February 16, 2013

FORTUNE — Few would disagree that reducing China’s disturbingly high level of income inequality is one of the most difficult but critical challenges facing the nation’s new leadership, headed by Xi Jinping.

Both official figures and scholarly estimates paint a worrisome picture of unprecedented income and wealth disparity that will likely grow worse in the future. Official data on income inequality released recently (the Chinese government has refused to release such official data for years) shows that the core measure of income inequality — the Gini coefficient — peaked in 2008 and has since fallen slightly (to around 0.47 — the higher the number, the wider the income disparity). But this piece of good news has been met with disbelief, if not ridicule, since independent analysis shows no such trend. A more recent survey conducted by a joint Chinese-American research team based on surveys of several thousand households concludes that China’s Gini coefficient is 0.61, considerably higher than the official figure (only South Africa, with a Gini coefficient of 0.63, has a higher level of income inequality than China).

Even if we accept the official data, the news is hardly encouraging. High income inequality usually portends social unrest and long-term poor economic performance. In China’s case, what should make the members of the ruling Chinese Communist Party (CCP) stay awake at night is the combination of the high level of inequality, the rate of its increase, and how these trends fly in the face of the party’s nominally egalitarian ideology.

The steep cost of wealth disparity

Generally speaking, societies with huge income and wealth disparities display more symptoms of social distress and political instability. But societies in which such disparities have risen rapidly in a short period of time fare even worse. China is a prime example. In the late 1970s, the Gini coefficient in China was under 0.30. In the last three decades, it has increased more than 50% (if we use the official data). For a country ruled by a party that pays lip service to communist egalitarianism, rising income inequality poses an existential political threat. It will allow an ambitious political entrepreneur to rally disgruntled segments of society through appeals to populism, as the disgraced former Chongqing party chief Bo Xilai effectively did between 2009 and 2011.

MORE: How China’s lonely bachelors are helping its economy grow

Obviously aware of the threat posed to its long-term survival, the CCP has vowed repeatedly that it would adopt reforms to reduce inequality. Its latest pledge is an official blueprint jointly drawn up by three key ministries — the National Development and Reform Commission, the Ministry of Finance, and the Ministry of Human Resources and Social Security. The State Council, China’s cabinet, has endorsed the document, a small but important first step in China’s complicated policy-making process (only the CCP Central Committee’s decision can give the final word).

The reaction to this document, titled “On Deepening the Reform of the System of Income Distribution,” has been mixed. On the one hand, the mere fact that such a document was released suggests that the issue of income inequality has risen to the top of the new leadership’s policy agenda — certainly a welcome development in itself. The document also reflects clear-headed thinking on addressing inequality income at a more systemic level — by both leveling the playing field (equality of opportunity) and redistributing income through policy (equality of outcome).

Among some of the policy measures mentioned in the document, the most notable ones are those that would reform non-salary income of government officials and executives at state-owned enterprises (at the moment, such income is huge but concealed), monitor the income and investment of officials and their families, and crack down on illegal income through corruption.

On the other hand, the document has been criticized for being too vague. It may have set broad policy guidelines, but it lacks the specific measures to convince a skeptical public that such measures will actually be adopted. To be sure, one may expect China’s new leadership to bolster public confidence by providing more detailed policies later. But given the Chinese government’s sad record of promising much but delivering little in its previous efforts to reduce income inequality, the CCP has to overcome its lack of political credibility on this issue. The most effective measures to address China’s income disparities will unavoidably hurt the interests of China’s elite, so ordinary Chinese people doubt they can “negotiate with a tiger for its skin.”

Will China’s elite go along with change?

Well-designed policies can address some of the principal drivers of income inequality in China, such as the urban-rural divide, the premium on education, technological change, social mobility, and access to business opportunities, government services, and taxation policy. Reforming the household registration system (called Hukou in Chinese) and broadening rural residents’ access to social services would be a start.

However, the most politically challenging reforms would require the ruling elite and their families to surrender lucrative privileges and enormous wealth. In the current hybrid economic system in China, political elites control the allocation and disposal of economic resources and state-owned assets, allowing them to monetize their political power almost effortlessly. Such monetization can take the form of corruption, but in most cases, it takes place within a gray legal zone.

MORE: If you could put China’s problems in a bottle…

For instance, employees and executives in monopolistic state-owned enterprises have much higher real income than their counterparts in the private sector, mainly because they enjoy many hidden subsidies. Government officials are given, as legal perks, apartments for a fraction of their market value. They have lavish entertainment budgets and unrestricted use of official vehicles for personal purposes. They receive high-quality health care for free and enjoy generous retirement pensions.

But such privileges pale in comparison with how these officials and their families can turn their political power into opportunities to amass private wealth. These well-connected individuals can acquire state-controlled assets, such as land, mines, and companies, at prices substantially below market, and then flip them quickly for windfall profits — all in pro forma compliance with official procedures. This form of crony capitalism has produced a new Chinese kleptocracy.

Addressing such inequality would benefit ordinary Chinese citizens, and the privileged and the powerful would have to foot the bill. Achieving such a feat is difficult but possible in democracies as less well-off voters far outnumber plutocrats. In autocratic regimes, however, ruling elites rarely initiative such efforts.

For China, the challenge of reducing income inequality, like other socioeconomic challenges, would require transparency, openness, limits on political power, and popular empowerment. For the CCP, such requirements will quickly endanger its political monopoly. So unless and until the CCP can convince the Chinese people that it values China’s national well-being above its own survival and privileges, nobody should take its promises seriously.

Minxin Pei is the Tom and Margot Pritzker ’72 Professor of Government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States.

You May Like