decentralization under which local governments were given the right to establish TVEs and retain the profits generated by them (Oi, 1999). The implied autonomy and control, combined with a hard budget constraint imposed from above provided exactly the right incentives at the outset to invest and operate efficiently. The resultant increase in rural non-farm output and employment, was spatially uneven, but probably inequality reducing overall (given the rural base for this innovation) and contributed to China’s growth up to the mid-1990s.

However, with the proliferation of TVEs and the increased competition this implied in various product categories, pressures emerged for local and provincial governments to protect the (local) markets of the TVEs and enterprises under their control. The result was increasing impediments to inter-jurisdictional trade and to entry by outside firms, leading to fragmentation of China’s domestic product and factor markets and a deterioration in the investment climate in many localities (World Bank, 2005).

# **Perceptions and tolerance for inequality: The “bad” can drive out the “good”**

Bad inequalities are doubly harmful. First, they directly reduce the potential for growth because segments of the population are left behind, lacking the opportunity to contribute to the growth process. Second, on top of these direct human and economic costs, persistent bad inequalities in a setting of heightened aspirations can yield negative perceptions about the benefits of reform. Because it is difficult for citizens to disentangle the sources of the aggregate inequality in observed outcomes—to determine whether the underlying drivers are good or bad—societal intolerance for inequality of any kind emerges. And that can trigger social unrest or harden resistance to further needed reforms, thereby (indirectly) threatening the sustainability of growth. In effect, the persistence of bad inequalities drives out the good ones.

In China, Han and Whyte (2006) report results of a survey of over 3,000 Chinese adults interviewed in 2004; 40 percent of respondents “strongly agreed” that inequality in the country as a whole is “too large” while a further 32 percent “agreed somewhat” with this view. An astonishing 80 percent favored “governmental leveling” to assure a “minimum standard of living” (split roughly equally between “strong agree” and “agree somewhat”). Interestingly, the correlates of perceptions of unfair inequalities did not suggest that the concern was greatest among those most disadvantaged, such as farmers or migrants from rural areas. Also notable is that most respondents did feel that education, ability and effort were rewarded in China.

Such high levels of concern about inequality do not imply dissatisfaction with the distributive outcomes of economic reforms. However, there are also signs that perceptions of (or direct experience with) bad inequalities is translating into growing dissatisfaction with reforms in both countries. Social protests about various perceived injustices are becoming common in China. Land disputes have been especially common in rural and peri-urban areas, where the poorly-defined land rights of farmers leave ample opportunities for local officials and developers to expropriate a large share of the rent from land-use conversions. In a poll conducted by the Chinese Academy of Social Sciences in 2002, 60 percent of the 15,000 respondents thought that party and government officials had benefited the most from reforms, while other polls (cited in Pei, 2006) consistently rank corruption as one of the most serious problems facing China. In 21