on education, health and social security significantly increases the income of children from low income families, but only moderately helps children from high income families. In other words, public expenditures significantly compensate for endowment insufficiency of children from low income families.

    Our research has some implications for policymakers in transitional China, who are seeking ways to prevent the "middle income trap" experienced by Latin American countries after entering the middle income country tier. One of possible explanations for theses middle income countries' failure to escape the trap is that they were not able to deal with the social and economic problems caused by enlarged income gaps and immobility of social hierarchies. As China is transitioning to a middle income country, similar issues emerge, such as growing income gaps and the solidification of social classes. It is somehow observed that there is emerging of "guan er dai" and "fu er dai" (in Chinese spelling) groups, who are the second generation of the privileged government officials and the super-rich. Therefore, the Chinese government not only needs to pay attention to outcome equity associated with income distribution but also focuses on mobility among social strata, i.e., opportunity equity. It is then important to evaluate to what degree the fiscal instruments could help increase income mobility. Our study provides an empirical support for how to improve income redistribution mechanism through reforms on public expenditure structures in China.

    The paper proceeds as follows: we begin with a literature review in the second section. Then we describe the data and outline our empirical approach in the third section. Results and robustness checks are presented and discussed in the fourth section. In the last section, we conclude the paper with policy implications.

  2. LITERATURE REVIEW

    Empirical study on the relationship between public expenditures and opportunity equity is rooted in the human capital theory. Becker and Tomes (1979) propose that offspring's income level is determined by their own endowment and the human capital investment by their parents. Their own endowment is composed of a series of characteristics such as height, skin color and IQ that are controlled by gene. Human capital investment includes supply of nutritious food, good education and medical treatment, etc. According to the human capital theory, average income levels of the offspring from high income families should exceed those from low income families, holding endowment constant. Mulligan (1997) points out that it violates the principle of opportunity equity that children of the rich get better education than those of the poor and then argues that intergenerational income elasticity could serve as a measure for social opportunity equity. If intergenerational income elasticity is larger, then parental income affects their offspring's income to a larger degree, which implies worse opportunity equity in the society.

    The key in estimating intergenerational income elasticity lies in how to measure parental life income accurately. Life cycle permanent income is adopted because it reflects the wealth level of parents and their abilities to make human capital investment. According to the life cycle theory, income of a single year usually deviates from permanent income because of volatility of income caused by idiosyncratic shocks, such as unemployment and diseases. Early empirical studies on intergenerational income mobility use one period income of parents to approximate the life cycle permanent income (Sewell and Hauser, 1975; Bielby and Hauser, 1977; Behrman and Taubman, 1985; and Becker and...

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