Home is Where the Hukou is? Measuring the Impact of the Hukou System on GDP, Labor and Capital Distribution and Wage Equality across Provinces in China

Abstract

The Hukou System in China has long been viewed as a source of inefficiency and inequality as it restricts labor mobility by assigning individuals to reside and work in either the rural or urban regions in their native province. Traditional research is mostly statistical and focus on the rural and urban divide. In light of the recent policy change in 2014 which eliminated a large part of the differences between rural and urban Hukou, my aim for this paper is to quantify the inter-provincial inefficiency and inequality caused by the Hukou System by building a macro-economic model of the labor market. I begin with a basic Cobb-Douglas Model and assume that differences in wage across regions are caused solely by the Hukou System, which results in the complete immobility of labor across provinces. I then calibrate the model using economic data from 2003 to 2013 before computing the counterfactual equilibrium after a hypothetical removal of the Hukou System. By comparing the counterfactual with the real economy, I determine the efficiency gains and changes in inequality among other trends that result. I then relax some of the initial assumptions and consider three more model variants of increasing complexity, incorporating addition factors that account for differences in labor skills, capital mobility and differences in housing prices. By incorporating factors in a series, I demonstrate the significance of each individual factor, analyze their relative and combined impact on the economy, and create a final coherent model that accounts for all of the above-mentioned factors. In my analysis, I find that differences in housing has a stronger influence on GDP, migration and wage than capital mobility, which in turn has a stronger influence than differences in labor skills. I also discover and quantify additional trends and present their policy implications. Such trends include the widening of income inequality between labor of different skill levels, the strong localization of mass migration into provinces like Shandong, Shanghai and Tianjin and the fact that capital distribution depends strongly on skilled labor distribution but not vice versa. Finally, using the complete model, I perform simulations of different counterfactual equilibria where modifications are made to the Hukou System without its complete removal, and present a strong case for the economic benefits of a partial relaxation of the system which limits the amount of population influx into and outflow from any province.