Decomposing Earnings Growth in China: The Role of Implicit Labor Taxes

Transcription

1 Decomposng Earnngs Growth n Chna: The Role of Implct Labor Taxes John A. Bshop Andrew Grodner Hayong Lu* Department of Economcs East Carolna Unversty June 2007 JEL classfcaton: P2, J3 Keywords: Asa; Chna; Transton Economy; Earnngs Decomposton *Correspondng author: Hayong Lu, Department of Economcs, East Carolna Unversty, Greenvlle, NC 27858, USA; Emal: luh@ecu.edu; Phone: ; Fax:

2 Decomposng Earnngs Growth n Chna: The Role of Implct Labor Taxes Abstract: Chna's economc reforms n the 1990 s caused a dramatc ncrease n earnngs. We hypothesze that a sgnfcant source of the earnngs growth s the reducton n mplct taxes pad by the workers. Usng the fronter model to estmate potental earnngs we fnd that three-ffths of the change n earnngs between 1988 and 1995 can be attrbuted to the reducton n mplct taxes, one-ffth to an ncrease n average level of human captal, and the fnal ffth to exogenous shocks to the overall economy. We fnd dfferental reductons n mplct taxes by age, occupaton, and regon, consstent wth Chna s development polcy of lettng some grow rcher sooner. JEL classfcaton: P2, J3 Keywords: Asa; Chna; Transton Economy; Earnngs Decomposton

3 I. Introducton A major event n any economc transton to a market economy nvolves labor market reforms. A promnent example of labor market reforms s Chna. The Chnese economy experenced very rapd growth between 1988 and nomnal wages trpled and average annual real wage growth was nearly fve percent. It s well-known that the market-orented reform has been an mportant factor n the unprecedented economc growth. We hypothesze that a sgnfcant source of ths earnngs growth s the reducton n mplct taxes pad by workers under a socalst system. Dong and Putterman (2000) characterze pre-reform Chna as smlar to the Sovet Unon under Staln: The Chnese Communst Party s leadershp prorty goal was rapd ndustralzaton. To obtan the resources for captal nvestment that fueled ndustralzaton the monopsonst state [pad] ts workers less than the value of ther margnal product (p.35). Korna (1992, p. 2270) suggests that central management normally seeks to counteract the wage pressure n order to spare the resources ntended for other purposes (nvestment, defense spendng). Ima (2000) concurs wth ths analyss, argung that the government channeled resources from households to the state n leu of an explct personal ncome tax system (p. 525). Hs approach s to treat wage controls as mplct labor ncome taxaton. Hs estmate of the mplct labor tax rate for the perod 1970 to 1978 s 27.9 percent of labor ncome. We vew the reform perod after 1988 as characterzed by a weakenng of the state s monopsony power (see Dong and Putterman, 2002). To fnance captal nvestment, the government ncreasngly turned to foregn nvestment; foregn drect nvestment n Chna ncreased from 6.2 bllon $US n 1988 to bllon n 1993 (Mnstry of Foregn Trade and 1

4 Economc Cooperaton). Thus, the ablty and necessty of rasng funds through mplct taxes on labor has fallen durng the reform perod. We use stochastc fronter analyss to estmate the gap between actual earnngs under a socalst system and those earned after a reducton n mplct taxes. The stochastc fronter method (Agner, Lovell, and Schmdt, 1977; Lovell, 1995) has been employed by labor economsts to study ncomplete worker nformaton (Hofler and Polachek, 1985; Holfler and Murphy, 1992, among others), dscrmnaton (Robnson and Wunnava, 1989; Robnson, 1993), and mmgrant s relatve earnngs performance (Daneshvary et al, 1992; Lang, 2005). We assgn the shortfall between the actual pre-reform earnngs and those potentally earned under reform condtons as Ima s mplct tax. The goal of ths paper s to decompose earnngs growth and dentfy the major factors responsble for the more than ffty percent ncrease n earnngs between 1988 and Our earnngs decomposton assgns about three ffths of the ncrease n earnngs to a reducton n mplct taxes, about one ffth to ncreases n human captal, and about one ffth to exogenous changes. 1 To support our overall fndngs we analyze earnngs growth by provnce and fnd that the reductons n mplct taxes track closely to what we know about regonal growth n Chna. We fnd that younger, better educated, professonal workers experence a dramatc mprovement n economc status over ths tme perod, as ther mplct taxes were rapdly reduced. The fndng of dfferental reductons n mplct taxes by age, occupaton, and regon s consstent wth Chna s well-known development polcy of lettng some grow rcher sooner. 2

5 II. Estmatng Potental Earnngs wth Stochastc Fronter Models Ths paper follows a small, but growng labor economcs lterature that employs the stochastc fronter approach to descrbe the hghest potental earnngs assocated wth a gven human captal stock. Under fully effcent condtons, (.e., n the absence of ncomplete nformaton, dscrmnaton, monopsony, or mplct taxaton) a worker wll have the same potental and actual earnngs. In the ncomplete nformaton examples, fronter analyss s used to estmate the degree of shortfall between the wages workers earn and what they could earn assumng perfect or costless nformaton n the labor market (Hofler and Murphy, 1992, p. 511). In the dscrmnaton examples, fronter analyss s used to fnd the true wage regresson for both males and females. The stochastc fronter approach elmnates the need to assume that the non-dscrmnatory wage s ether the male or female wage (Robnson, 1993, p.45). Lang (2005) argues that mmgrants are neffcent at convertng ther human captal nto earnngs hence ther actual earnngs fall below ther potental earnngs. Genercally, the gap between actual and potental earnngs s known as earnngs neffcency, or alternatvely, the degree to whch an ndvdual captures hs potental earnngs as earnngs effcency. An mportant source of earnngs neffcency n Chna n 1988 s due to mplct taxaton by the Chnese government. Followng Dong and Putterman (2002) and Ima (2000) we note that ths mplct taxaton was dramatcally reduced as part of the economc reforms of the early 1990 s. Thus to dentfy the effectve fronter we use the 1995 data because t represents the outcome of a labor market wth lower mplct taxes, as opposed to 1988 where wages were set by a formula based prmarly on senorty and mplct taxes were a major feature of the centralzed wage-settng scheme. We then predct the potental earnngs for both years from the 3

6 1995 fronter model. Ths allows us to measure the effect of reductons n mplct taxes on earnngs over tme. Clearly, n a socalst labor market there are alternatve sources of earnngs neffcences. Our approach s to measure the change n effcency over tme. We note that our data s before the major restructurng of Chna s state owned ndustres, whch generated alternatve sources of earnngs effcences. It s therefore unlkely that other sources of effcency gans such as ncreased labor moblty sgnfcantly contrbuted to earnngs growth. For a thorough dscusson Chna s labor market reforms and ther tmng, see Meng (2000). The Stochastc Fronter Model The stochastc fronter model s can be wrtten as: ln( w ) = α + βx + γr + v u, (1) where ln( w ) s log earnngs, X s a vector of human captal measures, R s an ndcator for 2 geographcal regons, v ~ N 0, σ ) s normal error, and 0 s earnng neffcency due to the ( v ncomplete nformaton, dscrmnaton, or n our case, mplct taxaton. Whleγ s may capture the dfferences of lvng standards, they also reflect the real earnngs dfferences and dspartes of the degree of mplct taxaton n dfferent geographcal areas. The predcted wage effcency s gven by EFF= E[exp( u ) ln( w ) ( α + βx + γr )]. (2) To estmate earnngs potental we assume that a worker s human captal endowment s measured solely by one s educaton and experence (c.f., Polachek and Xang, 2005). Other factors such as gender, occupaton, ndustry, famly status, or Communst Party membershp status affect earnngs ndrectly by nfluencng how effcently one s able to convert ther human 4 u

7 captal nto earnngs. Ths assumpton suggests that n order to estmate potental earnngs we model (log) earnngs as a functon of experence, experence squared, years of schoolng and a vector of regonal ndcators. As noted above n equatons (1) and (2), the stochastc fronter regresson ntroduces heterogenety n a worker s earnngs equaton by estmatng the degree to whch the employee can capture hs potental earnngs. Fnally, t s necessary to assume a structure for the nonrandom porton of the combned error term n equaton (1). We follow the lterature and mpose an exponental form on the error term as the most robust alternatve. Lke dscrmnaton, worker ncomplete nformaton, and mmgrants dsadvantage, mplct taxaton s observable only as a resdual. Polachek and Robst (1998) address the assumpton that effcency can be measured as a resdual. Usng ndependent nformaton they fnd that stochastc fronter estmates provde a reasonable measure of a worker s ncomplete wage nformaton (p, 231). Ths suggests that changes n earnngs effcences can be a proxy for changes n mplct taxaton. Fnally, we estmate an earnngs equaton wth ncludes effcency usng pooled data. The model s: ln( w ) = α + βx + γr + a1 * I(1995) + a2 * EFF + e, (3) where I(1995) equals 1 of the observaton s from year 1995 and 0 otherwse, EFF s effcency computed n (2) for every ndvdual (usng 1995 fronter model n 1988 data), and e() s the random dsturbance. Equaton (3) allows us to decompose the growth of log earnngs nto the contrbuton of the changes n human captal varables and effcency, gven any exogenous changes that happen between years 1988 and 1995 whch are ndependent of changes n our observed varables. We compute each varable s contrbuton as [(coeffcent*varable)/ Δ(log(w )]100%. 5

8 III. Data and Fndngs Our data source s the Chnese Household Income Projects (urban samples), 1988 and We select workers between 18 years and 59 years wth postve earnngs and labor market experence. We exclude workers whose prmary occupaton s lsted as owner and those workers whose real earnngs are less than one yuan per day. We defne earnngs as the sum of regular wages, floatng wages, all knds of bonuses, subsdes, cash ncome and allowances. 2 Our samples nclude 16,807 observatons for 1988 and 10,747 observatons for The samples contan data from 10 provnces n 1988 and 11 provnces n We note that our data contans very few workers employed by foregn frms and nearly 80 percent of our sample s made up of marred workers. Table 1 presents descrptve statstcs. Earnngs have rsen rapdly from 1847 yuan n 1988 to 2788 yuan n 1995 (n 1988 yuan). Schoolng ncreases from 10.3 years to 11.3 years between 1988 and 1995, prmarly due to an ncrease n the level of compulsory educaton to ten years. As both age and educaton are ncreasng over tme we fnd a slght ncrease n experence. We have nearly equal proporton of males and females n our samples and about one-quarter of workers are Party members. Table 1 also shows that the share of workers employed at State-Owned Enterprses (SOE) and n urban collectves both fell at the expenses of provncally-owned enterprses. In both years nearly all ndvduals n our sample are employed n the publc sector. However, there were some changes n employment patterns; for example, professonal employment rses from 22.9 percent to 35.9 percent. Fnally, the percent of workers wth a chld less than three (3) falls rapdly between 1988 and

9 Regresson Results Our goal s to decompose earnngs growth and dentfy the major factors responsble for the more than ffty percent ncrease n earnngs between 1988 and We frst estmate the fronter model and obtan measurements of effcency. Columns 1 and 2 n table 2 report our regresson results for each year separately. Standard OLS earnngs equaton results for 1988 and 1995 are smlar to those cted n the lterature (see for example, Zhang, et. al, 2005, among others). We observe a sharp ncrease n the educaton coeffcent (0.041 vs ) and a slght decrease n the experence coeffcent. Column 3 n Table 2 presents the fronter regresson results n year 1995 (equaton 1). We note that the rato of the standard errors for the random and neffcency-nduced dsturbances s close to 1 (lambda = 0.78), suggestng that the two error terms nearly equally contrbute to the total varance n earnngs. Comparng the OLS results of column 2 to the fronter results we see that both the schoolng and experence coeffcents are smaller n the fronter model whch dfferentates between actual and potental returns to human captal, whch further valdates the use of the fronter model. The last row of Table 2 presents the predcted earnngs effcences. Usng the 1995 fronter as our benchmark, we fnd that labor market effcency ncreased from to Table 3 presents earnngs effcences for overall sample and selected sub-groups n 1988 and The results show that males, Party members, and workers n State Owned Enterprses (SOE) have hgher earnngs effcences n both tme perods. In contrast, professonals and those wth above average schoolng have smaller earnngs effcences n 1988 and a larger than average earnngs effcences n We nterpret that groups wth relatvely low earnngs 7

10 effcences have relatvely hgh rates of mplct labor taxaton. More experenced (older) workers experenced a relatve declne n ther earnngs effcency; older ndvduals have hgher than average earnngs effcences n 1988 and approxmately average earnngs effcences n Lkewse, we nterpret these fndngs as evdence that older workers receved relatvely smaller reductons n mplct taxes. Overall, our results suggest that: 1) mplct tax polcy s now more favorable to younger, better educated workers, 2) workers employed n State Owned Enterprses enjoyed larger reductons n mplct taxes than workers employed n provncal enterprses or urban collectves, 3) Party members dd not suffer any ll effects due to changes n mplct tax polcy, and 4) whle some groups enjoyed larger reductons n mplct taxes, we fnd that even older, lower educated, non-party, and nonprofessonal workers faced lower mplct tax rates n 1995 than n Decomposton Results Usng a smplfed decomposton method proposed by Oaxaca (1973) we hold the regresson coeffcents constant and only allow the levels of the ndependent varables to vary. Table 4 presents the decomposton results from estmatng equaton (3) whch s based on the pooled data set. By poolng the data we can dentfy a year effect as well as effcency and human captal effects. The frst regresson ncludes the effcency term and the second excludes effcency. The decomposton results clearly show that most, but not all, of the earnngs gans can be contrbuted to an ncrease n labor market effcency,.e., reductons n mplct labor taxes. In fact, we fnd that whle 61.4 percent of the change n earnngs can be attrbuted to reductons n mplct labor taxes, nearly one-ffth (18.4 percent) s due to an ncrease n the average level of 8

11 schoolng. The fnal ffth can be explaned by exogenous changes captured by the year dummy (18.9 percent). If we exclude the effcency term we fnd that the schoolng effect generally remans the same (15.6 percent) whle the year ndcator now contrbutes more than 80 percent of the change n earnngs. 3 Whle the above results show that polcy changes have varyng effects on dfferent workers, we also have reason to beleve that there are regonal dfferences n mplct tax rates. Table 5 provdes average earnngs effcences and ts contrbuton to earnngs growth by provnce. In 1988, earnngs effcency vares by provnce from 62.6 percent to 78.8 percent; however, every provnce experenced an ncrease n earnngs effcency over tme, varyng by provnce from 77.5 percent to 80.5 percent n Consder the coastal, hgh growth, hgh ncome provnces, Guangdong, Bejng, and Jangsu. In each case the average earnngs effcency n these provnces s well below average n 1988; n Guangdong s case nearly 10 percentage ponts below the average and 16 percentage ponts below Gansu Provnce. It appears that hgher ncome provnces faced hgher mplct tax rates n 1988, whch s consstent wth the noton that pre-reform Chna extracted wages from regons wth hgher productvty to fnance the polcy of equalty. Examnng changes n earnngs effcences over tme we fnd that the rch coastal provnces experenced large ncreases n both actual and potental earnngs; of the three provnces only Guangdong has an earnngs effcency below the average for all of Chna n In each of these hgh growth provnces, the share of earnngs growth beng explaned by the changes n earnngs effcency s larger than Chna as a whole. For example, n Guangdong Provnce, the ncrease n earnngs effcency explans nearly three-quarters of the earnngs 9

12 growth. Ths suggests that whle Guangdong stll faced hgher than average mplct tax rates n 1995, t also enjoyed the largest net reducton n mplct tax rates. 4 In contrast, the northeastern provnce, Laonng, a center of heavy ndustry, was more favored n pre-reform Chna than n post-reform Chna. Table 5 shows that Laonng had a relatvely hgh earnngs effcency (relatvely low mplct tax rates) n 1988, and slow growth, whch results n a small (36.5 percent) contrbuton of mplct tax rate reductons to earnngs growth. The poor, central nteror provnce, Anhu, whch also enjoyed a relatvely hgh earnngs effcency (low mplct tax rates) n 1988, experenced slow growth, and the change mplct tax rats contrbutes less than half (43.4 percent) of the total change n earnngs between 1988 and In sum, changes n mplct tax rates (earnngs effcences), and ther contrbutons to the change n total earnngs, track closely to what we know about regonal growth n Chna over ths tme perod (Démurger, 2001; Ca et al., 2002). IV. Concluson The purpose of ths paper s to advance our understandng of the causes and sources of earnngs growth n Chna durng a perod of rapd growth and reform. To accomplsh ths task ths paper connects two dsparate threads n the lterature. The frst thread s the observaton that socalst economes contan a large degree of mplct labor taxaton (Korna, 1992; Imal, 2000; Dong and Putterman, 2000, 2002) n the form of below market wages. The second thread s the use of stochastc fronter analyss (Agner, Lovell, and Schmdt, 1977), orgnally developed for producton analyss, and adapted by labor economsts to measure the hghest potental earnngs assocated wth any gven human captal stock. 10

13 Usng the fronter model to dentfy latent mplct taxes we fnd that a sgnfcant source of earnngs growth n Chna s the closng of the gap between actual and potental earnngs, whch represents a reducton n the mplct tax on labor. We attrbute three-ffths of the change n earnngs between 1988 and 1995 to a reducton n mplct labor taxes, one-ffth to an ncrease n the average level of human captal (schoolng and experence), and the fnal ffth to exogenous shocks to the overall economy. In addton to decomposng the overall earnngs growth n Chna, we also decompose earnngs growth by provnce. The effect of reducng mplct taxes on earnngs growth vares wdely by provnce as well, rangng from a hgh of 73.3 percent (Guangdong) to a low of 36.5 percent (Laonng). Before the reforms (1988) the poorer provnces were generally able to capture a much larger share of ther potental earnngs than the rcher provnces;.e., faced lower rates of mplct taxaton. However, the fast growng, rcher provnces attrbute a larger fracton of ther earnngs growth to a reducton n mplct taxes. Also, younger, better educated, professonal workers experence a dramatc mprovement n economc status over ths tme perod, as ther mplct taxes were rapdly reduced. The fndng of dfferental reductons n mplct taxes by age, occupaton, and regon s consstent wth Chna s well-known development polcy of lettng some grow rcher sooner. Fnally, we note that several prevous studes argue that an ncrease n the returns to educaton s the source of earnngs growth over the years 1988 and 1995 (see Park et al., 2004 and Zhang et al. 2005). Indeed, standard decomposton results ndcate that the major source of change n earnngs s attrbuted to the hgher returns to educaton, but when the effcency s ncluded n the year-specfc earnngs equatons, the effect of schoolng s less pronounced (results not reported). One nterpretaton of the result s that the returns to schoolng n 1988 may 11

14 be underestmated due the hgh mplct taxes on educated workers. However, we acknowledge that ths s an open queston and subject to future research, where one needs to address possble shfts n both supply and demand for labor n Chna, as well as address the ssue of properly dentfyng the components of latent effcency. References: Agner, D., Lovell, C. and Schmdt, P. (1977). Formulaton and estmaton of stochastc fronter producton models, Journal of Econometrcs, 6, pp Bshop, J., Luo, F. and Wang, F. (2005). Economc transton, gender bas, and the dstrbuton of earnngs n Chna, Economcs of Transton, 13, Ca, F., Y., Dewen, and Du, Y. (2002). Regonal dsparty and economc growth n Chna: The mpact of labor market dstortons, Chna Economc Revew, 13, Daneshvary, N., Herzog, Jr., H.W., Hofler, R.A., and Schlottman, A.M. (1992). Job search and mmgrant assmlaton: An earnngs fronter approach, Revew of Economcs and Statstcs, 74, Démurger, S. (2001). Infrastructure Development and Economc Growth: An Explanaton for Regonal Dspartes n Chna? Journal of Comparatve Economcs, 29(1), Dong, X. and Putterman, L. (2002). Chna s state-owned enterprses n the frst reform decade: An analyss of a declnng monopsony, Economcs of Plannng, 35,

15 Dong, X. and Putterman, L. (2000). Pre-reform ndustry and state monopsony n Chna, Journal of Comparatve Economcs, 28(1), Hofler, R.A. and Polachek, S.A. (1985) A new approach for measurng wage gnorance n the labor market, Journal of Economcs and Busness, 37, Hofler, R.A. and Murphy, K.J. (1992) Underpad and Overworked: Measurng the Effect of Imperfect Informaton on Wages, Economc Inqury, 30(3), Hussan, A. and J. Zhuang (1994) Impact of reform on wage and employment determnaton n Chnese state enterprses, , Workng Paper, London School of Economcs. Ima, H. (2000) The Labor Income Tax Equvalent of Prce Scssors n Prereform Chna, Journal of Comparatve Economcs, 28(3), Khan, A. and Rskn, C. (2001) Inequalty and Poverty n Chna n the Age of Globalzaton, Oxford: Oxford Unversty Press. Kdd, M. P. and Meng X. (2001). The Chnese state enterprse sector: Labour market reform and the mpact on male-female wage structure, Asan Economc Journal, 15, pp Korna, J. (1992) The Socalst System: The Poltcal Economy of Communsm. New Jersey: Prnceton Unversty Press. Lang, Günter. (2005). The dfference between wages and wage potentals: Earnngs dsadvantages of mmgrants n Germany, Journal of Economc Inequalty, 3, Lovell, C.A. K. (1995) Econometrc effcency analyss: A polcy-orented revew, European Journal of Operatonal Research, 80, Meng, X. (2000). Labour Market Reform n Chna, Cambrdge: Cambrdge Unversty Press. Mnstry of Educaton (2000). Educatonal statstcs yearbook of Chna Bejng, Chna: People s Educaton Press. 13

16 Mnstry of Foregn Trade & Economc Cooperaton (1997), Zhongguo Duwa Jngj Maoy Nanjan. Oaxaca, R. (1973). Male-female wage dfferentals n urban labor markets, Internatonal Economc Revew, 14(3), pp Polachek, S.A. and Robst, J. (1998). Employee labor market nformaton: Comparng drect measures of workers knowledge to stochastc fronter estmates, Labour Economcs, 5, Polachek, S. and Xang, J (2005). The effects of ncomplete employee wage nformaton: a cross country analyss, Luxembourg Income Study workng paper no.415. Robnson, M.D. (1993). Measurng dscrmnaton aganst females: Is the 'non-dscrmnaton' wage the male or the female wage? Amercan Economst, 37(1), Robnson, M. D. and Wunnava, P. V. (1989). Measurng drect dscrmnaton n labor markets usng a fronter approach: evdence from CPS female earnngs data, Southern Economc Journal, 56(2), Natonal Bureau of Statstcs of Chna, (1998). Chna Statstcal Yearbook 1998, Chna Statstcs Press. Park, Albert, Xaoqng Song, Junsen Zhang, and Yaohu Zhao (2004) Rsng Returns to Skll, Labor Market Transton, and the Growth of Wage Inequalty n Chna, workng paper. World Bank, (1999). World Development Report, Washngton, DC Zhang, J, Zhao, Y., Park, A. and Song, X. (2005). Economc returns to schoolng n urban Chna, 1988 to 2001, Journal of Comparatve Economcs, 33,

17 Table 1. Descrptve Statstcs mean std.dev. mean std.dev. Experence (years) Schoolng (years) Male (%) Party membershp (%) Chld < Male wth chld < 3 (%) Female wth chld < 3 (%) Age (works n) state-owned enterprse SOE, (%) (works n) provncally owned (%) (works n) urban collectve (%) (works n) other employment (%) Professonal worker (%) Offce worker (%) Earnngs, 1988 Yuan Sample Sze (N)

18 Table 2. Human captal regresson results. (dependent varable: log earnngs) OLS Fronter Experence (.0009)*** (.0017)*** (.0016)*** Experence² (.00002)*** (.00004)*** (.00004)*** Schoolng (.0010)*** (.0018)*** (.0018)*** Provnce ndcators yes yes yes R²/LL N Lambda (0.10) Mean Predcted Effcency (.0008) (.0010) -- Notes: Standard errors n parenthess; *** ndcate that the estmated coeffcents are statstcally sgnfcant at the 1% level. Mean predcted effcency s computed usng parameters of the fronter model (thrd column) estmated on 1995 data. 16

19 Table 3 Predcted Share of Potental Earnngs Overall (.0008) (.0011) Male (.0011) (.0013) Female (.0013) (.0017) Party member (.0014) (.0015) State-Owned Enterprse (.0013) (.0016) Professonal (.0019) (.0017) Greater than mean schoolng (.0012) (.0014) Greater than mean experence (.0011) (.0014) Note: Standard devatons are n parentheses. 17

20 Table 4. Decomposton of the ncrease n log earnngs between 1988 and (dependent varable: log earnngs) Wth Wthout Contrbuton Effcency Effcency Contrbuton Experence % % (.0003)*** (.0008)*** Experence² % % (.0000)*** (.00002)*** Schoolng % % (.0003)*** (.0009)*** Effcency % (predcted) (.0072)*** Year 1995 dummy % % (.0017)*** (.0049)*** Provnce ndcators yes -- Yes -- R² N Notes: standard errors n parenthess; *** ndcate that the estmated coeffcents are statstcally sgnfcant at the 1% level. 18

21 Table 5 Retaned Share of Earnngs and Its Contrbuton of Earnngs Growth, By Provnce Sample mean log earnngs Mean retaned share of Contrbuton of change n potental earnngs retaned share of Year 1988 Year 1995 Change Year 1988 Year 1995 potental earnngs Bejng % Laonng % Henan % Jangsu % Anhu % Hube % Guangdong % Shanx % Gansu % Yunnan % Chna % 19

22 1 Other sources of earnngs growth nclude rasng the compulsory educaton to ten years and a more outward lookng economc polcy. Destroyed by the Cultural Revoluton, Chna has wtnessed a remarkable expanson of hgher educaton nsttutons from 598 n 1978 to 1,984 n 1998 (Mnstry of Educaton, 2000). Chna also became more outward lookng durng ths tme perod, wth exports as a fracton of GDP growng from 14 percent n 1988 to 20 percent n 1997 (World Development Report, 1999). 2 Bshop, Luo and Wang (2005) provde detaled descrptons of the CHIP data and of the components of earnngs defnton. For example, they show that whle subsdes fell between 1988 and 1995 they were nearly offset by an ncrease n bonuses. 3 We also performed the decomposton wth a more complete set of controls n the pooled data. These nclude presence of a chld, sector, occupaton, Party status and gender. These addtonal varables dd not change the contrbutons of effcency, schoolng, or experence so for economy we dd not nclude them n Table 4. 4 Guangdong s relatvely low earnngs effcences provdes some evdence aganst labor moblty beng the major source of change n earnngs effcency as ths provnce attracted the greatest amount of labor from other parts of Chna. 20