person’s adult skill level. As resource constraints differentially affect access to education of individuals in different parts of China, especially in rural areas and in the poor inland provinces, inequality in opportunity may be closely linked to inequality in income which tends to perpetuate disparity (Heckman, 2005). In pre-reform era, people with different education level earned similar income due to policy distortions. After the reforms, wage returns to one additional year of schooling almost tripled, increasing from 4% in 1988 to 11% in 2003 (Zhang et al., 2005). As well-educated people are more likely to live in urban areas with higher income, the increase in returns to education often initially leads to an increase in overall inequality. However, as Dollar (2007) argues, such changes in equality is expected to be inverted U-shape – it will ultimately tend to reduce inequality if equality of opportunity, especially equality in access to education, can be achieved as over time a greater and greater share of the population will become educated.

Consistent with the findings that human capital and skill are important, we also find that returns to professions outside of agriculture, army and police, and the unemployed, increased during 1989-2004. In urban areas, the income level of households whose members work primarily as “white-collar workers”, such as professional/technical personnel, administrator, factory manager, government official, office staff, is significantly higher than that of households whose members work primarily as “blue-collar workers” or other. The coefficients of “Technical, skilled worker”, “Non-technical, non-skilled worker” and “Service worker” are also significantly positive. As these “white-collar jobs” are often filled with workers with higher level of education, the differentiated returns to occupation also indirectly captures the positive marginal impact of education. Such impact was even stronger in 2004. The income of households earning a living on farm activities is significantly lower than that of other urban households.<sup>8</sup> One important reason for the widening income inequality in urban areas is the sharp increase in unemployment from 1989 to 2004. In the 1980s, explicit urban unemployment did not exist and the wage level was generally low. The difference between employment wage and retirement pension was small. Income gap between the employed and those who are out of employment was insignificant. However, in the 1990s, as the reforms deepened, wage income and bonus income increased for the employed, while retirement pension stayed almost unchanged. The coverage of retirement pension even decreased due to the closure of bankrupt enterprises (see also Fang et al., 2002; Meng et al., 2007). In theory, an increase in “out of employment” may generally result from two forces: first, the aging of population leads to an increase in retirement rate; second, unemployment increases among active population. We find that both are important sources in our case. In 1989, there is little out-of-employment. Total employment rate was 87.7%. However, in 2004, total employment rate dropped to 59.8%. In 1989, employment rate for adults under 60 years of age and over 60 are respectively 90.9% and 65.7%; in 2004, these two dropped to 70.3% and 24.1%. In other words, in 2004, not only employment rate of adults over 60 decreased twothirds, but also that of adults under 60 decreased sharply – about one in three of the active population is out of employment in 2004 compared to only 10% in 1989. The likely reasons could be, many enterprises and government institutions reduce their redundant staff and require some employees to retire earlier (e.g., for many firms and institutions, retirement age fell from 60 to 55 for men and from 55 to 50 for women). Since the SOE reforms in the 1990s, urban unemployment increased drastically, of which a large part of redundant workers became

> 8 According to CHNS’s sampling design, cities include suburban neighborhoods and county seat. Thus there is a small part of households who live on farm activities in urban areas.

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