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Asia

Beware of the Chinese Dragon: Overcoming the Middle Income Trap

 8 min read / 

China ranks second in terms of GDP, just behind the United States. However, if a recent report by the World Bank is to be believed, China has already surpassed the U.S. if one takes purchasing power into account. It implies that China produces more but is undercounted because of the lower prices. In terms of being perceived as a superpower, some Americans already think China has overtaken the States. China’s future seems promising. Even though its GDP is one of the highest, its per capita earnings puts it in the middle-income group of countries – this means it still has space to grow. There also seems to be a shift in the way the country wants to generate further growth with there now being more focus on innovation.

One problem China has to tackle is to successfully come out of the middle-income trap. In the 1960s, there were around a 100 countries that fell into the middle-income bracket but only thirteen of them transformed into high-income countries by 2008. This phenomenon occurs due to the exposure of structural flaws at later stages of development.

This article will explore what the middle-income trap is exactly and where China stands with respect to overcoming this obstacle.

The Middle-Income Trap

To understand the issues faced by a country trying to enter into the high-income bracket one needs to understand the factors that push it from low to medium income groups first.

In the initial stages of economic development, countries can easily mimic the technologies already being used by developed ones. They mostly focus on industries that have matured since it’s a tried and tested method and provides the initial boost to a country’s growth. Along with foreign technology, there is the existence of cheap and seemingly surplus labour. These two combine and reinforce each other to push an economy into the medium income bracket. Most countries show a very high growth rate at this stage of development due to these reasons.

Technologies can be copied to a limit and cheap labour can never be truly endless. As a country progresses towards a higher income, structural and institutional flaws become too enlarged to ignore. To further copy technologies from abroad the nation needs the support of sound infrastructure and efficient institutions. This is what creates the middle-income trap.

China’s Current Standings

China is fully aware of the position it is in currently. It needs to carefully evaluate its steps and move full steam ahead. To get out of the middle-income trap, countries need to invest more in technology which is something China takes with full seriousness. President Xi Jinping has already talked about his technological ambitions back in 2016 and his dream to push his country to the innovative forefront by 2030. China currently houses the world’s fastest supercomputer and also the largest floating solar power station. Tech firms of Chinese origin such as Alibaba and Tencent now enjoy a valuation close to that of major players such as Facebook. China has also joined the fight to develop autonomous cars by aspiring to launch 30m autonomous cars onto the roads within a decade.

The President thinks the economy is shifting from high-speed to high-quality growth. He wants the nation to focus on exporting new technologies rather than relying on heavy commodities. China has increased its share of high-value exports from 8% to 15% over the past few years. Even though China was the world’s leading exporter of electronics in 2009, around 40% of the inputs used to make these electronics were imported themselves. This reduces the value added by China. However, China is now trying to capture the high-value export shares which is evident in their commodities exported to the U.S. They are producing more capital and technology-intensive goods such as semiconductors, sophisticated industrial equipment and chemicals. China is able to achieve competitive exports despite rising labour costs because it is investing and developing more machine-intensive manufacturing. They constitute about 30% of the global demand for industrial robots.

Issues Faced by China

China’s economy grew to prominence by tapping into their endless reserve of cheap labour to staff their factories. Alas, the endless supply seems to have come to an end. The one-child policy rolled out in the 1960s seems to have had a lasting effect on the population growth. Though this policy was repealed in 2016, the birth rate is still below the level required to maintain the current population. The policy had long-term effects by bringing about cultural shifts. Raising one child is financially gruesome enough for parents to hesitate before having a second child. It has been predicted that the population would reach its peak by 2030. So even though the population is the largest in the world, the share of people who are a part of the workforce is too small. This will lead to a quickly ageing population who would need and demand benefits from the state. The workforce would feel greater pressure to support themselves and the quickly ageing population. China needs to think for a way out of this soon as such an issue can only be resolved by long-term solutions.

Financial reasons aside, another concern parents have about having another child is the pollution problem that China faces. While driving forward their economy by pushing for greater manufacturing they neglected the environmental impact they were creating. In the year 2015, 1.1m people died due to the ill effects of pollution, the most compared to anywhere in the world. The government is finally realising the necessity of clean and green development. It has initiated action against producers who do not adhere to the strict standards on emissions and has set numbers to be achieved in the short term. Focussing on greener development requires a sacrifice in terms of the economic growth achievable but it’s a step the government is willing to and has already prepared to take.

China: The New ‘Japan’?

Japan was on its way to the high-income group of countries when it was hit by such economic stagnation that it didn’t grow for around a decade. This period, often dubbed as “Japan’s lost decade”, saw a very low productivity increase. In the years leading up to the financial stagnation, Japan saw overinvestment in projects and real estate. This led to the creation of bubbles which reached such astounding levels that at one point in time, the Imperial Palace in Tokyo was worth more than the entire state of California. The bubble was so huge that when it finally did burst it took an entire decade for the economy to recover.

There are concerns regarding China headed down the same path. China’s debt to GDP ratio currently stands at around 260%, higher than any other emerging economy and even greater than America. This ratio has increased drastically in recent years and there is always scepticism about investments being made unnecessarily when it occurs so quickly. There has been a lot of money pumped into infrastructure development, both abroad and at home, but the former is still small compared to the latter. There are doubts about whether such heavy investments were actually required. Factories have expanded their production capacities but there doesn’t seem to be a need for such. Even though China was capable of producing 1.1bn tons of steel in 2015, it only produced 70% of this, while half of the steel producers reported a loss. The excessive production of steel leads to prices dropping. There was a time when steel was cheaper than cabbage. China seems to have a problem of driving into overproduction, which proves to be detrimental to its own people and firms.

Optimists are wary of comparing the two countries. They accept the similarities but claim that a simple number is often overlooked when comparing the two. Japan’s productivity fell from 2.4% to just 0.2% during the lost decade. China, on the other hand, still has sufficient room for productivity growth. While Japan lost out on research and development, China seems to be putting in enough investment and infrastructure into it. Furthermore, China is still far from the level Japan had achieved just before the stagnation. China faces resource allocation inefficiencies. so even if innovation is a bit slow they can push for growth by restructuring their resource allocation.

China has a lot going on for itself but it also has its fair share of problems. A major advantage is that the government recognises these issues and is trying to work out a solution. While time will tell how some of these things will be mapped out, China is definitely a country to watch out for in the future as it would either become the next superpower or the country which almost made it.

2 Comments

2 Comments

    WP_Comment Object ( [comment_ID] => 129167 [comment_post_ID] => 141528 [comment_author] => Piyush [comment_author_email] => [email protected] [comment_author_url] => [comment_author_IP] => 162.158.50.32 [comment_date] => 2018-04-12 20:20:36 [comment_date_gmt] => 2018-04-12 19:20:36 [comment_content] => What's your say on awarding President Xi Jinping as President for life who can be treated as rider of the Chinese Dragon? [comment_karma] => 0 [comment_approved] => 1 [comment_agent] => Mozilla/5.0 (Windows NT 10.0; Win64; x64; rv:59.0) Gecko/20100101 Firefox/59.0 [comment_type] => [comment_parent] => 0 [user_id] => 0 [children:protected] => [populated_children:protected] => [post_fields:protected] => Array ( [0] => post_author [1] => post_date [2] => post_date_gmt [3] => post_content [4] => post_title [5] => post_excerpt [6] => post_status [7] => comment_status [8] => ping_status [9] => post_name [10] => to_ping [11] => pinged [12] => post_modified [13] => post_modified_gmt [14] => post_content_filtered [15] => post_parent [16] => guid [17] => menu_order [18] => post_type [19] => post_mime_type [20] => comment_count ) )
  1. Piyush

    April 12, 2018 at 8:20 PM

    What’s your say on awarding President Xi Jinping as President for life who can be treated as rider of the Chinese Dragon?

      WP_Comment Object ( [comment_ID] => 129389 [comment_post_ID] => 141528 [comment_author] => Nikita Kishore [comment_author_email] => [email protected] [comment_author_url] => [comment_author_IP] => 162.158.166.57 [comment_date] => 2018-04-16 18:35:21 [comment_date_gmt] => 2018-04-16 17:35:21 [comment_content] => Xi Jingping maintains that he opposes lifetime ruling himself. He views lifting term conditions necessary to be able to align with the other two important posts that he holds as a member of the ruling party. It is sometimes difficult to implement harsh reforms in a single term period and if this was the only reasons behind passing such an amendment, then it shouldn't be much of an issue given that he does step down once his work is done. Another problem with lifetime ruling is that it tends to be misaligned with other democracies who don't appreciate one man calling all the shots. [comment_karma] => 0 [comment_approved] => 1 [comment_agent] => Mozilla/5.0 (Windows NT 10.0; Win64; x64) AppleWebKit/537.36 (KHTML, like Gecko) Chrome/65.0.3325.181 Safari/537.36 [comment_type] => [comment_parent] => 129167 [user_id] => 5328 [children:protected] => [populated_children:protected] => [post_fields:protected] => Array ( [0] => post_author [1] => post_date [2] => post_date_gmt [3] => post_content [4] => post_title [5] => post_excerpt [6] => post_status [7] => comment_status [8] => ping_status [9] => post_name [10] => to_ping [11] => pinged [12] => post_modified [13] => post_modified_gmt [14] => post_content_filtered [15] => post_parent [16] => guid [17] => menu_order [18] => post_type [19] => post_mime_type [20] => comment_count ) )
    • Nikita Kishore

      April 16, 2018 at 6:35 PM

      Xi Jingping maintains that he opposes lifetime ruling himself. He views lifting term conditions necessary to be able to align with the other two important posts that he holds as a member of the ruling party. It is sometimes difficult to implement harsh reforms in a single term period and if this was the only reasons behind passing such an amendment, then it shouldn’t be much of an issue given that he does step down once his work is done. Another problem with lifetime ruling is that it tends to be misaligned with other democracies who don’t appreciate one man calling all the shots.

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