Rural Investment, Growth and Poverty Reduction – Conference Report #1

Growth, Inequality, and Poverty in Rural China:

The Role of Public Investments

Revised IFPRI Research Report,August Final DraftOctober 2001

Shenggen Fan

Linxiu Zhang

Xiaobo Zhang

Shenggen Fan is sSenior Rresearch Ffellow, and Xiaobo Zhang is Ppostdoctoral Ffellow, respectively, both of at the Environment and Production Technology Division, at the International Food Policy Research Institute, Washington, D.C.; Linxiu Zhang is deputy director of the Center for Chinese Agricultural Policy, Chinese Academy of Sciences, Beijing, China.

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Rural Investment, Growth and Poverty Reduction – Conference Report #1

Contents

List of List of Tables

List of List of Figures

Foreword

Acknowledgements

Summary

1.Introduction

2.Growth, Inequality, and Poverty

Macroeconomic Reforms

Policy Reforms and Agricultural Growth

Rural Nonfarm Sector

Structural Change and the Role of the Rural Sector

Rural Income, Inequality, and Poverty

3.Public Capital and Investment

Research

Irrigation

Education

Infrastructure

4.Conceptual Framework and Model

Previous Studies

Model

Marginal Impact on Growth, Inequality, and Poverty Reduction, and Regional Inequality

5.Data, Estimation, and Results

Data

Model Estimation

Estimation Results

The Effects of Public SpendingInvestment

  1. Conclusions

Major Findings

Priorities of Future Government Investment

Future Research Directions

Implications for the Other Developing Countries

Appendix 1: Major Milestones in Reforming Chinese Agriculture

Appendix 2: Chronology of Poverty Alleviation Policies

Appendix 3: Provincial Data on Rural Public Spending

Bibliography

Tables

  1. GDP and input growth by sector
  2. Development of the rural nonfarm sector
  3. Per capita income and incidence of poverty in rural China
  4. Regional distribution of rural poor
  5. Public spending in rural China,(million 1990 yuan)
  6. Development of irrigation, education, and infrastructure in China
  7. Definition of exogenous and endogenous variables
  8. Estimation of the simultaneous equation system
  9. Social development, productivity, and poverty in rural China among regions
  10. Returns of public investment to production and poverty reduction, 1997
  11. Contributions of input factors to regional inequality
  12. Marginal impact of public investments on regional inequality, 1997

A1.Production and productivity growth, annual growth rate (%), 1979-–97

A2. Agricultural research expenditures, million 1990 yuan

A3. Rural education expenditures, million 1990 yuan

A4. Irrigation and water conversancy investment, million 1990 yuan

A5. Illiteracy rate of rural laborers

A6.Length of roads, km

A 7. Rural telephones, thousand sets

A8. Percentage of irrigated areas in total arable land

A9. Rural electricity consumption, 100 million kw

A10. Percentage of nonfarm employment in total rural employment

A11. Rural poverty incidence

Figures

  1. Growth in agricultural production and productivity
  2. Structural shift of GDP, labor, and capital, 1978-–95
  3. Income, inequality, and poverty change in poverty in rural China
  4. Number of rural poor by province (million), 1996
  5. Percentage of rural poor in total rural population, 1996
  6. Effects of government expenditures on rural poverty

Foreword

Many developing countries increasingly face tighter budgets in the era of macroeconomic reforms. Therefore, it is hard for them to increase investments in rural areas. These investments have played critical roles in the past in meeting national food demand and reducing rural poverty. However, unstable food supply and the existence of large numbers of poor people remain thorny problems that require much government attention in many developing countries. As a result governments are asked to do more with the same or even fewer resources.

In this research report, Shenggen Fan, Linxiu Zhang, and Xiaobo Zhang show that the impact of government spending on agricultural growth, rural poverty, and regional inequality depends on the type of spending. Using provincial-level data for the past several decades, the authors construct an econometric model that tracks down the effects of government spending through different channels. The model has the ability to calculate the marginal returns to expenditures on agricultural R&D, irrigation, education, infrastructure, and anti-poverty programs, and to calculate tradeoffs between growth and reduction in poverty and regional inequality. Findings show that reprioritizing future spending can produce large gains for the poor.

The study found that agricultural research investment had the largest impact on agricultural production growth, which is much needed to meet the increasing food demands of a richer and larger population. Agricultural production growth also benefited the poor economically. To reduce rural poverty and promote rural economic growth, the government should not only increase agriculture-specific investment, such as agricultural R&D, but also gear broader investments, such as those on education and infrastructure, to rural areas. Government expenditure on education had the largest impact on reducing both rural poverty and regional inequality and a significant impact on boosting production. Increased rural nonfarm employment accounted for much of this poverty- and inequality-reduction. Similar to education, the large impact of rural infrastructure on poverty comes mainly from improved nonfarm employment opportunities, in addition to the impact on agricultural growth.

Government has played a prominent role in the past in using irrigation to promote agricultural growth. But today marginal returns to irrigation investment are small for both agricultural growth and poverty reduction.. However, making current irrigation investment more efficient by reforming institutions and policies should receive a higher priority. The low returns of anti-poverty loans imply that the government should better target this spending or improve the efficiency of its use. And in terms of regional priorities, if the government aims to maximize poverty and inequality reduction, then investment should be targeted to the western region (a less-developed area).

This research report on China is another major outcome from IFPRI’s research program on rural public investment. The first publication dealt with India. Similar work is under way in Viet Nam and Thailand, and is planned for Africa.

Per Pinstrup-Andersen

Director General, IFPRI

Acknowledgements

The authors acknowledge pPartial funding provided by from the Australian Centere for International Agricultural Research and the China National Natural Sciences Foundation is acknowledged. The authors We would like to thank Peter Hazell for his encouragement, intellectual stimulation, and thorough review of the manuscript many times during the course of the study. Many colleagues at IFPRI have also provided valuable comments and suggestions,. They includeing Philip Pardey, Mark Rosegrant, John Pender, David Coady, and Hans Lofgren. Scott Rozelle provided a thorough reviewed of the manuscript, in . In particular, he pointeding out several key, but difficult-to-not easily accessible, references, for which the authorswe are grateful. Michael Lipton and Randy Barker challenged us on every number in the report, which has led us to go through our data and estimates again and again. Ann Gloria provided assistedance in formatting and typing of many of the figures and tables used in the report.

Summary

Despite the global slowdown in poverty reduction, China has achieved a world- renownrecordsuccess in eradicating reducing its rural poverty during the past two decades, despite the global slowdown in poverty reduction. Contributing to this success are a series of policy and institutional reforms, promotion of equal access to social services and production assets, and public investments in rural areas. YetHowever, as China’s economy continues to grow, it is becomesing harder to further reduce poverty and inequality further. How can the government can better design its policyies, particularly public investment policy, to promote growth while, , and meantime toat the same time, reduceing poverty and regional inequality, is hotly debated in both academic and policy circles. Thise major purposes of this report are to disentangles the specific roles of specific public investments in promoting growth, and reducingregional inequality and poverty and regional inequality reduction in rural China. It also, and to provides insights forngainful the future priorities for priorities of government investments.

Using provincial -level data for 1970–-97, the report develops a simultaneous equations model to estimate the effects of different types of government expenditure on reduction in poverty and regional inequality, and growth in rural China. The model has the ability not only to ranksthe marginal effects of public investments on growth, inequality, and poverty reduction, but it also to tracks various channels of investment and their effectiveness. The latter is important because it enables the policymakers can to focus on strengthening the weak links in the the poverty -reduction chains.

The results show that government’s spending on production -enhancing investments, such as agricultural R&D, irrigation, rural education, and infrastructure (including roads, electricity, and telecommunications) have all contributed to not only to agricultural production growth, but also to reduction inof rural poverty and regional inequality. But variations in the magnitude of the effects are large among different types of spending, as well as across regions.

Based on the actual investments in 1997, and the parameters estimated from the model, we calculated the marginal returns of various investments to to growth in agricultural and nonfarm production and reduction inof rural poverty and regional inequality. These returns awere calculated for the nation as a whole ands well as for three different economic zones. Since the estimated returns are recent, they can serve as a, and can used directlyas an input into the current policy debate since these estimated returns are for 1997, the last year in which we have the data.

Government expenditure on education hads the largest impact ion reductiongin rural poverty and regional inequality, and a significant impact on production growth. Increased rural nonfarm employment was accountable for much ofLarge part of this poverty- and inequality -reduction effect is realized through improved rural non-farm employment. Government spending on agricultural R&D has substantially improved agricultural production substantially. In fact, this type of expenditure hasd the largest impact on effect on agricultural production growth, which growth. Such growth is still much much needed to meet the increasing food demands of a richer and larger population. Benefits of This growth agricultural production growth alsohas also led to trickled down large benefits for to the rural poor through the trickle-down process. The poverty- reduction effect per unit of additional of agricultural R&D investment rankedsthe second, only next to rural education investment in rural education. Government spending on rural infrastructure (communication, electricity, and roads, electricity, and telecommunications) also hads substantial impact ion reducing rural poverty and inequality reduction as well., owing mainly These reduction effects mainly come from to improved opportunities for non-farm employment and increased rural wages. Investments in irrigation investment has had only a modest impact on growth in agricultural production growth and even lessa smaller impact oon reduction in rural poverty and inequality, even after trickle-down benefits weharve been allowed for. Another striking result finding is the minimal impact of specifically targeted government anti-poverty loans. In fact, the poverty reduction impact of these loans iwas the smallestleastamong of all the types of government spending considered in the study.

Disaggregating the analysis into different regions reveals that, for all types of government spending, returns to investments toin poverty reduction were highest in the Wwestern region are the highest, while returns toin agricultural production growth wein the Central region are the highest in the central region for most types of spending. Furthermore, for all types of government spending, more investments in the Wwestern region lead to the greatestrreductions improvement in regional inequality, while more investments in either coastal or central regions worsened the already existing large regional inequalityies.

These findings resultshave hold important policy implications forn future government investment priorities. In order to reduce rural poverty and promote rural economic growth, the government should not only increase agriculture-specific investment, such as agricultural R&D, but also gear broader investments, in rural areas such as education and rural infrastructure, to rural areas. ForIn irrigation, governmentithas played a large prominent role in promoting agricultural growth in the past. But today marginal returns to investment into both agricultural growth and poverty reduction are small. NThere is no doubt that investment in flood and lodging control is important and should remain aone of the top prioritiesy in government investment portfolios. But,how to makeing the current irrigation investment more efficient by reforming institutions and policies should receive an even a higher priority. The lowest returns off anti-poverty loans impliesy that the government should better target this spending or to improve the efficiency of its use.

In terms of regional priorities, if the government aims to maximize its poverty- and inequality -reduction effects, then the investment should be targeted to the Wwestern region (a less-developed area). However, if the government is to maximize the returns to investment in agricultural production,,then investmentit should be targeted to the Ccentral region.

Suggested fFuture research includes a general--equilibrium approach to analyze the overall impact of public investments on the whole economy, and as well as on urban poverty and inequality. Further, China’s entry into the World Trade Organization (WTO) calls for more research on how public investments can be used to alleviate its possible adverse impacts. The political, economyic, and institutional aspects of public investment in rural areas also need to be better understood to improve efficiency and effectiveness of use of public resources, an issuewhichhas been largely neglected in the past.

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Rural Investment, Growth and Poverty Reduction – Conference Report #1

CHAPTER 1

Introduction

During the past two decades, China is one of the few countries in the developing world that has there has not been much progress made progress in reducing itshe total number of poor during the past two decadesin the developing world except inChina (World Bank 2000)., where thenNumbers of poor in China felldeclinedprecipitously, from 260 million in 1978 to 50 million in 1997 when the official poverty line was used.[1] A reduction in poverty ofn this scale and within such a short time is unprecedented in period has never occurred before in the world history , and hais been considered by many to beas one of the greatest achievements in human development in the twentieth20th century.[2] Contributing to this success are a series of policy and institutional reforms,, promotion of equal access to social services and production assets,, and public investmentss in rural areas.

The literature on Chinese agricultural growth, regional inequality, and rural poverty reduction is extensive. But only a few have attempted to link these topicsm to public investment.[3] We argue that even with the economic reforms that began in the late 1970s it would have been impossible to achieve rapid economic growth and poverty reduction withoutif there had not beengovernment investment for the past several decades of government investment. Prior to the reforms, the effects of government investment were restrainedinhibited by many policy and institutional barriers. The reforms have reduced these barriers, enablingmaking it possible forthese investments to generate tremendous amounts of economic growth and poverty reduction. Similarly, public investment may also have played a large role in reducingthe changes in regional inequality, an issue of increasing concern tof policymakers.

China’s experience provides important lessons for other developing countries. In the general literature on public economics, the rationale behind governmentpublic spending is to spur rationalized for efficiency (or growth) purpose by correcting market failures. Examples of such failures are, such as: externalities; scale economies; failures in related markets like credit, insurance, and labor markets; non-excludability; and incomplete information problems about benefits and costs. But lLess attention has beenis paid to the role of public investment in pursuing equity or poverty alleviation objectives. Many neo-classical economists are in favor of solving poverty problems by using welfare redistribution means, for example, by taxing the rich and transferring income directly to the poor. But few countries, particularly developing countries, have succeeded in solving the poverty problem solely through the means of direct income transfers. Therefore, more and more governments have beenare now convinced that it may be more effective to reduce poverty and inequality may be more effectively reduced by promoting the income -generation capacity of the poor. Effective public spending policy is one of the instruments used to achieve theise development goals.

Considering Because many developing countries are currently undergoing substantial macroeconomic adjustments and facing tight budgets, it is critical to analyze the relative contributions of various expenditures to growth and poverty reduction. , as this will provide important information Valuable insights can thus be gained to for further improveing the allocative efficiency of limited, even declining, public financial resources.

The primary purpose of this study is (1) to develop an analytical framework and apply it to rural China ftor examineing the specific role of differenteach types of government expenditures on growth, regional inequality, and ,poverty reduction regional inequality, and poverty reduction by controlling for other factors such as institutional and policy changes and (2) to apply that framework to rural China.

Using provincial -level data for the lpast several decades, we construct estimate an econometric model that permits calculation of economic returns, the number of poor people raised above the poverty line, and impact on regional inequality for additional units of expenditurespending on different expenditure items. The model enables us to identify the different channels through which government investments impact on growth, inequality, and poverty. For instance, increased government investment in roads and education may reduce rural poverty not only by stimulatingthrough improved agricultural production, but also by creatingthrough improved employment opportunities in the non-farm sector. Understanding these different effects would provides useful policy insights for the government to improve the effectiveness of the government's poverty alleviation strategyies.