Education and Income Inequality in China

This paper studies the dynamic evolution of returns to human and physical capital and their effects on income equality in China. We employ a Markov switching OLG model to capture the dynamic interactions of education policies, financial constraints and income distribution. We find that increasing basic education levels across the country and relaxing financial constraints can reduce the income Gini coefficient. Due to different accumulation mechanisms for human and physical capital, both urban and rural income Gini coefficients display an inverted U-shape. Improving basic education and loosening borrowing constraints in rural areas can effectively speed up arrival of the Kucinici turning point and accelerate rural population migration. We also find these policies to be more effective during periods in which returns to human capital are high; furthermore, high marginal returns to education tend to worsen a country's income Gini coefficient