Will China's 'Have-Nots' Be Next to Rebel?

China, the planet's most populous country and home to one of its most dynamic economies, is in most respects a world away from the smaller, less influential, oil-dominated nations in the Mideast currently boiling with anti-government unrest.

But beneath the obvious differences, China faces some similar issues: rapidly rising inflation in food and other essentials, and a troubling gap between the financial and political "haves" and the far more numerous "have-nots."

These developmental issues aren't lost on China's leadership, which recently announced major initiatives to tame inflation and narrow the gap between those who have grown wealthy during the nation's remarkable rise and those primarily rural citizens who've been left behind.

Considering where China started in 1978 -- without much industry or opportunity for its then nearly 1 billion citizens -- its rapid ascent has been remarkable, lifting hundreds of millions of people out of poverty in a mere generation. But the same forces that turned China's economy into a juggernaut have created an enormous gap between the wealthy and the typical worker -- a gap that could fuel dissatisfaction with the central government.

Extreme Wealth Concentrated at the Very Top

Chinese Premier Wen Jiabao opened the annual gathering of the National People's Congress last week by announcing a campaign to reduce China's wealth gap. That divide is uncomfortably on display in the People's Congress itself: The richest 70 of its 2,987 members have a combined wealth of 493.1 billion yuan ($75.1 billion), according to the research group Hurun Report.

By contrast, the wealthiest 70 people in the 535-member U.S. Congress have a combined wealth of $4.8 billion, according to the Washington-based Center for Responsive Politics. Factor in that America's per capita income is roughly 10 times greater than China's, and you get a feel for the depth of China's wealth divide.

China's Gini coefficient, an income-distribution gauge used by economists that ranges from 0 (perfect equality) to 1 (complete inequality), has climbed to near 0.5 from less than 0.3 a generation ago, according to Li Shi, professor of economics at the School of Economics and Business at Beijing Normal University. Levels of inequality above 0.4 are widely considered a predictor of social unrest. (The U.S. has a Gini coefficient of 0.46, compared to 0.31 for the European Union.)

One way to narrow the gap is to increase the minimum wage, a move analysts at Credit Suisse expect China's regional governments to take in 2011. A boost of the minimum wage in 2010 helped raise rural incomes by 10.9% that year. That increase hasn't necessarily translated into higher disposable income, however, as skyrocketing inflation and home prices have sapped households' purchasing power.

Savings System Is Stacked Against Workers

Changes in the labor market are helping factory workers earn more, but the improvements aren't necessarily helping new college graduates, whose wages have stagnated to the point that some are earning less than migrant workers in factories. A shortage of migrant workers in key industrial cities has also fueled higher wages for factory workers.

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Though profits and GDP have been surging over the past decade as China's productivity improved, these gains have not trickled down to the workers' paychecks. According to the National Development and Reform Commission, incomes kept pace with profits and GDP in only three of China's 27 provinces.

Victor Shih, an associate professor of political science at Northwestern University in Illinois, has suggested in an article in international current-affairs magazine The Diplomat that the basic makeup of China's economy and political structure is creating a nation of haves and have-nots. Shih sees the government's tight control over yields on savings accounts and lending rates as one cause of rising inequality: As inflation accelerates, China's savers are losing money because the return on savings is lower than the rate of inflation. Negative returns on savings are a stealth tax on China's households and a subsidy to the government-owned banks.

The banks then turn around and loan money to politically connected real estate developers and government-owned enterprises at interest rates that are near zero in inflation-adjusted terms. "In effect," Shih writes, " the Chinese financial system channels wealth from ordinary households to a small handful of connected insiders and state-owned firms."

Leadership Faces a Thorny Dilemma

Another source of wealth inequality stems from the substantial cash payments made to insiders and top managers that go unreported in regular channels -- so-called "grey income." These large cash payments are considered "commissions" or "bonuses" in China, but by Western standards, they would widely be considered as bribes and payoffs.

A Credit Suisse survey of urban households in China found that $1.5 trillion in grey income had gone unreported in the official household income numbers. About 60% of this grey income flowed to the top 10% of households. According to Shih, while income of typical households rose 8%, the top 10% saw their incomes leap by 25%

The net result of these structural imbalances, in Shih's view, is a China that is "increasingly splitting into a small upper class that spends freely on luxury goods, and a remaining population whose earnings and savings are eroded by inflation and state confiscation."

The Communist Party leadership is keenly aware of the discontent created by widespread corruption and rising prices. Premier Wen named illegal land seizures, food safety, housing price increases and corruption as evidence that institutional changes are needed to end excessive concentrations of power. And he said combating inflation is China's top economic priority in 2011.

Taking No Chances

That will be easier said than done, however. China's leadership is on the horns of a dilemma: If it continues pumping up rapid growth, it will inevitably feed inflation, while if it raises interest rates and curbs lending to limit inflation, that will restrain overall growth.

In the meantime, China's autocratic government isn't taking any chances with social unrest. Recent crackdowns on Internet activity and foreign journalists are highly visible signs of the central government's resolve to head off any anti-government unrest.

But suppression of the media and dissent will only go so far. China's leadership knows it has to effectively tackle the thorny issues of rising inflation, widening wealth inequality and corruption -- and soon, because the aspirations of its people cannot be returned to where they were in the low-opportunity days of 1978.