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Income inequality in China has risen rapidly in the past decades across regions, between rural and urban sectors, and within provinces. The dynamics of divergence across these sub-national areas have taken the form of a "race to the top" - meaning that all segments of the population, including the poor with low education in lagging inland rural areas, have experienced gains in average income. The largest gains have been registered by those with higher income and education in leading coastal urban areas. Using the China Economic, Population, Nutrition and Health Survey data of 1989 and 2004, the most important factors explaining overall inequality are differential returns to schooling and sector of employment. A decomposition analysis based on household income determination shows that the increase in returns to education explains two-thirds of income changes in urban areas and one-sixth in rural areas. The widening income gaps are the consequence of higher growth in leading urban and coastal areas and that the skilled population has benefited more from the economic reforms carried out during the last 25 years. It could also be argued that rising income inequality can be part of a normal process of development at a certain stage, and that the dynamics of spatial income divergence in the form of "a race to the top" can be desirable to some extent as it unleashes competitive pressure and creates incentives for investment in skills. Continuing to improve market efficiency and investing in people, in particular improving education service in lagging areas to poor people, are important for sustainable growth and equitable distribution in the long run.12
2. In the case of China, the issue of economic inequality and the consequent social ill effects, is far more serious than that in India because of faster economic growth, as revealed by comparative inequality indicators. Despite the fact that an estimated 270 million people have been lifted above the poverty line in China, there is growing evidence that poverty is still a serious problem, which is getting accentuated by a steady rise in inequality. China's income distribution is now analogous to the socially and economically corrosive divides in Latin America setting China apart from its prosperous East Asian neighbours and to a somewhat lesser extent, India. 
Changes in Inequality in China
3. 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 advantages implied by economic geography, contribute to reshaping the regional aspects of geo economic development 
The coastal-inland development gap and the rural-urban divide are the two major components of overall inequality in China. Urban to rural household per capita income ratio and coastal to inland GDP per capita ratio both increased by almost 50 percent from 2.2 times and 1.7 times in the late 1980s to 3.2 times and 2.4 times respectively in 2004. The Gini-coefficient, a measure widely accepted as a proxy for income inequality also increased by about 50 percent, from around 30 to 45 over the past 25 years. Changes in the Gini coefficient are closely associated with changes in the urban-to-rural income ratio and the coastal-to-inland per capita GDP ratio. The evolution of reform focus and the policy inclination over coastal/inland region and rural/urban sectors play an important role in income distribution changes. The sharp increase in urban inequality is a main component of the increase in overall inequality.
4. Inequality in rural China remained slightly higher than in urban China. However, inequality in urban China has increased so rapidly in recent years that it may surpass that of rural China sometime in the future. 
5. Prior to the reforms in China, income was relatively equal. Despite the fact that incomes were low, there was no evidence of serious unequal distribution of income. A Gini-coefficient of 32.5 shows, that Indian growth has been more inclusive in nature. The regional imbalances in China are further highlighted by the fact that the ratio of incomes of the richest to poorest province stood at 11 in 2002 as compared to eight (8) in India. 
Wealth Disparity in China
6. Inequality in China rose as the benefits of economic liberalisation materialised. Regional inequalities increased dramatically, creating major new divisions across geographic space. Certain sectors, notably those that were apparently able to exploit newfound market power, gained in relative position. Of these, finance, utilities and transportation were the most important.
7. An analysis of the available data for 16 major economic sectors for 30 provinces in China taken from the annually published Statistical Yearbook for the period 1979 to 2000, using the Theil's T statistic, is helpful in assessing the spatial distribution of the gains of economic reforms.  The Theil's statistic is a very simple measure of inequality, relying only on two bits of information about each cell, its weight in total population (or employment), and the ratio of average income within the cell to average income in the country as a whole. Theil's T makes it possible to arrive at cross-sector and cross-province measures of inequality, contribution to overall inequality of each cell, sector or province, and to gauge the change in that contribution from year to year. In particular, it provides a very convenient way to visualize the winners and losers in the process of economic change.
8. The Chinese transition to a "socialist market economy" began with the liquidation of the Great Proletarian Cultural Revolution in 1979 and the re-institution of the Household Responsibility System for Chinese agriculture. There followed a period of rapid agricultural productivity growth, with consequent surplus population, which became absorbed in light industry (township and village enterprises). In the early 1980s, special economic zones began the process of opening China's coastal cities to foreign investment and to inward capital flow, a process, which also facilitated technology transfer to Chinese industry. Chinese growth was fuelled by rising agricultural productivity in the first phase of reforms, and then by the development of light industry under the rubric of township and village enterprises, as well as heavy investment in housing and urban infrastructure. The effects are apparent everywhere, though less so in the heavy-industrial Northeast (Manchuria) than in the export-oriented South. Growth was financed largely by internal savings, which amounted to over 35 percent of income in the middle 1990s, and it was also facilitated by a vast expansion of China's external trade, known as the open-door policy, culminating in China's admission to the WTO. The tremendous success of the Chinese reforms in the 1980s led to large increases in living standards throughout the country, and a very substantial reduction of absolute poverty. Food deprivation virtually disappeared. However, economic slowdown at the end of the decade produced inflation, particularly in food prices, which contributed to the discontent of urban populations. This factor played a role in building popular support for the political movement for democracy of 1989, which culminated in the bloody battles of June 4 in Beijing. Following that profound political shock, Chinese economic reform continued but along revised lines. The post-Tiananmen government particularly encouraged the municipal authorities of Shanghai, the coastal regions of South China and an extraordinary redevelopment of the capital city. All of the above developments have visible, effects on the outline of income distribution in the People's Republic of China over the 1990s.18 A similar pattern of inequity has been observed in the current decade.
Unequal Distribution and Trends in Changes in Inequality
9. A historical factor that contributed to China's regional income variations is the heavy industry-oriented development strategy pursued vigorously by the government during the pre reform era. In order to accelerate the pace of industrialization, the state extracted massive amount of resources from agriculture mainly through the suppression of agricultural prices and restrictions on labor mobility. Despite some effort to move industry towards the less developed interior regions and the rural industrialization drive during the Great Leap Forward, the development strategy resulted in a large rural-urban income gap. The main mechanisms of enforcing the strategy were a trinity of institutions that included the unified procurement and sale of agricultural commodities, the people's communes, and the household registration system. Since urbanization varied widely across regions, the high rural-urban disparity translated directly into regional inequality in the central planning era. It follows that when the heavy industry emphasis was gradually abandoned during reforms, the narrowing of the rural-urban income gap, and thus regional inequality, was to be expected. 
10. Indeed, sectoral and regional income differences declined in the initial years of reform, due in large part to the successful rural reforms that quickly raised farmers' earnings. However, the decline was short-lived; it was followed by a steady increase in rural-urban disparity starting in 1985. Urban-biased fiscal and monetary policies were largely responsible for the upswing, replacing the heavy-industry oriented development strategy as the tool of maintaining urban bias. When the cost of living in cities rose due to steady increases in agricultural prices, urban residents reacted by putting political pressure on the government and fighting for a greater share in the fruits of economic reforms. Because the government was concerned with economic and political stability, the state succumbed to pressure by installing income transfer programs in favor of the urban sector. 
11. Over a longer time period, China's regional development strategies since reform may have contributed directly to the widening spatial income variations. As early as 1980, China formally established four special economic zones in the coastal provinces of Guangdong and Fujian, and in 1984, another 14 coastal cities were opened in order to attract foreign direct investment and trade. These special economic zones and coastal open areas acquired considerable autonomy, enjoyed superior tax treatments, and received preferential resource allocations. As part of the Coastal Area Development Strategy, the government gradually extended these special policies to all coastal areas in the late 1980s. Although many cities in the interior regions were eventually opened in 1994, these time lags may have differential effects on attracting investments and generating growth, putting the non coastal provinces at significant disadvantages. Throughout the 1980s and early 1990s, the coastal provinces attracted disproportionately high shares of foreign investments and trade and became the cradle of rural enterprises, which have been the driving force behind China's income growth. During this period, the income levels of interior and coastal regions diverged. As a result, the inland-coastal contribution to overall inequality increased several folds, becoming the largest component in the regional inequality decomposition. Preferential investment and trade policies contributed directly to the differences in provincial growth rates. 
12. An examination of the sectoral distribution of wealth indicates the preeminence of the industrial sector such as power, transportation and utilities along with banking being clearly ahead of the others. Manufacturing, considered one of the pillars of the Chinese economy emerges as a relative loser. Farming and trade have deteriorated even more than before. Mining and construction have been conspicuous by their fall from grace. A* closer assessment of these factors reveals that the integration of the Chinese economy with that of the world has adversely affected the traditionally man power/labour intensive sectors, fuelling the rise in sectoral, social and household income inequality. Statistics depicting the rise in inequality in China between the period of 1987 to 2000 are placed at Appendix Q.
13. Rising regional disparity will eventually cause social and economic instability, leading to a situation in which lagging regions could obstruct the nation's overall economic growth. The increase in urban income inequality in 1989-2004 is largely a result of the differentiated opportunities and remuneration between the skilled and unskilled, as reflected in the rising returns to schooling and the occupations in secondary and tertiary sectors. During the transition from planned to market economy, institutional reforms failed to keep pace. Rent-seeking, unclear property rights in SOEs, and imperfect tax system have benefited some more than the others. Retrenchment from SOEs and collective-owned-enterprises, and reduction in real income of the retired also contributed to widening income gap, especially in urban areas. In rural areas, participation in non-farm activities is among the main factors of income growth. Differentiated returns to education, especially between those with primary middle school education or above and those with less education, is also an important factor that contributes to rural income inequality.
14. Rising inequality is a characteristic feature of transition from a socialist to a capitalist system. However, this can lead to far reaching social and political consequences in the absence of strong agricultural support programs and social security systems such as those existing in the United States and Europe, as a particular feature of redistribution is a sharp decline in the relative income of the countryside. The above analysis clearly demonstrates that the labour intensive sectors of the economy are undergoing a slowdown in China. This is leading to an ever-widening schism between a large section of the population that is economically disadvantaged and the relatively smaller privileged segment. This pronounced spatial and sectoral pattern of income inequality sets up political decentralization and also powerful incentives for internal migration, with resulting pressures on housing and social services in the magnet areas. The consequent political and class related upheavals have the capacity to derail even the most emphatic reform and developmental processes. Economic discussions in China in the 1990s concerned the scope and speed of reforms. However, today a more fundamental re-evaluation of the entire reform process is beginning to take place. This has been prompted by the realisation that the widening gap between winners and losers is leading to increasing resentment amongst the marginalised groups, which is now spilling out on the streets. China has seen an unprecedented rise in the number and size of protests, demonstrations and incidents of social unrest.  The Chinese government reported that there were over 87,000 protests (many of which became violent) in 2005 (compared with 53,000 protests in 2003) over such issues as pollution, government corruption, and land seizures. A number of protests in China have stemmed in part from frustrations among many Chinese (especially peasants) that they are not benefiting from China's economic reforms and rapid growth. A 2005 United Nations report stated that the income gap between the urban and rural areas was among the highest in the world and warned that this gap threatens social stability.  The social consequences of widening economic disparity have the potential to significantly curtail the rate of economic growth in China.