Increasing Returns to Education, Changing Labor Force Structure, and the Rise of Earnings Inequality in Urban China, 1996-2010

Xiang Zhou, University of Michigan

Earnings inequality in urban China has experienced a rapid growth over the past two decades. Meanwhile, the composition of the urban labor force has been dramatically altered by three large-scale structural changes: (1) college expansion, (2) state sector shrinkage, and (3) rural-to-urban migration. In this article, I discuss how the recent upswing in earning inequality can be shaped by these institutional and demographic shifts. To adjudicate between competing explanations for the rise in inequality, I capitalize on variance function regressions to decompose and simulate the change in earnings inequality between 1996 and 2010. Results suggest that nearly half of the growth in earnings inequality during this period can be explained by increases in returns to education, while the other half is attributable to compositional shifts in the labor force. The composition effects, moreover, stem mainly from the expansion of tertiary education and the decline of state sector employment.