China’s provincial disparities and the determinants of provincial inequality

The paper explains the growth — inequality nexus for China’s provinces. The theoretical model of provincial development consists of two regions and studies the interactions of a mutually depending development process. Due to positive externalities, incoming trade and FDI induce imitation and hence productivity growth. The regional government can influence the economy by changing international transaction costs and providing public infrastructure. Due to mobile domestic capital, disparity effects are reinforced. The implications of the theoretical model are tested. As the central intention of the paper is to explain provincial disparity we directly relate income disparity (indicated by the contribution to the per capita income Theil index) to the disparity of selected income determining factors (indicated by the contribution to every other Theil index of the determinants). We examine the determinants of income and inequality for 28 Chinese provinces over the period 1991-2004 and apply a fixed effects panel estimation. Our analysis is based on revised GDP and investment data from Hsueh and Li (1999) and various sources of Chinese official statistics provided by the National Bureau of Statistics (NBS). The results confirm the theoretical framework and suggest a direct linkage between the factors that determine regional income and regional disparity. More specific, it is apparent that trade, foreign and domestic capital and government expenditure have an impact on the provincial inequality. Moreover, it is the success of the coastal regions and hence potentially geography with the low international transaction costs that drives the provincial inequality of China.