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American Interdisciplinary Journal of Business 

and Economics 
ISSN: 2837-1909| Impact Factor : 4.6 

Volume. 9, Number 2; April-June, 2022; 

Published By: Scientific and Academic Development Institute (SADI) 

8933 Willis Ave Los Angeles, California 

https://sadipub.com/Journals/index.php/aijbe 

 

 

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NEW INSIGHTS INTO THE DETERMINANTS OF THE URBAN-RURAL 

INCOME GAP IN CHINA 

 

 

 
1Chen Li and 2Xong Wu 

1School of Economics, Nankai University, China 
2University of Birmingham, UK 

 

Abstract: This article analyzes the determinants of the urban-rural income gap in China by taking the 

endowment structure as a starting point. The paper proposes a theoretical hypothesis and proves it with a 

mathematical model, demonstrating that policy measures can effectively narrow the urban-rural income gap 

by narrowing the urban and rural endowment structure gap. The authors used China's provincial panel data 

from 2006 to 2019 to empirically test the theoretical model. The paper also summarizes previous literature on 

the impact of industrial structure upgrading on the urban-rural income gap and unifies the impact of policy 

factors and economic factors on the upgrading of the endowment structure to provide a general analytical 

framework for studying their relationship. The study concludes that the fluctuation of the endowment structure 

difference in urban and rural areas fundamentally determines the urban-rural income gap. Overall, the article 

highlights the importance of narrowing the urban and rural endowment structure gap through policy measures 

to reduce the urban-rural income gap in China. 

Keywords: China, endowment structure, urban-rural income gap, policy measures, industrial structure 

upgrading, comparative advantage. 

 

Introduction 

China's rapid economic growth has led to a significant urban-rural income gap, which has become a major 

challenge to the sustainability of its development. The impact of urbanization and industrialization on the 

urban-rural income gap has been widely discussed, but the role of the endowment structure in determining the 

gap has not been fully explored. This article aims to analyze the determinants of the urban-rural income gap 

in China by taking the endowment structure as a starting point. 

The paper proposes a theoretical hypothesis and proves it with a mathematical model, demonstrating that 

policy measures can effectively narrow the urban-rural income gap by narrowing the urban and rural 

endowment structure gap. The study also used China's provincial panel data from 2006 to 2019 to empirically 

test the theoretical model. The paper summarizes previous literature on the impact of industrial structure 

upgrading on the urban-rural income gap and unifies the impact of policy factors and economic factors on the 



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upgrading of the endowment structure to provide a general analytical framework for studying their 

relationship. 

Overall, the article highlights the importance of narrowing the urban and rural endowment structure gap 

through policy measures to reduce the urban-rural income gap in China. The study is significant in advancing 

the understanding of the determinants of the urban-rural income gap in China and provides insights for 

policymakers to effectively address this challenge. 

2. Theoretical Hypothesis  

In new structural economics, endowment structure represents the economic resources that an economy can 

use at a certain point, and it is the basis for establishing the industrial structure. At the same time, 

heterogeneous industries have heterogeneous demands for endowment, so the need for different levels of 

industrial structure for endowment structure is different. Only when the demand for endowment structure 

matches its supply, can the optimal industrial structure that maximizes labor productivity be established.  

Justin Yifu Lin (2019) regards the per capita capital stock as the core of the endowment structure, this paper 

also uses it to express the endowment structure. This choice conforms to the reality and theoretical logic of 

the urban sector. For the rural sector, the reason for choosing per capita capital stock are as follows: on the 

one hand, the land endowment can be regarded as exogenous which is difficult to accumulate; on the other 

hand, the rapid economic growth depends fundamentally on the accumulation of capital factor, the latter can 

increase the capital investment to purchase equipment and improve the production efficiency.  

Therefore, this paper chooses per capita capital stock to represent the endowment structure to explain the 

fluctuation of the urban-rural income gap. On this basis, the accumulation of endowment structure refers to 

the increase of per capita capital stock through investment, and the flow of endowment structure refers to the 

flow of capital and labor between urban and rural areas, which causes the change of per capita capital stock.  

First, it is assumed that at an initial time point, there is no accumulation and flow of endowment and policy 

influence. The initial endowment structure of urban and rural sectors determines the initial optimal industrial 

structure and then determines the initial output level of urban and rural sectors, which determines the initial 

urban-rural income gap. Specifically, in the initial state, the rural sector is relatively scarce in capital and rich 

in labor, so the per capita capital stock is relatively low. The urban sector is relatively rich in capital and scarce 

in labor, and the per capita capital stock is relatively high. Therefore, under the theoretical framework of 

optimal industrial structure, the optimal industrial structure in the rural area is labor-intensive, which 

determines the relatively low output level of the rural area. However, the optimal industrial structure of the 

urban sector is capital-intensive, which determines the relatively higher output level of the urban area. Thus, 

the first hypothesis of this paper is obtained:  

Hypothesis 1: The initial difference in the level of endowment structure fundamentally determines the 

difference in per capita output between the urban and rural areas, and thus determines the initial urban-rural 

income gap.  

Second, relax the assumption that there is no endowment accumulation, and consider the change of urban-

rural income gap determined by the difference of initial endowment structure and endowment accumulation. 

According to the Solow model, the growth of per capita capital stock depends on the output level, savings 

rate, and depreciation rate, assuming that there is no difference in depreciation rate between two areas. Among 

them, the output level is fundamentally determined by the initial endowment structure level. The savings rate 

depends on the capital income, and the latter is endogenously and determined by the initial endowment 

structure. Therefore, the savings rate is fundamentally determined by the initial endowment structure level, 

and the higher the latter, the higher the savings rate. Therefore, under the condition that both urban and rural 



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areas conform to the comparative advantage to establish the optimal industrial structure, the capital 

accumulation level of urban sectors is higher. 2. It is assumed that the growth rate of the labor force in the two 

areas is the same. The change in the ratio of capital stock to labor force determines the level of endowment 

accumulation. The endowment structure of the urban area accumulates relatively faster, which aggravates the 

urban-rural output gap and the urban-rural income gap. This leads to the second hypothesis.  

Hypothesis 2: When the urban and rural sectors are separated from each other and conform to their 

comparative advantage to establish industry, the initial endowment structure gap determines that the 

endowment accumulates faster in the urban area, expanding the urban-rural output gap, and ultimately 

expanding the urban-rural income gap.  

Third, relax the assumption that there is no endowment flow. 1. Consider capital flow. Under the condition 

that capital can flow freely between urban and rural areas, the direction of capital flow depends on the 

difference in capital return between the two sectors. The amount of capital flow depends on the level of capital 

accumulation and the flow ratio, which is positively related to the absolute amount of the urban-rural income 

gap. As the capital income level in the urban sector is higher, the capital will flow from rural to urban. The 

income level, savings rate, and flow ratio of the rural sector jointly determine the amount of capital flow from 

rural to urban. 2. Consider labor mobility. When the labor force can flow freely, the urban-rural income gap 

determines that the labor force flows from the countryside to the city. The quantity of labor mobility depends 

on the quantity of rural labor and the proportion of rural labor mobility, which is positively related to the 

urban-rural income gap. Under the influence of economic factors, the capital and labor force will both flow 

from the countryside to the city. Therefore, it is impossible to determine the impact of endowment flow on the 

difference in the upgrading speed of the endowment structure between two areas through qualitative analysis, 

and it is impossible to determine the direction of its impact on the urban-rural output gap and the urban-rural 

income gap. This needs to be further analyzed in combination with policy factors.  

Fourth, relax the assumption that there is no policy impact. 1. The endowment flow is affected not only by 

economic factors, but also by policy factors, and the effect of the latter is often greater than that of the former. 

In China's economic reality, urban-biased policies have existed for a long time since the three major reforms, 

including the registered residence system, the urban-biased welfare system, and fiscal policies. These urban-

biased policies will accelerate the capital flow from rural to urban areas, and limit or promote the labor flow 

according to the need of urban development: labor flow will be restricted when there is too much labor supply 

in cities, and labor flow will be promoted when labor is inefficient in cities. Urban-biased policies and 

economic factors jointly promote the capital flow from rural to the urban areas, while the regulation of the 

labor force fluctuates, it will promote the upgrading of the urban endowment structure in general, which will 

be compounded with the endowment accumulation to expand the urban-rural income gap.  

When the urban-biased policy leads to a large income gap between urban and rural areas, there are sometimes 

rural biased policies, including increasing the purchase price of agricultural products, relaxing the household 

registration system, and increasing government subsidies, which are mixed with economic factors to reduce 

or reverse capital transfer, accelerate the labor flow to cities, and make the output growth of rural area faster 

than that of cities in a certain period time. It can offset the expansion of the urban-rural output gap caused by 

the effect of endowment accumulation to a large extent, thereby narrowing the urban-rural income gap. Based 

on Hypothesis 1 and Hypothesis 2, the core hypothesis of this paper is obtained by adding the effect of 

endowment flow.  

Hypothesis 3: The fluctuation of the difference in the endowment structure, which is jointly determined by the 

difference in the initial endowment structure, the effect of endowment accumulation and endowment flow, 



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fundamentally determines the fluctuation of the output gap between urban and rural sectors, and ultimately 

determines the fluctuation of the urban-rural income gap. This is the core theoretical hypothesis of this paper, 

which is then demonstrated by a mathematical model and empirical test respectively.  

3. Mathematical Model  

3.1 Theoretical Basis: Endowment Structure, Industrial Structure, and Optimal Per Capita Income  

3.1.1 Profit Maximization and Optimal per Capita Income  

Set the production function and per capita output function as:  

Y = F(K, L) = AKαL1−α，y = f(k, l) = Akα                          (1) Assume that the factor density feature is α and 

it is constant, technology progress rate A is exogenous, p is the exogenous price of products, and the profit 

function of per capita output is:  

𝜋�(𝑥�) = 𝑝�𝑦� − 𝑟�𝑥� − 𝑤�                                     (2)  

W is the wage per worker and r and x represent respectively the unit price and quantity of per capita capital. 

Suppose that the per capita income of the previous period is all used for the production activities in the next 

period, that is rx + w = py0. py is the per capita nominal income of the current period, π(x) represents the new 

value created by the unit labor force, and the per capita income of the current period is equal to the per capita 

income of the previous period determined by exogenous factors plus the new value created by personal labor 

of the current period:  

py = π(x) + rx + w                                     (3) The logic of neoclassical economic theory is that a single 

department chooses the input level of factors to pursue the maximization of profits:  

𝑚�𝑎�𝑥�*𝜋�(𝑥�) = 𝑝�𝑦� − 𝑟�𝑥� − 𝑤�+                                    (4)  

                                            (5)  

Under the given exogenous conditions that y0 = rx + w, the maximization of profit in the current period is 

equivalent to the maximization of per capita income in the current period, that is, the optimal per capita income 

is: 𝑚�𝑎�𝑥�*𝑝�𝑦� = 𝜋�(𝑥�) + 𝑟�𝑥� + 𝑤�+                                    (6)  

3.1.2 Optimal Industrial Structure and Optimal per Capita Income  

Relax the assumption that the feature of factor density α is exogenous, and establish the optimal industrial 

structure by selecting the feature of factor density. Let the value creation function of the labor force be:  

                 (7)  

The optimal industrial structure is determined by making the supply and demand of the endowment structure 

equal, that is x = k, to maximize the value created by the labor force, that is, maximize the labor productivity:  

                           (8)  

                           (9) The structure change equation is obtained:  

                                        (10)  

The per capita income function is:  

pf(α(k)) = π(x) + rk + w = pAkα                                (11)  

                                       (12)  

The supply of endowment structure is given as k, and ， because 1 ≥ α ≥ 0, so k ≥ e and the above  

function can be written as:  

                                     (13)  



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Given the level of price p and endowment structure k, the optimal per capita income increases with the increase 

of factor density α. At this time, the maximization of the value created by the labor force is realized at the 

same time as the maximization of the profit, the latter is equivalent to the maximization of the per capita 

income. The structural change equation reveals that the level of the endowment structure determines the 

optimal industrial structure which is the result of labor productivity maximization.  

3.1.3 Endowment Structure Level and Optimal per Capita Income Relax the assumption that k is exogenous:  

                            (14)  

                                          (15)  

Therefore, given the price and technology level, the optimal per capita income is fundamentally determined 

by the level of the endowment structure, and the above reveals the path that the endowment structure 

determines the optimal per capita income.  

3.2 Initial Endowment Structure of Two Sectors, Endowment Accumulation and the Widening of the Urban-

rural Income Gap  

3.2.1 Initial Endowment Structure, Endowment Accumulation and Optimal per Capita Income in the Rural 

Area Suppose that the production function of the rural sector and per capita production function is:  

Yr = Fr(K, L) = ArK
αL1−α,  yr = fr(k, l) = Arkr

α                   (16) The initial endowment structure supply of the 

rural sector is kr, and the optimal production structure to maximize the value of rural labor is . 

Therefore, the initial optimal per capita income in the rural sector is:  

                                    (17)  

The price level and technical level are exogenous.  

Relax the assumption that there is no endowment accumulation, consider the accumulation effect based on the 

initial endowment structure, and consider the impact of the endowment accumulation on the optimal per capita 

income growth.  

First, consider the change in the capital stock in the rural sector:  

∆Kr = srF
r(α(k)) − δrKr                                  (18)  

sr represents the savings rate of the rural sector, Fr(α(k)) represents the total output of the rural sector, δrKr 

represents the capital depreciation and assumes that the depreciation rate is exogenous. The steady state of 

capital, consumption, and gold saving rate is available:  

                                           (19)  

                                            (20)  

                      (21)  

                                        (22)  

Therefore, the level of the savings rate is fundamentally determined by the level of the endowment structure, 

which rises with the accumulation of the endowment structure. Then, consider the change in the labor force 

in the rural sector:  

∆Lr = nrLr                                            (23)  

nr represents the net growth rate of the rural labor force that is exogenous. Thus, the accumulation level of the 

endowment structure can be obtained:  

                            (24)  



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Then we can get the growth rate of the endowment structure:  

                                     (25)  

The growth rate of the endowment structure increases with the increase of the savings rate, while the savings 

rate increases with the accumulation of the endowment. Therefore, given the exogenous depreciation rate and 

the net growth rate of labor, the accumulation level of the endowment is fundamentally determined by the 

level of the initial endowment structure.  

Then consider the upgrading of the industrial structure of the rural sector:  

                                           (26)  

                                        (27)  

                             (28)  

                                    (29)  

μαkr represents the elasticity of α and kr. It can be seen that the upgrading speed of the industrial structure 

depends on the accumulation speed and supply level of the endowment structure.  

Finally, consider the optimal per capita income change in the rural sector. Per capita output growth in the rural 

sector: lnyr = αlnkr                                           (30)  

           (31)  

Therefore, the growth rate of per capita output is equal to the growth rate of the endowment structure. The 

latter is determined by the level of the savings rate, which is fundamentally determined by the supply level of 

the initial endowment structure. Therefore, the optimal per capita output growth rate of the rural sector is 

fundamentally determined by the supply level of its endowment structure.  

The initial optimal per capita income of the rural area is known as:  

                                          (32)  

After considering the accumulation of endowment, the optimal per capita income of the rural sector in the first 

period is:  

                            (33)  

3.2.2 Initial Endowment Structure, Endowment Accumulation, and the Optimal per Capita Income of the 

Urban Sector  

Set the urban sector production function and per capita production function as:  

Yu = Fu(K, L) = AuK
βL1−β，yu = fu(k, l) = Auku

β                     (34) The initial endowment structure supply of 

the urban sector is ku > kr. Thus, the optimal industrial structure of the urban sector can be obtained as:  

                                       (35)  

The initial optimal per capita income of the urban sector is:  

                                     (36)  

The price level and technical level are exogenous. The change in total capital in the urban sector is:  

∆Ku = suF
u(β(k)) − δuKu                                      (37)  

su represents the savings rate of the urban sector, Fu(β(k)) represents the total output of the urban sector, and 

δuKu represents the depreciation of capital, assuming that the depreciation rate is exogenously given. The 

saving rate that maximizes steady-state consumption is:  

                                          (38)  



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Next, consider labor force changes in the urban sector:  

∆Lu = nuLu                                              (39)  

nu represents the net growth rate of the labor force in the urban sector. Thus, the accumulation and growth rate 

of the endowment structure can be obtained:  

                       (40)  

                                 (41)  

Consider the upgrading of the industrial structure of the urban sector:  

                                          (42)  

                                   (43)  

Considering the optimal per capita income growth of the urban sector, the optimal per capita output growth 

rate of the urban sector is:  

                                   (44)  

The initial optimal per capita income of the city is:  

                                       (45)  

After considering the accumulation of endowment, the optimal per capita income of the urban sector in the 

first period is:  

)                          (46)  

3.2.3 The Change in Urban-rural Endowment Structure Difference and the Widening of the Urban-rural 

Income Gap The initial endowment structures of urban and rural sectors are kr and ku respectively.  

The difference in the initial endowment structure is ku − kr. After the accumulation of endowment structure, 

the  

urban-rural endowment structures are ) and  respectively. Since the level of  

the endowment structure determines the level of the saving rate, the gap of the initial endowment structure 

determines the difference in the saving rate and endowment accumulation, which expands the gap of 

endowment structure between the two areas. The gap in endowment structure in the first period is:  

                          (47)  

The widening gap in endowment structure brings about the widening of the urban-rural income gap:  

       (48)  

3.3 The Endowment Flow of the Two Sectors and the Fluctuation of the Urban-rural Income Gap  

3.3.1 The Endowment Flow of the Rural Sector and the Optimal per Capita Income  

The direction of capital flow depends on the urban-rural capital income gap and policy impact. The amount 

of capital flow depends on the savings rate, output level, and capital flow rate. The capital flow rate depends 

on the urban-rural income gap and policy impact.  

First, consider capital flows. The capital gains of urban and rural sectors are:  

                 (49)  

The gap in the endowment structure of urban and rural sectors determines that the level of capital returns of 

urban sectors is higher:  

ru > rr          (50)  



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Therefore, under the influence of economic factors, capital flows from rural to urban areas. This is different 

from the traditional conclusion. According to neoclassical economics, when other factors remain unchanged, 

marginal productivity decreases with the increase of capital investment. Therefore, capital will flow from 

urban areas with low capital prices to rural areas with high capital prices. This analysis only considers the 

supply and demand factor of the endowment structure but neglects the influence of structural factors. In the 

theory of optimal industrial structure, the per capita capital price r depends on the combined effect of the 

supply and demand factors of the endowment structure and the level of industrial structure. The increase in 

capital investment in urban areas will not lead to the decline of the marginal price, on the contrary, its marginal 

contribution will increase, which makes the per capita capital price higher in the urban sector with abundant 

capital. In addition, in the presence of policy impact, urban-biased policies and urban-rural capital income gap 

will compound to accelerate the flow of capital from rural to urban areas. The impact of rural-biased policy 

on capital flow is opposite to the impact of the urban-rural capital income gap, and the former will reverse the 

direction of capital flow, making capital flow from cities to villages. Second, consider the amount of the capital 

flow. The change of rural capital after considering capital flow is:  

∆Kr = srF
r(α(k)) − (φsrF

r(α(k)) − ϵsuF
u(β(k))) − δrKr                   (51)  

φsrF
r(α(k)) represents the capital transferred from the countryside to the city, and ϵsuF

u(β(k)) represents the 

capital transferred from the city to the countryside. srF
r(α(k)) − δrKr represents the capital accumulation effect 

and (φsrF
r(α(k)) − ϵsuF

u(β(k))) represents the net outflow of capital from the rural sector. It reflects the 

compound effect of capital flow and accumulation. Under the influence of purely economic factors, 

(φsrF
r(α(k)) − ϵsuF

u(β(k))) is positive, which means capital flow from rural to urban areas. φ is positively 

related to the level of the urban-rural income gap, and ϵ is negatively related to the amount of the urban-rural 

income gap. Then we consider the influence of policy factors. When the policy is urban-biased, the amount of 

net capital outflow is positively related to the policy strength, φ is positively related to the policy strength, and 

ϵ is negatively related to the policy strength. The urban-rural income gap and policies will compound to 

increase net capital outflows. When the policy is rural-oriented, the net capital outflow quantity is negative, 

and the net capital outflow quantity is negatively correlated with the policy intensity, φ is negatively correlated 

with the policy intensity, and ϵ is positively correlated with the policy intensity. Since China is a socialist 

country, policy factors will play a more important role than economic factors and bring net capital inflow to 

the countryside.  

The direction of labor mobility depends on the urban-rural wage gap and policy impact, the number of labor 

mobility depends on the number of rural laborers and the proportion of migration, and the proportion of 

migration depends on the urban-rural wage gap and policy impact.  

First, consider the direction of labor mobility. Wages of urban and rural departments are respectively:  

                             (52)  

wu > wr                                             (53)  

Therefore, under the influence of economic factors, the direction of labor flow is from the rural areas to urban 

areas. Second, consider the number of rural labor flows. The change in rural labor after considering labor 

mobility is:  

∆Lr = nrLr − ωLr = (nr − ω)Lr                             (54)  

ω indicates the proportion of labor mobility. Under normal circumstances, there is almost no labor flow from 

cities to villages, so it is not considered. The quantity of labor transfer depends on the total amount of labor 

and the mobility ratio, which is positively related to the urban-rural wage gap. When the policy is urban biased, 



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ω may be negatively related to the policy intensity or positively related to the policy intensity, because the 

demand for urban labor will fluctuate in different stages. When the policy is rural biased, it is positively related 

to the policy intensity and accelerates the transfer of the labor force.  

Third, consider the growth of rural endowment structure that joins in the flow of endowment structure. The 

growth formulas of rural capital and labor force are:  

∆Kr = srF
r(α(k)) − δrKr − (φsrF

r(α(k)) − ϵsuF
u(β(k)))                    (55)  

∆Lr = (nr − ω)Lr                                      (56) The modified endowment structure growth formula is obtained:  

         (57)  

 is the difference between the unmodified endowment structure growth formula  

and the modified endowment structure growth formula, which represents the flow effect of the endowment. 

The first item is the decrease of per capita capital caused by capital outflow from rural sectors, the second 

item is the increase of per capita capital caused by the capital inflow, and the third is the increase of per capita 

capital caused by labor outflow. The growth formula of the endowment structure reflects the combined effect 

of the accumulation effect and the flow effect of the endowment. The growth rate of the endowment structure 

is:  

                   (58)  

The optimal per capita income in rural areas is determined by the accumulation effect and mobility effect of 

the endowment:  

              (59)  

The flow effect will fluctuate with policy bias, and the direction of its influence cannot be analyzed in a blanket 

way. When the policy is rural-biased, the outflow effect of the endowment structure is small or even negative. 

Under the compound effect of the endowment accumulation effect and flow effect, the endowment structure 

and the optimal per capita income of rural areas increase rapidly. When the policy is urban-biased, the outflow 

effect of the endowment is positive, which will offset the accumulation effect of endowment in the rural areas, 

hindering the upgrading of rural endowment structure and the growth of optimal per capita income.  

3.3.2 Flow of Urban Sector Endowment and Optimal per Capita Income  

The formulas for the growth of capital and labor in the urban sector with capital flows are:  

∆Ku = suF
u(β(k)) − δuKu + φsrF

r(α(k)) − ϵsuF
u(β(k))                       (60)  

∆Lu = nuLu + ωLr                                              (61)  

The modified endowment structure growth formula of the urban sector is:  

         (62)  

Compared with the unmodified growth formula of urban endowment structure, there are three different items, 

which represent the flow effect of the endowment. The first item is the increase of per capita capital caused 

by rural capital inflow, the second item is the decrease of per capita capital caused by urban capital outflow, 

and the third item is the decrease of per capita capital caused by population inflow. Then we can get the growth 

rate of the endowment structure:  

                     (63)  

The optimal per capita income of the urban sector in the first phase determined by the accumulation effect and 

mobility effect of the endowment is:  



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}              (64)  

Generally, the two effects strengthen each other to promote the growth of the endowment structure and optimal 

per capita income. However, if the policy is rural biased, the flow effect of the endowment will be negative, 

which will offset the accumulation effect of endowment and inhibit the growth of the endowment structure 

and the optimal per capita income.  

3.3.3 The Flow of Endowment and the Fluctuation of the Urban-rural Income Gap  

The gap in the endowment structure in the first phase after joining the endowment flow is:  

     (65) The urban-

rural income gap in the first phase after joining endowment flow is:  

 

                                (66)  

Assuming that the policy is urban-biased, the mobility effect of endowment in urban and rural sectors is 

positive, and both are positively related to the urban-rural income gap and policy strength. The combination 

of the accumulation effect and the mobility effect of endowment further expands the urban-rural output gap. 

When the policy is rural biased, the mobility effect of endowment in the two sectors is negative, which makes 

the endowment structure gap between the two sectors and the urban-rural income gap smaller than when only 

considering the accumulation effect of the endowment. When the effect is large enough, it can make the urban-

rural income gap smaller than the initial income gap. Therefore, the urban-rural income gap fluctuates with 

the fluctuation of the endowment structure gap in different economic development stages.  

Considering the above analysis, this paper verifies the core hypothesis through mathematical models: Without 

considering the price factor, the initial endowment structure gap and the accumulation effect of endowment 

expand the income gap between urban and rural sectors. The combination of economic factors and policy bias 

determines the mobility effect of the endowment. The combination of the accumulation effect and the mobility 

effect of endowment determines the optimal industrial structure of urban and rural sectors, and ultimately 

determines the fluctuation of the urban-rural income gap in different economic development stages.  

4. Regression Model, Variables, and Data  

4.1 Model Settings  

In the mathematical model, Hypothesis 1 and Hypothesis 2 are the basis of Hypothesis 3, and Hypothesis 3 is 

the modeling of economic reality, which is the theoretical core of this paper. The core explanatory variable is 

the per capita capital stock, which represents the level of the endowment structure. The per capita capital stock 

data displayed in the statistical yearbook is the final result of the combined effects of the initial endowment 

structure, the accumulation effect of the endowment structure, and the flow effect of the endowment structure. 

Therefore, it can be directly used as an indicator to measure the level of the endowment structure in the urban 

and rural sectors. According to the theoretical model and hypothesis 3, this paper believes that the per capita 

capital stock will have a positive impact on the urban-rural income gap, which is the conclusion to be 

demonstrated by the empirical test in this part. The following will study the impact of per capita capital stock 

on China's urban-rural income gap based on provincial panel data from 2006 to 2019. The benchmark 

regression model is set as follows:  

GAPit 0 1lnk 4Xit i it                        (67)  



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i represents the province and t represents the year. GAPit represents the urban-rural income gap, lnk represents 

the logarithm of the ratio of urban-rural per capita capital stock, Xit represents control variables, γi is the 

provincial fixed effect, εit is a random perturbation term.  

4.2 Variable Description  

4.2.1 Explained Variable  

This paper chooses Theil index to measure the urban-rural income gap. Theil index refers to the weighted 

average sum of the logarithms of the ratio of income share and population share in urban and rural areas, 

where the weight is the income share in urban and rural areas. Thiel index is more sensitive to the income 

changes of people in both the low-income and high-income groups, which is in line with the changes in the 

urban-rural income gap reflected primarily in the high-income and low-income groups in China. Therefore, 

this paper uses the Thiel index to measure the urban-rural income gap. Its expression is as follows:  

                              (68)  

y1 and y2 respectively represent the proportion of urban and rural income in total income; p1 and p2 

respectively represent the proportion of urban and rural population in total population; x1 and x2 represent the 

per capita income of the urban and rural population; n1 and n2 represent the number of the urban and rural 

population.  

               (69)  

When there is no income gap between urban and rural areas, the income share is equal to the population share, 

and the Theil index is 0, that is, y1=p1, y2=p2.  

                                (70)  

When there exists an income gap between urban and rural areas, the expressions p1, p2, y1 and y2 are 

substituted into Theil index calculation formula to obtain:  

                               (71)  

                                          (72)  

                                (73)  

The greater the urban-rural income gap, the greater the Theil index.  

4.2.2 Explanatory Variable  

This paper selects the logarithm of the ratio of urban and rural per capita capital to measure the difference 

between urban and rural endowment structures. The perpetual inventory method is adopted to measure the 

physical capital stock in urban and rural areas of each province. The calculation formula for the physical 

capital stock is:  

                                          (74)  

Ki2006 represents the capital stock of region i in the base year 2006, Ii2006 represents the fixed asset investment 

of region i in the base year 2006, g and δ represent the investment growth rate and depreciation rate 

respectively. Among them, the data of Ii2006 is taken from the China Statistical Yearbook, and the value of g is 

calculated by the formula:  

                                          (75)  

and the depreciation rate refers to the data used in the literature. Then we can calculate the capital stock of 

each region in 2006. Based on the data in 2006, we can calculate the capital stock for the following years:  



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                              (76)  

Pit refers to the fixed asset price index of year t in region i.  

This paper selects the provincial consumer price index (last year=100) to measure the price change. This is 

because the common price change in urban and rural areas can explain the income gap to a certain extent on 

the one hand, and is conducive to the simplified expression of the equation on the other hand. Therefore, this 

paper selects the consumer price index of each province.  

4.2.3 Control Variables  

First, the degree of opening up, which is measured by the proportion of total imports and exports of each 

province in GDP. Second, the government's support for agriculture, which is measured by the proportion of 

the local government's expenditure on supporting agricultural production in local fiscal expenditure. Third, 

the degree of industrialization, which is measured by the proportion of the added value of the secondary 

industry in GDP. Fourth, the urbanization rate, which is measured by the proportion of the urban population 

in the total population.  

4.3 Data Source  

The data used in this paper are mainly from the China Statistical Yearbook, the China Rural Statistical 

Yearbook, and the database of the National Bureau of Statistics. Among them, Beijing, Shanghai, Tianjin, and 

Chongqing are special samples of municipalities that are not included in this empirical test. At the same time, 

interpolation and extrapolation are used to supplement some missing data. The sample period of selected data 

is 2006-2019.  

5. Empirical Results and Analysis  

5.1 Benchmark Regression  

In the analysis of panel data, it is necessary to test the model setting to determine the empirical analysis form 

of the model. Therefore, mixed effect regression is made at first. Secondly, the fixed effect regression is carried 

out. The P value in F test is 0, indicating that fixed effect regression is better than mixed effect regression. 

Thirdly, the random effects model is tested. The LM test rejected the original hypothesis that there are no 

individual random effects, indicating that the random effect regression is better than the mixed-effect 

regression. At last, the Hausman test indicates that fixed effect regression is better than random effect 

regression, and we choose the fixed-effect model.  

Next, we will examine the impact of the ratio of urban and rural per capita capital on the urban-rural income 

gap. Table 2 shows the results of benchmark regression from 2006 to 2019. It can be found that the goodness 

of fit of the model (3) is more ideal which adds control variables and fixed effects of year and provinces. 

According to model (3), the marginal effect of the endowment structure on the urban-rural income gap is 

0.015, which is significant at the level of 5%, indicating that under the control of other factors, the net effect 

of the endowment structure on the urban-rural income gap is significantly positive, and a 1% increase in the 

endowment structure will lead to a 0.015 increase in the urban-rural income gap. So Hypothesis 3 is verified.  

Table 2. Benchmark regression  

Variables  
(1) Theil index  (2) Theil index  (3) Theil 

index  

lnk  0.019**  0.017***  0.016**  

  (0.009)  (0.004)  (0.007)  

CPI  0.003*  0.002***  0.003***  

  (0.002)  (0.000)  (0.001)  



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trade    -0.033*  -0.062***  

    (0.019)  (0.014)  

gov    0.118  0.238**  

    (0.106)  (0.104)  

industry    0.456***  -0.054  

    (0.086)  (0.088)  

Constant item  -0.213  -0.328***  -0.214  

  (0.172)  (0.054)  (0.145)  

Year fixed effect  Not control  Not control  Control  

Province fixed effect  Not control  Not control  Control  

Observation numbers  378  378  378  

R2  0.784  0.539  0.814  

Note: t values are in parentheses; * ,＊＊, and＊＊＊represent the significance levels of 10%, 5%, and 1%, 

respectively. The below is the same.  

5.2 Robustness Test  

5.2.1 Instrumental Variable  

When the urban-rural income gap expands to a certain extent, the government will increase its support for the 

development of the rural area through rural biased policies, thus increasing the per capita capital stock in the 

rural areas, which may lead to the emergence of reverse causal problems and result in inconsistent estimates. 

For example, during 2004-2012, in response to the three rural issues of "agriculture, rural areas, and farmers", 

the central "No. 1 Document" made strategic arrangements and instructions around increasing farmers' output 

and income, forming a systematic policy framework for strengthening, benefiting and enriching farmers. 

Taking agriculture as an example, the Land Contract Law of the People's Republic of China was implemented 

in 2003, the minimum purchase price policy for rice, wheat, and other agricultural products was introduced in 

2004, the direct subsidy policy for grain planting was implemented in 2004, the fine seed subsidy for livestock 

products was implemented in 2005, the comprehensive subsidy for agricultural materials was implemented in 

2006, and the agricultural tax was completely abolished in 2006. During this period, the urban-rural income 

ratio shrunk from 3.23 in 2004 to 3.10 in 2012. To avoid the endogenous problem caused by the above reverse 

causality, this paper uses two-stage least squares regression to test the relationship between the endowment 

structure and the urban-rural income gap. Since the urban-rural income gap in each year does not affect the 

ratio of urban and rural per capita capital stock in the past and meets the exogenous assumption of instrument 

variables and disturbance terms, this paper uses the ratio of urban and rural per capita capital stock that lags 

behind two periods as the instrumental variable for 2SLS regression and the result is listed in column (4) of 

Table 4. The test of the correlation between instrumental variables and endogenous variables can be identified 

by the following two tests: first, the value of Kleibergen-Paap rk LM statistic is 62.011, and the P value is 

0.0000<0.01, which strongly rejects the original hypothesis, indicating that tool variables are related to 

endogenous variables. Second, the Wald F statistic of the weak instrumental variable test is 541.528, strongly 

rejecting the original hypothesis, indicating that the instrumental variable is not a weak instrumental variable. 

According to the results in column (4) of Table 4, the marginal effect of the endowment structure on the urban-

rural income gap is significantly positive at the level of 1%. At the same time, the regression coefficient of the 

endowment structure that lags behind two periods is greater than the benchmark case, indicating that the lag 



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effect of the endowment structure gap on the income gap may be more important, and hypothesis 3 is still 

valid.  

5.2.2 Indicator Replacement  

This paper conducts a robustness test by replacing the Thiel index with the logarithm of the ratio of the urban-

rural per capita income gap. The results are shown in column (5) of Table 4. It can be seen from the results 

that the marginal effect of the endowment structure on the urban-rural income gap is significantly positive at 

the level of 1%. Hypothesis 3 is still valid.  

5.2.3 Adding Control Variable  

This paper further conducts a robustness test by adding the control variable of urbanization rate, and the results 

are shown in column (6) of Table 3. It can be seen from the results that the marginal effect of the endowment 

structure on the urban-rural income gap is positive, but its significance has decreased, and it is significant at 

the 10% level. Hypothesis 3 is still valid.  

Table 3. Robust test  

Variables  

(4)  

IV(2sls)  

(5)  

Indicator 

replacement  

(6)  

Adding control 

variable  

lnk  0.031***  0.040***  0.014*  

  (0.005)  (0.011)  (0.007)  

CPI  0.008***  0.004  0.003**  

  (0.003)  (0.003)  (0.001)  

trade  -0.005  -0.172***  -0.044**  

  (0.012)  (0.027)  (0.019)  

gov  0.292***  0.645***  0.232**  

  (0.088)  (0.145)  (0.102)  

industry  0.043  -0.382***  -0.084  

  (0.033)  (0.092)  (0.080)  

urban  

  

  

  

  

  

-0.149  

(0.090)  

Constant items  -0.890***  0.707**  -0.077  

  (0.309)  (0.340)  (0.118)  

Year fixed effect  Control  Control  Control  

Province fixed effect  
Control  Control  Control  

Observation numbers  
324  378  378  

R2  0.530  0.882  0.819  

5.3 Heterogeneity Test  

This paper examines the impact of the endowment structure gap on the urban-rural income gap in provinces 

with different government support for agriculture. We calculate the average of government support to 

agriculture in each province from 2006 to 2019, and take the average of government support to agriculture in 

the national sample from 2006 to 2019 as the dividing line, then divide the sample into two groups and conduct 

regression respectively. According to the results in Table 4, on the one hand, the impact of the endowment 

structure gap on the urban-rural income gap is significant at 5% and 10% levels respectively. On the other 



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hand, in regions with less government support for agriculture, the regression coefficient of the endowment 

structure is higher and the impact is more significant, which indicates that the income gap effect caused by the 

endowment structure change due to policies is higher in these areas.  

Table 4. Heterogeneity test  

Variables  

(7)  

Areas with less support for 

agriculture  

(8)  

Areas with great support 

for agriculture  

lnk  0.022**  0.013**  

  (0.008)  (0.006)  

CPI  0.003*  0.005**  

  (0.001)  (0.002)  

trade  -0.036***  -0.164***  

  (0.007)  (0.041)  

gov  0.015  0.354***  

  (0.073)  (0.086)  

industry  -0.133  0.004  

  (0.121)  (0.054)  

Constant item  -0.164  -0.349*  

  (0.131)  (0.211)  

Year fixed effect  Control  Control  

Province fixed effect  Control  Control  

Observation numbers  196  182  

R  0.919  0.778  

6. Conclusion  

Based on the basic principle of new structural economics, this paper conducts mathematical and empirical 

analysis of the fundamental determinants and transmission paths of urban-rural income gap fluctuations.  

First of all, through theoretical analysis and mathematical model, this paper draws the following conclusions: 

the initial endowment structure determines the accumulation effect of endowment, the mobility effect of the 

endowment depends on the combined impact of economic factors and policy bias, the effect of accumulation 

and mobility of endowment jointly determine the change of the endowment structure, the latter determines the 

upgrading of the optimal industrial structure, and ultimately determines the per capita income level, Therefore, 

the fluctuation of the endowment structure gap in two sectors determines the fluctuation of output growth rate, 

and ultimately determines the fluctuation of the urban-rural income gap. As a result, this paper answers the 

question raised earlier: policy factors and industrial structure are upgrading at different economic development 

stages in China. The fundamental focus of the policy factor is to determine the flow of endowment, which 

together with the accumulation of endowment determines the upgrading of the industrial structure. The 

establishment of the optimal industrial structure ensures the improvement of production efficiency and affects 

the urban-rural income gap by affecting per capita output growth.  

Secondly, this paper uses the provincial panel data of China from 2006 to 2019 to empirically test the 

relationship between the endowment structure and the urban-rural income gap. The study found that the 

fluctuation of the endowment structure will determine the fluctuation of the urban-rural income gap. It can be 



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seen from the research that the urban-rural income gap in China is not an overnight result, nor is it Kuznets's 

"inverted U" model, but the result of economic factors and policy adjustments in different periods, which is a 

constantly fluctuating process. Economic development itself is not the reason for the widening of the urban-

rural income gap. It cannot be expected that the urban-rural income gap will automatically close with 

economic development like a set procedure. It depends on the industrial structure level of the urban and rural 

sectors and fundamentally depends on the difference in the endowment structure of the urban and rural sectors. 

To effectively promote the upgrading of industrial structure and narrow the urban-rural income gap, we must 

give full play to the role of policies, and promote the upgrading of rural endowment structure by influencing 

the flow and accumulation of endowment.  

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