Market Transition and Income Inequality in Urban China: Evidence from Shapley Value Decomposition

China¡¯s market-oriented reform is expected to strengthen the role of the market in allocating resources, which raises concerns over the impact of market transformation on income distribution and earnings inequality in the past decades. This paper decomposes the sources of inequality based on the newly developed Shapley value approach and examines the contributions of the market, along with other nonmarket factors, to total inequality. Using the China Health and Nutrition Survey data over the period 1989¨C2009, we find that the income gap between laborers with a higher level of education and those with a lower level has widened since the transformational reforms of the economy. Our results suggest that the largest contribution of changes in income inequality can be attributed to the increase in returns to education, while the relative contributions of the household registration (hukou) system, type of sector ownership, geographic location, and gender to inequality experienced a downward trend between 1989 and 2009. The authors argue that rising income inequality is the consequence of efficiency improvements and an imperfect economic system, and that the market is a decisive force in economic development as it releases competitive signals and creates incentive mechanisms for innovation. Creating a more efficient labor market and increasing investment in human capital, particularly equalizing educational opportunities and improving the quality of education in lagging rural and inland regions to disadvantaged groups, are significant for an equitable distribution of income and sustainable development in the long run.