Joseph E. Stiglitz¹

China has long recognized that sustainability means not just environmental sustainability, but political, social, and economic sustainability. Indeed, the International Commission on the Measurement of Economic Performance and Social Progress argued that one of the reasons that GDP was not in general a good measure was that GDP metrics did not include assessments of sustainability: GDP could appear to be both strong and growing, but the growth episode might only be short lived.

Here, I want to focus on one aspect of sustainability: the "social" risks that China faces and what can be done to mitigate them. The Commission recognized too the importance not only of economic and environmental risks, but also of social risks.

There are two (and I will argue related) risks: high levels of inequality, and especially inequality of opportunity, and a lack of trust in established institutions, both in the public and private sectors. Both of these give rise to a sense that the system is unfair, the dice are loaded in favor of some at the expense of others. And while there can be broad societal consequences—including implications for social and political stability—there can even be adverse economic effects. We often don't appreciate the importance of trust in making a modern economy function; but in the absence of trust, one party will cheat another; each party will go to great lengths to insure that it won't or can't be cheated, or that if it is cheated, the damages will be limited. Societies with low levels of trust risk ending up as litigious societies, where valuable societal resources are devoted to dispute resolution, rather than to wealth creation—the only real winners are the lawyers. In recent years, a large body of economic literature has developed focusing on the importance of trust and a sense of fairness in society, and the adverse consequences of a lack of trust for economic performance.

In this brief note, I first discuss inequality, then "trust" before turning to the policies that can help China manage both risks.

Ⅰ. Inequality

One of the great achievements of China during the past third of a century has been the reduction in poverty--the greatest reduction in poverty in such a short span of time ever. All groups in society have benefitted from China's remarkable growth. Yet, some groups have benefitted more than others. There have been marked increases in inequality in China in recent years, in spite of the focus of government in achieving a harmonious society. Today, China's Gini coefficient, a standard measure of inequality, rivals that of the US—which has the highest level of inequality of any of the advanced countries. While many countries have sought to emulate the US in many ways, this is one area in which the lessons to be learned are about what not do.

While Kuznets observed that in early stages of development, there is often a marked increase in inequality, as some parts of the economy take-off before others, in the past half century, many developing countries showed not only that growth in early stages need not be accompanied by greater inequality, but that greater equality could actually help promote inequality.² (This is even more so if we use alternative, and arguably better, measures of economic performance, such as the income of the median household.)

Some have similarly attempted to justify the high level of inequality by asserting that growing inequality is a global phenomenon, an inevitable consequence of broader economic forces that are at play. A careful look at the evidence shows that that is not true. There are countries, both advanced industrial economies and emerging economies, which have bucked the trend; in which inequality is not increasing; there are even some in which it is decreasing. The laws of economics work on both sides of the Atlantic: it is politics and policies which have shaped the laws of economics, in some cases to produce societies with high levels of equality and equality of opportunity and a broad sense of fairness; and in other cases, just the opposite. It is imperative that China, in forging a "market economy with socialist characteristics" ensure that its policies are of the former kind, not the latter.

This is particular important given what might otherwise seem to be two contradictory statements within the resolutions of the 3rd Plenum. It called for "ensuring that the market has a decisive role in allocating resources..."But at the same time, it talked about "guaranteeing and improving the people's livelihood...and stimulating social fairness and justice," guaranteeing that "society is both full of vitality, as well as harmonious and orderly."

Market economies are often associated with high levels of inequality and inequality of opportunity, and in recent decades the problems posed by these inequities have become markedly worse, so much so that while GDP (as conventionally measured) has been going up in most Western countries, large fractions of the population are becoming worse off.³ (We note, however, that there may be long periods for which it is not true that GDP per capita has been going up in developed countries. Today, adjusted for inflation, GDP per capita in France, Greece, Italy, Spain, and UK are all below the level attained before the crisis, more than a half decade ago, in some cases, such as Greece, markedly so. Cutbacks in government programs, combined with reductions in income, are now posing major social risks in some of these countries. There is, in this, an important lesson, already noted: social and economic risks are intertwined.)

If this is the case, doesn't the move towards making the market more decisive necessarily lead to greater social risks? The answer is no, and the Report of the Plenum itself provides the answer to what otherwise might seem a conundrum.

The Report makes note of the critical question of the role of state: "the core issues are dealing with the relationship between the government and the market" Market forces, even when they work well in the manner that they are supposed to, do not necessarily lead to a distribution of income and wealth that is in any way consonant with social harmony; quite the contrary—as I have noted, they often can lead to high levels of inequality and to low levels of equality of opportunity. Those born to the privileged have access to education, health, and employment opportunities that are not available to others. But while they often lead to high levels of inequality, the outcomes are not inevitable. There are different forms of market economies, and these generate markedly different levels of inequality and inequality of opportunity. The Scandinavian model has result in economies that are full of vitality, but at the same time have more equality and equality of opportunity. In terms of the well-being of the typical citizen (say the median, whether measured more narrowly by income, or even more so, when measured more broadly, e.g. by the UNDP's Human Development Index, HDI, which takes into account not only income, but health and education) perform far better than, say, the U.S. The two are linked: the higher levels of opportunity and the better systems of social protection (including stronger safety nets) are part of the reason for these countries' vitality and dynamism.

As China strives to construct a distinctive socialist market economy with Chinese characteristics, it is imperative that it bears in mind the management of the social risks. The wrong rules of the game would increase these risks; the right ones would mitigate them and ensure that the objectives set forth in the 3rd Plenum would be achieved.

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¹ University Professor, Columbia University. Background Paper prepared for the China Development Forum 2014. The author is greatly indebted to Professor Lawrence Lau and Mo Ji for comments on an earlier draft. The views represented are solely that of the author.

² See, for instance, the World Bank report on the East Asia Miracle.

3 We note that even in the so-called best performing European country, Germany, a very large fraction of the population has been facing declining standards of living.

The article was published in China Development Review, No. 2, 2014.

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