As within-country inequality is on the rise worldwide, considering how people actually perceive inequality in their societies and how they respond to it is a question worth asking. In 1973 Albert Otto Hirschman proposed an explanation of changing tolerance for inequality associated with different ‘stages’ of the development process. In this post I’ll revisit Hirschman’s theory and link it to emerging studies of how inequality is perceived in China. The Chinese people generally seem to be satisfied with rising inequality, yet it is unclear how long this tolerance will last.

Development inevitably creates both winners and losers. This generates, at least in the early stage, an economic disparity in society. In 1973 Hirschman published “The Changing Tolerance for Income Inequality in the Course of Economic Development”. In it he argues that in the early stage of development, when income inequality among different classes, sectors, and regions tends to rise, society’s tolerance for this inequality will be substantial. The reason people can tolerate this inequality is that they hope and expect that this disparity will fall at one day or another. However, if this disparity does not narrow, there comes a point when people will no longer endure it. Hirschman uses the example of a two-lane tunnel to explain how people respond (the so-called “Tunnel Effect”). Suppose you are in a traffic jam, you are in the left lane and cannot move. Then, you can see that the cars in the right lane start to move gradually. You feel good because you know that good things will come. Start thinking about the beach? Even though you can’t move, you feel better because you expect to move soon. The initial gratification is the tunnel effect. However, suppose that it is only the right lane that can move and yours never starts moving. You feel furious and unfairly treated and want to do something to correct this injustice. Your expectation has not been met.

Hirschman also explains the determinants of this effect. He states that the tunnel effect will be strong in cases where the group that does not advance (the left-lane car) is able to empathize with the group that advances. In this case, class matters. If people from your class are a part of the growth process, you will be more likely to expect some positive spillover effects, such as new jobs or other opportunities. However, if the group of people involved in the growth processes are from a different class, ethnic, and religious group, the tunnel effect may not be realized.

In a homogenous society where resources are owned domestically, tolerance for income inequality tends to be high because there is no language, ethnic, or other systematic barrier that keeps the people lagging behind from empathizing with those benefiting from the economic growth. However, Hirschman suggests that the greater the tolerance, the greater is the scope for the reversal that comes once the tunnel effect wears off, if inequality is not corrected in time. National homogeneity is defined in terms of static characteristics, for example, unity of race, language, and religion. However, another effective homogenizing agent is an intense historical experience, for example, a war or political revolution, if shared by all members. Thus, the historical experience of country can also reveal something about the likely strength and duration of the tunnel effect.

Studies of inequality in China, whose economy has transformed dramatically over the past decades, are now emerging. Despite the difficulty in analyzing an evolution of Chinese inequality over time due to the limitation of data availability in household surveys, research by Milanovic (2016) and Alvaredo (2017) suggests that although income inequality has been rising, it is likely to reach a plateau and eventually start to decline, corresponding with a Kuznet’s curve. Kanbur et al. (2017), Wang et al. (2014) and Han et al. (2016) actually suggest that income inequality started decreasing after 2010. However, the ownership of capital is still heavily concentrated among urban households, similar to many other developing countries (Chi 2012).

There are two elements of Hirschman’s theory that allow for empirical testing in this context. The first is to examine whether the poor still have a positive attitude towards inequality (and development). The second is to examine whether the poor start being more unsatisfied with their condition over time as inequality increases or fails to decline. Although no long-term household survey exists that can give us definitive answers, there are several studies that provide us with indicative information.

Knight and Gunatilaka (2010) find that rural households tend to report higher subjective well-being than do the richer urban households. In fact, several studies find a positive relationship between the Gini coefficient and happiness in a Chinese context (Knight et al. 2009, Jiang et al. 2012), but it is worth noting that these results may not be generalized across China (indeed, Wu and Li 2013 finds that local income inequality significantly reduces the level of happiness). For example, Cheung (2016) finds that inequality is associated with higher life satisfaction in rural areas, but not in urban areas (drawing on a large sample of 30,255 Chinese respondents). This result is consistent with Whyte and Im (2014), who use Chinese national surveys from 2004 and 2009 to examine people’s attitudes to income inequality. Their key questions are whether the rise in income gaps lead to rising popular anger about current inequality patterns and whether the social contours of attitudes toward current inequalities shifted over the five years between surveys. They find that 2009 respondents were significantly more likely to view current inequality as fair, despite the increases in the income gap in this period. It also suggests that 2009 respondents did not rise in anger against the rich and successful, but that they rather expressed a stronger desire for government-provided social safety nets. Another example is from Wang et al. (2015), who investigate an inverted-U shaped association between the Gini coefficient and individual happiness. They find that a certain level of income inequality is beneficial to individual happiness, while an excessive income inequality yields the opposite effect. Inequality can encourage a strong motivation to work hard and obtain more wealth, especially among the middle and lower class income groups. However, when income inequality goes beyond a personal threshold of tolerance, this can lead to anxiety and reduce confidence in future well-being. Thus, based on the studies mentioned above, it is similar to the Hirschman’s key quote “As long as the tunnel effect lasts, everybody feels better off, both those who have become richer and those who have not”.

Figure 1: China’s Gini Index Since 1980

Source: Solt (2016)

Note: Graphs are derived from the Standardized World Income Inequality Database (SWIID). Gini Index of inequality in household disposable income uses post-tax and post-transfer income. Gini Index of inequality in household market income uses pre-tax and pre-transfer income.

The figure above shows that income inequality using the Gini Index (market income)[1] has increased since the 1980s and started to flatten out in the 2010s. This raises the challenging question of how the Chinese respond to a slight decrease in income inequality. However, there is no recent study to my knowledge on how people respond to a lower inequality at this time. For the prediction based on Hirschman’s proposition, there would not be a discontentment towards inequality among the Chinese community after this period because income inequality is expected to decline.

However, one of the missing explanations of Hirschman’s argument is that it does not inform us how long the left-behind people can tolerate for income inequality. In the Chinese case, a negative feeling can occur in the 1990s or the early 2000s after a decade of high growth with increasing inequality. A study by Smyth and Qian (2008), using a large-scale survey in 31 Chinese cities with 9,284 respondents in 2002, find that people who think that the income distribution is unequal report lower levels of happiness, especially among poor respondent. This may signal a change from gratification to indignation. At some point, people could become unhappy about the inequality. However, as mentioned there are other studies that suggest that many Chinese people are still optimistic about inequality. These contradictions suggest that there is a need for further studies on this topic.

The world today has dramatically changed since Hirschman theorized about the tunnel effect 45 years ago, as societies are more connected and highly interdependent through international economic linkages. These changes may call for a new set of frameworks for analyzing how people perceive economic disparity.

Reference

Alvaredo, F, Chancel, L, Piketty, T, Saez, E, & Zucman, G 2017, ‘Global inequality dynamics: new finding from WID.world’, National Bureau of Economic Research Working Paper 23119.

Cheung, F 2016, ‘Can income inequality be associated with positive outcomes? hope mediates the positive inequality-happiness link in rural China’, Social Psychological and Personality Science, vol.7, no. 4, pp. 320-330.

Chi, W 2012, ‘Capital income and income inequality: evidence from urban China’, Journal of Comparative Economics, vol. 40, pp. 228-239.

Kanbur, R, Wang, Y & Zhang, X 2017, ‘The great Chinese inequality turnaround’, BOFIT Discussion Papers 6/2017. BOFIT Institute for Economies in Transition, Bank of Finland.

Knight, J, Song, L & Gunatilaka, R 2009, ‘Subjective well-being and its determinants in rural China. China Economic Review, vol. 20, pp. 635-649.

Knight, J & Gunatilaka, R 2010, ‘The rural-urban divide in China: income but not happiness?’, Journal of Development Studies, vol. 46, pp. 506-534.

Hirschman, A & Rothschild, M 1973, ‘The changing tolerance for income inequality in the course of economic development’, The Quarterly Journal of Economics, vol. 87, no. 4, pp. 544-566.

Milanovic, B 2016, ‘Global inequality: a new approach for the age of globalization’. Belknap Press, Cambridge, MA.

Smyth, R & Qian, X 2008, ‘Inequality and happiness in urban China’, Economics Bulletin, vol. 4, No. 23, pp. 1-10.

Solt, F. 2016, ‘The standardized world income inequality database’, Social Security Quarterly, vol. 97. SWIID Version 6.2, March 2018.

Wang, C, Wan, G & Yang, D 2014, ‘Income inequality in the people’s republic of China: trends, determinants, and proposed remedies’, Journal of Economic Surveys, vol. 28, no. 4, pp. 686-708.

Wang, P, Pan, W, & Luo, Z 2015, ‘The impact of income inequality on individual happiness: evidence from China’, Social Indicators Research, 121, 413-435.

Whyte, M K & Im, D-K 2014 ‘Is the social volcano still dormant? trends in Chinese attitudes towards inequality, Social Science Research, vol. 48, pp. 62-76.

Wu, X & Li, J 2013 ‘Economic growth, income inequality and subjective well-being: evidence from China’, PSC Research Report 13-796. Population Studies Center.

Wannaphong Durongkaveroj is a PhD candidate at Arndt-Corden Department of Economics, Crawford School of Public Policy, College of Asia and Pacific, The Australian National University (e-mail address: wannaphong.durongkaveroj@anu.edu.au).

[1] According to Solt (2016), the SWIID covers several income inequality data set. User can see several types of inequality based on different types of income, for example, net-income inequality (disposable income) and market-income inequality (pre-tax and pre-transfer income). The author suggests that net-income inequality series is likely to be the best suited to researcher’s definition of inequality because market-income inequality cannot be interpreted as a pre-government inequality as it also includes non-redistributive policies, for example, public education and job-training programs, which can affect income distribution. However, the use among these two types of inequality depends mainly on researcher’s question.