China’s Household Registration System, Economic Growth, and Stability



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China’s Household Registration System, Economic Growth, and Stability

Jess Martin

12/13/06

Economics Thesis 411



Table of Contents

Introduction

-The Great Migration Debate 1


Background

-Economic and Political Reform in Post-Mao China 4

-Awkward facts 6

-Literature Review 8


Theory

-Lewis, Todaro Model 11

-Relationship between Labor, Migration, and Development 18
Findings

-Costs Associated with Restricting Urban Migration 20

-Benefits to Restricted Labor Migration 25
Conclusions

-Theory Correct, but Incomplete 28


The Great Migration Debate

The movement of people within countries, as from rural to urban areas, is generally associated with economic growth and development. However, China, the world’s fastest-growing large economy, restricts rural-urban migration. Despite these restrictions, China is experiencing the largest rural-urban migration in history, as some 150 million people have left their registered rural residences to move to cities over the past 25 years. In the United States, by contrast, about 25 million people moved from rural to urban areas between 1945 and 1970. (CIA World Fact book, 2006)

The result of large-scale rural-urban migration could be a more productive China, with millions more workers in higher wage jobs, or a more unstable China, as unemployed migrants demand rights and benefits now available only to urban workers. The Chinese central government is juggling rapid population growth and rapid modernization, while attempting to maintain power and stability. Given the Chinese government’s concerns about stability, can rural-urban migration be managed to accelerate economic growth without contributing to instability?

Historically, China has managed labor migration with its household registration system, hukou, which ties its citizens to the place in which they were born. Those who move away from the place in which they are registered are not entitled to government services such as education for their children, nor protected by minimum wages and other labor laws

Moving within regions of China also puts in jeopardy the job security historically offered by the government. In less than 25 years, China has gone from an “iron rice bowl” policy in which the government provided jobs, health care and security to every citizen, to a more market-oriented economy whereby individuals are expected to seek out and take advantage of opportunities. Despite the benefits gained from a more liberal market, the Chinese government has continued to restrict labor market mobility, which could slow economic growth and development by forcing peasants to remain in low-income agriculture, or become vulnerable migrants in the cities.

However, China’s economic growth has generated regional inequalities with more benefits accruing in coastal cities than inland rural areas. The per-capita income of the 800 million rural residents in 2005 was $403, while the per-capita income of the 500 million city dwellers was $1,292 (Yin, 2004). One result of this inequality is that up to 150 million Chinese have migrated from rural to urban areas (the “floating population”). However, since they are not registered to live in Beijing or Shanghai, migrants cannot get access to public housing, send their children to public schools, and are subject to fines by police officers for not possessing the correct registration.

China may be a special case, since the central government has historically struggled to maintain control of a large and populous country. However, China has over 100 million workers in manufacturing, compared to 17 million in the US, making China the world’s factory (CIA World Fact book, 2006). Moving more rural workers into Chinese factories, it would seem, could increase manufacturing capacity and exports. However, the Chinese government values both growth and stability, and fears that allowing even more rural residents to move to cities could lead to unrest that could threaten governmental control. This thesis examines the effects on economic growth of Chinese restrictions on internal migration.

The organization of this thesis is as follows; first, we outline and question the real world implications of the traditional (liberal) economic development theory based on the Arthur Lewis model of development with an unlimited labor supply. We next turn to the expected income migration model of Michael Todaro, which explains why migrants in developing nations move to cities despite high unemployment. Both the Lewis and Todaro models dominate academic discussions, but their policy suggestions are weak. Many development economists urge the Chinese government to remove hokou migration restrictions to speed up economic growth, ignoring the social and political consequences of massive migration. This thesis will argue that economic development theory correctly explains why voluntary rural-urban migration is economically beneficial, but other factors often outweigh the benefits of growth that can accompany fluid migration for governments struggling to maintain control in rapidly modernizing societies.



Economic and Political Reform

The Chinese Communist Party came to power in 1949 and inherited an agrarian economy dislocated and damaged by civil war. John Knight and Lina Song, authors of The Rural-Urban Divide; Economic Disparities and Interactions in China (1999) explain that the hukou emerged between 1953-54 as a government effort to regulate employment, migration and food allocation in an unstable China.

Originally justified to allocate food coupons for urban and rural residents during the Great Leap Forward, Knight and Song (1999) draw attention to the evolution of the hukou from grain allocation to population management, “The urban-rural income differential provided a great incentive for peasants to migrate. From 1957 onwards, however, central government acted to prevent all migration that it did not authorize.” Knight and Song (1999) also found during the hukou’s early years, the government was able to restrict migration by maintaining a firm grip on the urban jobs, “Government planned the labor needs of the growing urban sector and authorized the transfer of peasants only to meet residual needs.” The government’s population dispersal method was possible because “Unauthorized migration was prevented by an array of institutional obstacles” (Knight and Song (1999).

Following the death of Chinese Communist leader Mao Zedong in 1976, the Chinese Communist Party revised its policies, creating a socialist system with Chinese characteristics. One result was market-friendly reforms, including the opening of the Chinese economy to foreign investors, who invested primarily in coastal cities. High wages in these cities lured peasants from the countryside, but the hukou allowed the government to restrict rural residents from migrating to the cities. The China Rights Forum (2003) observes, “In effect, the hukou system is merely a means of enforcing divisions created by inequitable and discriminatory policies for investment and development.”

The government was fearful of a mass exodus from the poor rural areas to the prosperous coastal cities, and used the household registration to keep people locked in place. Kam Wing Chan (1994), a Chinese author of The Hukou system and Rural-Urban Migration in China: Processes and Changes, “Unlike population registration systems in many other countries, the Chinese system was designed not merely to provide population statistics and identify personal status, but also directly to regulate population distribution…In fact, the hukou system is one of the major tools of social control employed by the state.” This method has been criticized by many in the international community as a peasant apartheid discriminating against the nation’s 800 million rural dwellers by denying them the basic rights enjoyed by their fellow urban neighbors.

A hukou is normally required for government services that range from employment to housing and health care. Chan (1994) emphasizes that “Its functions go far beyond simply controlling populations’ mobility.” After reforms, it became more feasible to migrate and obtain a job without the correct hukou, and millions of mostly young rural residents moved to cities for jobs that offered higher wages. The hukou system has been relaxed, but the fear of increasingly overburdened cities, rising urban unemployment and massive protests maintain residency permit restrictions similar to the relaxed hukou. The next section will explain how this thesis has taken into account the weakening power of the hukou.



Awkward facts

I find the Chinese government has rational and legitimate reasons to restrict labor migration, but there are two major reservations. First, the data, albeit from reliable sources, are incomplete, in part because stability is a sensitive topic in China. This does not mean the numbers should be ignored, for these are the best estimates to date. As Ullman (Breese Ed., 96) explains, the data attempt to account for most migrants for whom it is in their best interests to elude governmental surveys questioning their illegal status,

“To what extent the migrants have been included in public estimates of the population of various urban places in not known. Since this migration was not sanctioned, it is likely that many rural migrants living in cities avoided registration in order to escape the attention of the authorities.”
A second caveat lies in the legal status of the hukou system itself. Although the precise number of migrants may be questioned, there is agreement that a large rural population is working in the cities, and that some levels of government fear the effects: “From the nature of official actions and newspaper accounts, it is clear that a considerable movement of population from rural areas to the city took place… and that numerous official attempts were made to reverse this movement.” (Breese, 96) However, despite the empirical evidence of government-imposed restrictions to migration, the Chinese government has sometimes made proclamations that suggest the imminent complete removal of the hukou system.

As Human Rights Watch in China reports, “…some commentators claim that China’s residence registration system is no longer operational.” This is due to the gradual relaxation of hukou restrictions during the opening of China’s economy, possibly in response to pressure from groups like the Human Rights Watch in China, the WTO, the Olympic committee, and other international organizations concerned with Chinese equality. However, some argue that these relaxations have simply changed the hukou system, and that the Chinese government continues to use the hukou as a weapon to control Chinese peasants. This is the point made by academic Fei-Ling Wang when discussing the hukou’s future, “The hukou system, for its crucial political values and socioeconomic functions, is likely to continue in the PRC to be the basis for organizing the Chinese people through administrative division and exclusion, in addition to the now increasingly important division between he haves and the have-nots.”

The hukou system bolsters attitudes, customs and laws ingrained into Chinese society that separate rural and urban residents. Recent hukou reforms have allowed the government to maintain migration restrictions in other ways, “(reforms) have constructed complex new barriers to migrants’ entry into the cities and a web of discriminatory rules that effectively put them in a similar situation to “guest workers,” illegal immigrants, or sans papiers in rich countries” (HRIC, 2002). Despite the weakening link between registration and residence in China, this thesis will examine the effects of regulating migration on Chinese economic development.

Literature Review

Justin Y. Lin (2004), at the China Center for Economic Research


Peking University, found that inequality between rural and urban regions in China was large and growing in the late 1990s, and was one of the most significant contributors to the rapidly rising overall income inequality in China. Despite a relaxation of hukou policies in the 1990s, Yin (2004) identified government control over migration as a major obstacle to development: “Given the much larger differences in income in China, both regionally and between urban and rural areas than in the United States, one would expect that migration rates would be much higher in China if there were no restrictions on migration.” However, D Gale Johnson (1989) recognized that even without any legal restraints on rural-urban migration, it would take a long time for the rural and urban incomes to converge because of other conditions keep rural incomes low, including poor quality rural education.

The history of the hukou is provided by John Knight, a labor economist at Oxford, and Lina Song, a former government employee who advised the Chinese government on rural economic reform. Their research on the Chinese economy have been published in numerous journal articles, including The Rural-Urban Divide; Economic Disparities and Interactions in China (1999) and Towards a Labor Market in China (2005), which follows the hukou’s reform, “It was now necessary (for the reformers) to promote development and welfare in order to provide a new form of legitimacy for the regime: Failure to reform would mean economic stagnation, social tension and political decline.” Lina and Song combine economic, social and political perspectives in their analysis.

John Walley and Shunming Zhang (2004) of the National Bureau of Economic Research present the dominant argument in modern economic development theory; that increased labor mobility increases efficiency, decreases inequality, and increases growth. Walley evaluates the popular belief that the hukou system has supported growing inequality by restraining labor migration. Walley’s unique contribution lies in his “injection of economic modeling into the debate…which was thus far largely statistical.” However, Walley’s model concludes that “when we remove migration restrictions, all wage and income inequality disappears.” If influential economists have long supported the removal of the hukou system, why does it remain in place? To answer this question, this thesis will widen its focus to draw on the political and social justifications for the continued enforcement of the hukou.

Thomas Hertel and Fan Zhai (2005) in Labor Market Distortions, Rural-Urban Inequality and the Opening of China’s Economy, agree with Walley’s basic conclusion and policy suggestions, “if there were no barriers to the movement of labor between rural and urban areas, we would expect real wages to be equalized for an individual worker.” Hertel finds that this movement increases the supply of rural labor to the urban economy, thereby boosting rural wages and depressing urban wages. Hertel’s model suggests economic efficiency could be improved by increasing rural-urban labor mobility. However, Hertel and Walley’s focus on GDP growth and wages ignores other economic, social and political impacts that have convinced the Chinese government to create and enforce these policies. But what are these other impacts?

Fei-Lei Wang of the Sam Nunn School of International Affairs, Georgia Institute of Technology specializes in international relations and Asian politics. His book, Organizing Through Division and Exclusion (2005) provides a more comprehensive approach to China’s hukou. Wang emphasizes the importance of the hukou for political stability, “Institutional exclusion experiments allows for orderly organization of an unevenly developed and diverse nation by a centralized government.”

Alice Goldstein and Sidney Goldstein’s (1987) Migration in China: Methodological and Policy Challenges is a concise summary of the positive link between the benefits of labor flexibility and the Chinese government’s reasons for maintaining the hukou system. “Current policies allowing temporary mobility form rural to urban places may therefore serve only as a short-term solution to China’s efforts at rural development and overall modernization.” Goldstein and Goldstein support my conclusion that economic theory that finds faster rural-urban migration speeds up economic growth is correct, but a narrow focus on economics fails to account for political and social factors that motivate the central government to maintain controls over mobility.



Theory

Standard labor theory (Ehrenberg, 1997) assumes that labor flexibility and mobility will increase efficiency, since the “free movement of workers among employers allocates labor in a way that achieves maximum satisfaction for both workers and consumers.” Sir Arthur Lewis, winner of the Nobel Peace Prize in 1979, developed a model of economic growth based on St Lucia, the Caribbean island on which he was born. The Lewis model describes an economy with two sectors – (a) a traditional rural subsistence sector (with low wages and a surplus of labor) and (b) a high productivity modern urban industrial sector (with most of the nation’s capital). Lewis’s two sector model became the general theory of the development process in surplus-labor Third World nations by focusing on the process of labor transfer and the growth of output and employment in the modern sector. The following model portrays this process.

In the rural sector, the wage WA shows how subsistence food production varies with increases in labor inputs (L1). Total product is dependent on only one factor, labor, while land, capital, and technology are fixed. The modern sector shows average and marginal product, which are derived from the total product. Note that when total product reaches a maximum, AP is zero and MP is negative, which means that adding more workers actually reduces output, implying a negative wage as workers get in the way of one another. As workers move into the urban sector, rural wages do not rise because there was surplus labor in agriculture. Low rural wages and high urban wages draw workers from rural to urban areas.

Source Todaro (2006)
In the modern sector, WA is the average level of real subsistence income in the traditional rural sector. WM is the real wage in the modern sector, where the supply of rural labor is assumed to be ‘unlimited’ or perfectly elastic, as shown by the perfectly horizontal labor supply curve at WM. As the profit maximizing modern sector employers are assumed to hire laborers up to the point where their marginal physical product is equal to the real wage (point F), total modern sector employment will be equal at L1. As the total profits that accrue to capitalist are re-invested, the total capital stock causes the total product curve of the modern sector to rise, which in turn induces a rise in the marginal product or demand curve for labor. This modern sector growth and employment expansion will continue until all surplus rural labor is absorbed in the industrial sector.

Traditional or rural sector's labor migrates to the modern capitalist sector, attracted by higher wages. However, the rising supply of labor in the urban sector keeps urban wages from rising, which leads to high profits in the modern sector and finances its further expansion, attracting more and more migrants to the prospering cities. The Lewis model thus explains why wages often remain low and profits high despite rapid economic growth.

Michael P. Todaro (2006) had a different goal—to explain continuing rural-urban migration despite high urban unemployment: “it is now abundantly clear from recent Less Developed Countries experiences that rates of rural-urban migration continue to exceed rates of urban job creation and to surpass greatly the capacity of both industry and urban social services effectively to absorb this labor.” Todaro’s model, outlined in his 1969 article A Model of Labor Migration and Urban Unemployment in Less Developed Countries, explains the “apparently paradoxical relationship (at least to economists) of accelerated rural-urban migration in the context of rising urban growth.” The overwhelming evidence of the past several decades indicates, “Developing nations witnessed a massive migration of their rural populations into urban areas despite rising levels of urban unemployment and underemployment, which lessens the validity of the Lewis two-sector model of development,” argues Todaro in Economic Development (2006). Therefore, Todaro responds to this weakness in the migration and development theory by creating a migration model based on expected income.

The Todaro model has three basic parameters. First, it assumes that people are rational and migrate if their expected income is higher by moving. Second, the probability of obtaining a job in the destination area depends upon the unemployment rate. Third, there can be rural-urban migration despite high urban unemployment rates if the urban-rural wage gap is sufficiently large to make the expected income from moving large. Colin Danby (2000), at the University of Washington has interpreted the Todaro migration thesis through these two models.



WA=Agriculture Wage Rate

WM=Manufacturing Wage Rate

(Source Danby, 2000)


In Danby’s example, the rural wage will rise to $1.25 a day.  Two thirds of the urban workforce are employed, and the number of employed urban workers does not change because the wage is fixed by an effective minimum wage. This example is not yet in equilibrium, according to the graph WA = $1.25 and WM = $4.  Rural workers will perceive a two-thirds (LM/LU) chance of getting an urban job, yielding an expected income of $2.33 a day to being in the city.  Rural-urban migration thus continues despite a high urban unemployment rate, as in China today.

(Source Danby, 2000)


Danby finds Todaro’s final equilibrium condition WA = (LM/LU) x WM can actually generate a set of rural wage rates and rural/urban residence patterns that would make workers indifferent between being in the city or the country.  This equilibrium is represented by the purple dashed line. Moving down the equilibrium line, lower rural wages are compatible with more people crowding into the city.  At point Z, where the equilibrium line intersects the demand curve for rural labor, no more rural workers will migrate.

To summarize, Todaro assumes that rural workers compare expected incomes in the urban sector with prevailing average rural incomes, and migrate if the expected income in the urban sector exceeds the more certain income in the rural sector. Todaro’s policy implications for China include; (a) rising rural-urban income gaps can promote rural-urban migration even if not all the migrants find jobs in urban areas; (b) creating more jobs in urban areas may be associated with rising unemployment rates if the rural-urban wage gap is not narrowed, (c) wage subsidies and traditional scarcity factor pricing can be counterproductive, and (d) programs of integrated rural development should be encouraged.

Todaro’s model explains rural-urban migration in the context of rising urban unemployment leads many to question the basic conclusion that if the hokou system were relaxed, rural-urban migration would increase. The Chinese government, afraid of out-of-control rural-urban migration, believes that development economists are correct. How can the theory be applied to China?

The hukou system, intertwined with China’s economic and political history and influenced by China’s economic growth, guarantees low wages to produce manufactured goods for export. However, unlike the Lewis model of free rural-urban migration, the Chinese case is one of restricted migration. Therefore, the hukou system may protect Chinese stability but restrict economic growth.

If China were to completely lift hukou restrictions, the government could further exploit China’s comparative advantage, cheap labor, and increase its global competitiveness and thus economic growth. However, the Chinese government has chosen to control migration, even if the cost is slower economic growth. The remainder of this thesis will be devoted to explaining the economic effects on China, and the economic, political and social justifications for maintaining the hukou system after the next section explains the relationship among labor, migration and growth.

China’s labor market, migration policies, and economic development

The motivation for increasing labor flexibility is to speed up economic development. Historic economic development theory as explained by Todaro dictates that modernization in specific areas of a nation will produce higher wages with the increased efficiency resulting from improvements in technology. These higher wages in urban areas will attract those left behind in the rural sector, portraying economic development’s cataclysmic affect on migration.

R.W. Steel (1952) remarks in the speech Economic Aspects: General Reports, “The growth of population in urban and industrial centers appears to be inevitable if there is economic development, and (therefore) if governments desire economic development, they must be prepared to face the consequences and to attempt to mitigate the effects of the concentration of people in restricted built-up areas.” Therefore, migration is a direct result of modernization, and China’s large population shifts should speed economic development. This thesis focuses on the changing labor market because of its central role in employment and productivity, two key factors in determining the health of an economy.

The Central Intelligence Agency’s World Fact book (2006) estimates that in 2003, 150 million Chinese had fallen below international poverty lines, a majority being surplus rural workers adrift between the villages and the cities, subsisting through part-time, low-paying jobs. The officially registered unemployment rate in urban areas in 2004 was 9 percent, while an official Chinese journal estimated overall unemployment (including rural areas) for 2003 at 20 percent (CIA, 2006).

This relatively high urban unemployment rate coupled with congestion, pollution, lack of appropriate shelter, infectious diseases, and rising crime rates add to misery indexes frequently highlighted by media and assistance agencies. However, as A.S. Oberai (1993) of the International Labor Office in Geneva observes, despite these real and growing problems, cities play a critical role in economic development by expanding centers of labor demand. This paper draws its strongest conclusions by focusing specifically on migration’s interaction with economic development via the labor market.

As depicted by the Todaro model of restricted migration, most developing nations do not allow internal migration to equalize the returns to labor among rural areas and between rural and urban areas. To summarize, this large income gap acts as a magnet for people in poorer areas, who migrate for higher wages. This inflow of poor migrants to richer places raises unemployment rates, which motivated Chinese government officials to enact policies regulating rural-urban migration.



Costs Associated with Restricting Urban Migration in China

The economic literature on the benefits that would accrue to China after the hypothetical elimination of the hukou system is dominated by John Walley and Shunming Zhang (2004). Their article Inequality and Change in China and (Hukou) Labour Mobility Restrictions provides detailed empirical models to argue that the hukou plays an important role “in preventing movement towards a more equal distribution of income in China.” Walley advocates the complete elimination of the hukou in order to equalize the wages among regions, improve labor efficiency, reduce barriers to inequality and finally reduce the hukou’s retarding impact on urban housing prices in China.

Walley begins his argument by utilizing the Gini coefficient to represent the distribution of income in rural and urban sectors. Table 1 reports the estimates of the differing income levels in these sectors over the last 20 years to portray the growing income divide. The Gini coefficient measures income inequality by ranking households on the X-axis and their share of income on the Y-axis. A Gini coefficient of 0 is perfect inequality, as when one household gets all the income, and a coefficient of 1 is perfect equality, with all households having the same income. As shown below, the rural areas Gini Coefficient is closer to one, indicating a higher level of equality due to the more equal distribution of agriculture’s notoriously low income in developing nations. The urban areas however have much more unequal distribution of income due to the hukou’s impact of segregating the urban population into two starkly different income levels based on those exploiting and those being exploited by the household registration system.
Table 1.

Regional and National Income Inequality in China between 1978 and 2000

Gini Coefficients for Household Income
Year Urban Areas Rural Areas

1978 0.160 0.212

1979 0.160 0.241

1980 0.150 0.241

1981 0.150 0.232

1982 0.150 0.246

1983 0.160 0.244

1984 0.190 0.227

1985 0.190 0.304

1986 0.200 0.305

1987 0.230 0.303

1988 0.230 0.310

1989 0.230 0.310

1990 0.240 0.307

1991 0.250 0.313

1992 0.270 0.329

1993 0.300 0.321

1994 0.280 0.342

1995 0.280 0.323

1996 0.290 0.329

1997 0.300 0.337

1998 0.295 0.336

1999 0.457

2000 0.320

Source: Walley (2004)
Unequal distributions of income suggest significant wage differentials across regions (Table 2). By eliminating the hukou, wage rates could be equalized across regions, which lowers the pull for migration to overcrowded areas with higher wage rates. Below, Walley separates Chinese citizens into rich-poor and urban-rural to consider the differing economic and demographic factors of each.

Table 2. Chinese Inter-regional Labor Mobility Model
Urban – Rural Rich-Poor

GDP per capita U 12.38835 R 13.29862

R 6.05665 P 5.79754

Wage Rate U 16.63805 R 11.30238

(103 RMB) R 5.73975 P 6.71116
Work Force U 142.236 R 218.465

(106 People) R 482.291 P 412.062


Population U 472.20 R 442.38

(106 People) R 795.63 P 825.45


Walley (2004)
The data above will be used in Table 3 to predict the impact on the work force and regional populations if the hukou were eliminated. Walley shows in Table 3 that approximately 48 percent of the work force and 45 percent of the population would move from rural to urban areas after hukou removal, whereas 17 percent of the population would remain in rural areas. Those who stay in rural areas become richer, increasing their average income to 1.42 times that in urban areas. Additionally, total output increases by 13 percent, and GDP per capita and income per worker both increase, raising growth.
Table 3 Impacts of Hukou Elimination in Alternative Regional Divides in

Inter-regional Labor Mobility Model for China

Base Case

Urban - Rural Rich – Poor

Output U 5849.777 R 4818.849

(106 RMB) R 5883.043 P 4785.583

Y = 10668.626 Y = 10668.626

After Hukou Elimination

U 9531.818 R 7395.960

R 2730.995 P 3615.498

Y = 12082.813 Y = 11011.457

∆ = 1414.187 ∆ = 342.831

Base Case

U 12.38835 R 13.29862

Average R 6.05665 P 5.79754

(GDP per capita)

(103 RMB)


After Hukou Elimination

U 8.89620 R 9.71770

R 12.60758 P 7.13467

I = 9.53031 I = 8.68528

∆ = 1.11544 ∆ = 0.27041

Source Walley (2004)


Walley concluded that urban-rural or rich-poor differentials “are eliminated with the removal of the hukou restrictions, and average incomes across regions are more closely equalized.” Walley’s modeling of the complete removal of hukou system (a restrictor in the labor market) supports traditional development theory, which requires labor flexibility so that workers can move to higher paying and more efficient jobs. As the GDP per capita, income, and output increase, overall GDP rises, the best economic indicator of growth within a nation.

Thomas Hertel and Fan Zhai (2005) in Labor Market Distortions, Rural-Urban Inequality and the Opening of China’s Economy, agree with Walley’s basic conclusion and policy suggestions, “if there were no barriers to the movement of labor between rural and urban areas, we would expect real wages to be equalized for an individual worker.” However, Hertel builds on Walley’s findings by surveying recent hukou reforms (the gradual relaxation of restrictions keeping people in the place where they are registered) and found they have “the most significant impact on aggregate economic activity.” To prove this, Hertel models a relaxation of the hukou system through cutting the indirect transaction costs from 81 percent to 34 percent of non-farm rural wages, representing the portion of tax distortion attributed to the hukou operating like tax on rural labor-labeled hukou Reform to highlight the difference between rural-urban inequalities on Table 4.



Table 4. Hertel’s Effects of Hukou Reform

Implications of China’s reforms in 2007 (%change relative to baseline)

Relaxation of Hukou System



Macro-economic variables

Welfare 1.3

GDP 1.4

Consumption 1.6

Investment 2.7

Exports 1.8

Imports 1.6
Factor Prices

Capital returns -0.4

Unskilled wages

Urban -9.8

Rural non-ag 12.3

Agriculture 2.8

Semi-skilled wages

Urban -4.5

Rural non-ag 18.5

Agriculture 7.3


Inequality Measures

Urban/Rural income ratio -0.169

Gini -0.014

Urban 0.005

Rural 0.002
Labor Migration (Millions)

Off-farm labor 3.1

Rural-urban 26.8

Unskilled 9.1

Semi-skilled 17.8

Skilled 0.0


Labor Migration (%)

Off-farm labor 2.2

Rural-urban 38.1

Unskilled 31.4

Semi-skilled 49.4

Skilled -0.2

Source Hertel and Zhan (2005)
Hertel’s results indicate that when the transaction costs associated with temporary migration are reduced due to the elimination of the hukou system, rural-urban migration expands by 26.8 million workers. Hertel finds that this movement increases the supply of rural labor to the urban economy, thereby boosting rural wages and depressing urban wages. Hertel’s (2005) model suggests economic efficiency could be improved through institutional reform in the factor markets aimed at improving rural-urban labor mobility; “By reducing the implicit tax on temporary migrants, hukou reform boosts their welfare and contributes to increased urban-rural migration.” Thus, Hertel and Walley’s economic models both conclude that the economic benefits or more rural-urban migration increase efficiency and decrease inequality enough to outweigh any other arguments that could be used to maintain mobility restrictions.

Both simulations are important because they suggest continued reform, arguing that the costs of the hukou do not outweigh the benefits when focusing on the labor market. Hertel and Walley are convincing because they rely on survey data to test economic models, as opposed to the numerous abstract research papers arguing for the elimination of the hukou system based solely on the hukou’s contradictions with economic development theory. However, Walley and Hertel are too narrow-minded in their support of a flexible labor market in China, and weaken their policy relevance by blatantly ignoring the major obstacles that prevent the free movement of labor from the countryside to Chinese cities. The next section will explain what these authors neglected, that the utopian flexible labor market envisioned by Walley and Hertel cannot realistically be supported in Chinese cities, nor would the accelerated economic growth rates erase the social and political risks.



Benefits Associated with Restricting Urban Migration

Development theory would urge governments to foster labor mobility to speed economic growth. Walley and Hertel’s modeling of the complete removal of hukou system (to free up the labor market) supports traditional development theory in which migration leads to faster growth and convergence between rural and urban areas. Walley’s model concludes that “when we remove migration restrictions all wage and income inequality disappears,” raising the question of why the hukou system remain largely in place.

Dr. Fei-ling Wang, an Associate Professor at the Sam Nunn School of International Affairs, Georgia Institute of Technology provides the answer in his 2005 book Organizing through Division and Exclusion; China’s Hukou System. Wang outlines the socioeconomic benefits from the hukou registration system, such as helping the Chinese government to maintain the loyalty of better-off urban residents and maintain a firm grip on society, that is, hukou policies bind the vested interests of urban residents and industries with those of the Chinese government. Wang (2005) highlights the hukou’s “original and main” functions of identification and social control, after lessening the “undue” burdens of resource and job allocation through reforms.”

Wang argues that the hukou system provides an authoritarian government with a tool for social stability, provides factories with low-cost migrant labor, and supplies China’s growing urban population with preferential access to public services. Hukou restrictions supported the economic growth of China’s urban (but not rural) areas by slowing the influx of migrant labor into cities.

Full hukou reform requires significant political commitment to overcome resistance from an increasingly vocal urban middle class that has grown accustomed to its benefits and fears having to compete with rural migrants for housing, education, and other services. A lack of resources limits the ability of Chinese authorities to provide these services on an equal basis to an urban population growing rapidly because of rural-urban migration. According to some estimates, China’s migrant population may be 150 million, equivalent to a third of China’s total urban population. There are 760 million rural residents, almost 60 percent of China’s total population. Providing migrants or all rural residents’ with full access to public services on an equal basis with urban residents poses a formidable economic challenge.

Wang also argues that institutionalized exclusion of rural residents is not unique to China, and such exclusions may be necessary for a developing nation’s stability. India, home to a similar large population of low-skilled rural workers and with a dual economy, uses the socially enforced caste system to separate the haves and have-nots. Brazil, a large but much less densely populated developing nation, relies on the market to enforce institutional exclusion, based primarily on wealth or property. As Wang (2005) observes, Brazilians use money, rather than hukou registration, caste, or other sociopolitical features to determine political power, socioeconomic stratification, vertical and horizontal mobility; life chances often depend on residence.

Thus, Brazil, China and India, three large developing nations facing similar challenges during the Lewis Transition, have quite different institutional exclusions and varied mechanisms to shape population mobility. From this fact, Wang (2005) argues that these institutions are necessary, “In theory and in practice all nations must have at least one type of institutional exclusion.” Wang praises the hukou because it is a “residentially based institutional exclusion (where one is) may be a lesser necessary evil than exclusion based on genetic, religious or social group (who one is).” The sociopolitical stability that results from institutionalized exclusion provides an explanation for the maintenance of the hukou system in China despite slower economic growth.

Goldstein & Goldstein (1987) observe that China has embarked upon a most ambitious and concerted effort to modernize, and a key critical element identified by the Chinese policy-makers is control of population growth. As agriculture is modernized, industry expands, and the quality of life improves, rural residents will want to move to urban places. That many will no longer be needed in agriculture is already apparent from the increase in surplus labor that has been associated with the institution of the hukou system.

Goldstein notes that expanding industrial enterprises and service industries requires additional labor, so rural-urban migration is a potential win-win policy. However, new residents require housing and services, so that growth requires additional infrastructure. Some migration can beget more migration, as networks develop and those remaining in poorer rural areas crave the benefits of life in cities. Current policies that allow temporary mobility from rural to urban places may serve only as a short-term palliative in China’s quest for overall modernization. Goldstein (1987) summarizes the dilemma the Chinese government faces in regard to migration and development;

“On the one hand, China must learn from the experiences of other developing countries that have already faced the distribution consequences of a much greater degree of freedom of movement than China is likely to allow in the foreseeable future. On the other hand, China’s efforts at simultaneous development and migration control provide a striking contrast and hold special interest for the lessons that can be derived from them.”


Concluding Thoughts

This thesis began with the traditional Lewis model under which developing countries begin the development process with most of their workers employed in agriculture. As economic development proceeds, people are pulled out of agriculture by higher wages in urban areas, and pushed out by low farm wages due to surplus rural workers. In comparisons of countries, those with less than five percent of their workers employed in agriculture are among the richest, and those with more than 50 percent of their workers employed in agriculture are among the poorest (Todaro, 2000).

Development and agricultural economists next provided social and political evidence that the Chinese government should allow more rural-urban migration to speed up Chinese development, with John Walley and Shunming Zhang of the National Bureau of Economic Research developing estimates of the gains that could accrue from eliminating the hukou system. However, Walley and Hertel’s call for more rural-urban migration contrasts with Wang and Goldstein’s political analysis that the hukou is necessary for the stability of most less developed countries, including China. Walley and Hertel highlighted the economic benefits of a higher GDP and decreased inequality to justify elimination of the hukou, while other scholars emphasize the social, political and economic risks of more migration, and conclude that these risks outweigh the Chinese government’s economic incentives to eliminate the hukou.

This paper investigated the economic, political and social motivations for China’s labor market restrictions. Through revealing the often overlooked political fragility of the Chinese communist government, I believe that the decision of Chinese government officials to maintain the hukou are an effort to balance economic growth and political stability. Advocates of liberal or market-based development theory are correct to argue that increasing labor flexibility would likely accelerate economic growth. However, they fail to account for the social and political consequences of their policies, which may be more important than the additional growth in a fast-growing country such as China. Therefore, economic development theory correctly explains why voluntary rural-urban migration is beneficial, but other factors may outweigh these economic benefits in the minds of governments worried about stability. China is currently growing at 9-10 percent a year, the fastest in the world, and, with more rural-urban migration, it may raise the rate to 11-12 percent. However, the resulting extra growth may come at the cost of instability, which is a high price to pay for incrementally faster economic growth.



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