roles of increase in returns to education in income growth and the “race to the top”-type of income divergence suggest that rising income inequality is part of a normal process of development and can be desirable for efficient growth as it unleashes competitive pressure and creates incentives for investment in skills. The structure of the paper is as follows. Section 2 presents the data; section 3 reviews the literature on inequality in China since the economic reforms; section 4 presents the empirical methodology; section 5 describes the results of unequal distribution and trends of changes in income and non-income dimensions; section 6 examines the sources of widening income differentials; and section 7 concludes.

# **2. Data**

We use the China Economic, Population, Nutrition and Health Survey (CHNS), a longitudinal survey with six waves in 1989, 1991, 1993, 1997, 2000 and 2004. Li and Zhu (2006) and Zhang and Wan (2006) used part of this dataset in their analysis of income inequality in China. This data collection is an ongoing international collaborative project between the Carolina Population Center at the University of North Carolina at Chapel Hill, the National Institute of Nutrition and Food Safety, and the Chinese Center for Disease Control and Prevention.<sup>1</sup> The sample of households was randomly drawn from eight provinces, including three coastal provinces, _Liaoning_ , _Shandong_ , and _Jiangsu_ , and five inland provinces _Henan_ , _Hubei_ , _Hunan_ , _Guangxi_ and _Guizhou_ .<sup>2</sup> These provinces vary by geography and economic development, and can be considered as regionally representative. Four neighborhoods in each city, one county-town neighborhood, and three villages in each county, were then randomly selected. Approximately 20 households were sampled per community. Newly-formed households who resided in sample areas and additional households to replace those no longer participating were added to the sample. New communities were also added to replace communities no longer participating.

In this study, we use the 1989 and 2004 survey data to analyze the changes in income. The 1989 round included 3,795 households or 10,664 adults (18 years of age or older). The 2004 round included 3,810 households or 9,856 adults. In the CHNS dataset, household income in different survey years is adjusted to 1988 urban _Liaoning_ price using rural/urban Consumer Price Index (CPI) at the provincial level. In this paper, if not mentioned otherwise, household income is measured in 1988 urban Liaoning prices.

# **3. Changes in Inequality in China**

Regional development in China has been uneven since long before the reform. The problem was less visible mainly because of the overall low level of income. In the planning period, despite the government’s efforts in balanced growth, the entire economy was distorted by inefficient allocation of resources. Investment was largely allocated to inland provinces and the North-East, which followed political needs rather than regional comparative advantages. Regional development level did not well reflect comparative advantages or potential capacity. After the reform, several waves of preferential policies deliberately sequenced by the central government following market principles, along with differences in natural endowment and comparative

> 1 A detailed description of the data can be obtained from http://www.cpc.unc.edu/china/.

> 2 Liaoning was replaced by Heilongjiang in the round of 1997 and returned to the survey in 2000.

2