Mind the gap

China's rapid economic development, which has lifted more people out of poverty more quickly than any other place at any other time in history, has now produced the widest wealth gap the country has seen since Mao took over.

The National Bureau of Statistics released data showing that the income gap widened in the first quarter of the year, with 10% of the nation's richest people enjoying 45% of the country's wealth. The poorest 10%, meanwhile, had only 1.4% of the nation's wealth.

As the income gap grows, what are the consequences for China, negative and positive, and for all the companies that are counting on Chinese consumerism to fuel their growth?

The standard calculation used by economists to measure income inequality is the Gini Index. China scores 48 on it, while egalitarian Sweden scores 25 and the infamously unequal Brazil is rated at 59.1. China's current Gini coefficient puts it roughly on a par with Russia, much less equal than India, and slightly more equal than Peru.

History suggests it is natural for developing countries to exhibit increasing income disparity as the first wave of the population profits and then for the income gap to begins to narrow as the rest of the country catches up. History also teaches that income gaps can both cause social resentments and spur individual initiative.

Income gap's upside
In China, the growing inequality has actually been driven by some categorically positive changes, like higher returns in human capital – as skilled labor earns more than it did in the past, according to Victor Nee, a professor at Cornell University who researched income distribution in Shanghai and Guangzhou. This source of disparity is actually healthy to society, as it provides incentives for education and productivity, Nee said.

The existence of rags-to-riches entrepreneurs like Li-Ka Shing, who started out as a street vendor before scaling the heights of billionaire moguldom in Hong Kong, also serves as incentive for the millions of Chinese working long hours, lifting themselves and their country out of poverty. The rich, shopping at the Ferrari store in Shanghai can be beacons of possibility-China's own version of the American dream.

According to the new government figures, disposable income for China's top 10% has increased at 15.7% over the past year whereas income for the bottom 10% increased only 7.6%. But the growing income gap is on the basis of higher average incomes for all groups-almost everyone is earning more than they were a few years ago.

Alarm bells
What is troubling to many observers is that China's already-wide income gap keeps expanding. In 1998, China and the US displayed roughly the same theoretical level of inequality, with their Gini coefficients at 40.8 and 40.2, respectively. Six years later, China's measure has increased dramatically while the US index nudged up only slightly to 40.8. "If the inequality issue is not addressed, then the investment climate may not be as benign as it first appears," Brookings Institute fellow Wei Shang-jin said.

China's income tax regime doesn't help things either. The top 20% of the population own more than 80% of the country's bank deposits and contribute less than 10% to China's personal income tax revenue. While some economists say China's rich have the smallest tax burden in the world. China has repeatedly talked of reforming the tax code, but no timetable has been set.

And while incomes have, for the most part, increased across the board, not everyone is feeling happy about their lot. There have been a growing number of reported disturbances by migrant workers protesting poor pay across China, according to Yiyi Lu, head of the China project at the Chatham Institute, a British think tank.

There is a sense among some that income is distributed not just unequally, but also unfairly. "Business-government collusion, especially on the local level and a legal system, which is not wholly independent" allow corrupt behavior by companies that sometimes fail to pay workers at all, Lu said.

Even the Communist Party newspaper People's Daily cautiously noted the danger of the growing gap, stating in a recent editorial, "It is unavoidable that different people and different groups enjoy the fruits of reform and development to different degrees," adding: "Any behavior that wrecks stability and challenges the law will directly damage the people's fundamental interests."

In truth, China does not seem a society on the verge of revolution. But the prospect of an entrenched poverty cycle could be on the horizon. Education and health services in rural areas lag decades behind those available in cities and a country's development depends on an educated, healthy populace, said Brookings' Wei. If the elite fails to provide these services, progress can flounder, as has happened in many Latin American nations.

But the most immediate economic consequence of China's income gap may be market glut as the inland areas progress towards high consumption rates slower than the producers of fast moving consumer goods would like. "We cannot just talk about a 1.4bn person market. Maybe the meaningful markets are only 15 cities on the coast," Wei said.

China's market is over-supplied with cars and housing and many other commodities, and higher income levels and a greater willingness to spend would certainly help, regardless of the raw income gap statistics.