With the historic once-in-a-decade 18th Communist Party Congress slated to begin tomorrow, the incoming leadership in Beijing recognizes that one of its most critical tasks is to ensure that internal conflict doesn’t spin out of control and jeopardize the existence of the party itself.

It is not an idle concern. Undeniably, the past 30 years have seen headlong progress in lifting an estimated 400 million people out of poverty and increasing GDP growth fivefold. However, widening income inequality and wealth disparity have become a hotspot of public grievance and domestic tension. It has been famously reported that the country endures as many as 180,000 to 200,000 protests, riots or mass demonstrations a year – averaging about 500 every day, leading to the popularity of the sarcastic yet candid expression “rich nation poor population.”

For eight years, the Communist Party has been stalled by entrenched interests in working on income distribution reform. After three draft revisions, outgoing Premier Wen Jiabao has promised its publication before the year end. The third revision has been completed and approved by top Chinese leadership, according to mainland media reports. It awaits the arrival of Xi Jinping and Li Keqiang to be unveiled in order for them to take celebratory credit for populist policies.

This is a matter of political consideration. As the next president-in-line, the princeling Xi Jingping is sure to do all he can do consolidate Communist Party rule.

In this regard, Xi will tap Li’s broad expertise in economics, social and urbanization. Incoming Premier Li Keqiang, a protégé of outgoing President Hu Jintao and a strong believer in transformation wrought by urbanization, is likely to have played a key role in defining the income distribution reform, as well as setting policies concerning social welfare housing and healthcare reforms.

The document should be regarded as a serious undertaking to expand China’s middle class and drive the long-awaited consumer society that western exporters have been hoping for ever since the country began to open up in the early 1980s. There are obviously roadblocks in the way of the plan. The state-owned enterprises, which have taken the lion’s share of the development dollars so far, reportedly have been resisting, although they have finally acquiesced to its implementation.

Given the broad scope of the reform plan, and the fact that that it can be expected to encounter resistance on the ground, the implementation of the plan will follow China’s proclaimed gradualism doctrine. Beijing has abolished the agriculture tax, twice lifted the deductibles for individual income tax levels in recent years and nearly doubled the threshold for defining poverty. All are designed to strengthen support for grassroots workers.

Furthermore, fiscal revenue growth has been outpacing income growth. This suggests government is also capable of boosting wage increase through fiscal transfer. According to the plan, which has been discussed in mainland newspapers and other forums, the minimum wage is to be pushed steadily higher and low-end manufacturing is expected to be migrated to the rural countryside, reinforcing the government’s so-called Go-West infrastructure build-out. The rising middle class is expected to expand consumption and gradually free China from its reliance on investment and export. The near-term sacrifices that SOEs need to make will be more than compensated by prolonged growth in the broader economy which should deliver the resources to the banks and other large-state red chip stocks to keep them from harm.

To provide some understanding of the foundations of the discontent – in addition to often-unfair policing and arbitrary land acquisitions, the wage contrast from sector to sector is stark. For 2011, jobs at state-owned financial institutions paid an average of RMB91,364 annually while government jobs in the agriculture sector earned as little as RMB20,393. Company ownership structures are an even more dominant factor in determining the take-home pay of the average worker. The average annual wage for privately-run companies is approximately half of those of the state-affiliated enterprises.

Different sectors, very different wage rates

Source: National Bureau of Statistics

The reasons are two-fold. First, party businesses and SOEs have commanded most of the power and dominance of the economic landscape, tracing to the days of the command economy. When the economy took off in the past decade, the SOEs, very much because of their respective monopolistic positions, were able to collect the accompanying growth in profit.

A lack of incentive to maximize shareholder profit, combined with no hard-and-fast rules to distribute dividends – although that is gradually changing – have meant that SOEs paid staff handsomely in both salary and perks. Described as “interest groups” that interfered with the progression of previous drafts of the reform, the SOEs finally gave in after eight years of hard negotiation. They realize that their fortunes are tied to continuing populist support of the party regime.

The income distribution reform is thus expected to have an impact on benefits and wages payable to SOE staff, along with stronger enforcement of anti-corruption practices to improve public opinion.

In April, Wen openly labeled the Chinese banks as too powerful, saying on China National Radio: “Frankly, our banks make profits far too easily. Why? Because a small number of major banks occupy a monopoly position, meaning one can only go to them for loans and capital.” To counter this, Beijing has already given some flexibility to banks in setting their own lending and deposit rates to spur banking sector competition.

Rural incomes trail urban ones

Source: NBS

The second reason for the huge income gaps is that salaries for unskilled workers have been artificially suppressed by rock-bottom minimum wage rates. As illustrated by the chart above, the monthly minimum wage set by cities and provinces stands at the low-to-mid RMB1,000 level.

In today’s China, these salaries simply do not get anyone anywhere. These rates are earned primarily by migrant workers who graze for labor-intensive positions in privately run companies as they have few skills and no resident registration status. More often than not, they must leave their parents and children in the countryside.

Rock-bottom monthly minimum wages for migrant workers

Source: Local government announcements

China doesn’t publish updated data on the degree of wealth gap in its society. We combined a piecemeal Gini coefficient from studies and comments by the World Bank (1981-2005), China’s National Development and Reform Commission (2010), and Beijing Normal University (2007, 2012) to create the chart below. A Gini index above 40 implies that wealth inequality has entered a dangerous state. A 2007 survey by Li Shi at Beijing Normal University found China had risen to 48 at that time. Li thinks it's now close to or at 50.

(Steve Wang is an economist and research director for REORIENT Securities of Hong Kong. swang@reorientgroup.com)