China in Transition

China Watching out for the "Middle-Income Trap"

Chi Hung KWAN
Consulting Fellow, RIETI

(Published on the April 28, 2011 edition of the Allatanys Newspaper Guide)

The "middle-income trap" is a concept proposed in the 2007 World Bank's report, "An East Asian Renaissance." According to the report, many developing countries achieve a period of high economic growth, entering a "take-off stage" after emerging from a "poverty trap," only to walk into a "middle-income trap" when their per-capita GDP reaches the middle-income level. This trap takes the form of more sluggish performance and the emergence of strains associated with rapid growth, such as a widening gap between rich and poor and widespread corruption. Brazil and Argentina are typical examples.

China, with per-capita GDP exceeding 4,000 dollars last year, is standing at the point traditionally associated with the middle-income trap. The direction it takes going forward is attracting attention both within China and overseas: will it fall into the trap or it will continue to rapidly catch up with the developed nations.

The public is pessimistic

In China, many newspapers and magazines are featuring stories on the middle-income trap. For instance, the People's Tribune (July 2010) ran a questionnaire on the subject. The survey reveals that experts are optimistic that China will continue to grow steadily, while the public has the more pessimistic view that China is likely to be caught in the middle-income trap, as reflected in some of their responses: "corruption occurs frequently and people are getting more and more angry about it" and that "the gap between the rich and poor is widening, and social mobility is low." They also raise concerns that it is difficult to avoid the middle-income trap for the following reasons: "the authority of the government is withering away due to corruption;" "groups with vested interests are hindering reforms;" and "social security and income distribution are difficult to improve." The middle-income trap was also picked up as one of the themes at the Boao Forum for Asia held in Hainan in April 2011, and participating countries reported their efforts to avoid it.

Major foreign media outlets, including the New York Times in the United States (on October 25, 2010) and The Economist in the United Kingdom (on April 16, 2011) also point to the possibility that China may fall into the middle-income trap.

Advocating a "harmonized society"

While not specifically referring to "middle-income trap," the Chinese government has been working in recent years on the "transformation of growth patterns" and the building of a "harmonized society" to correct strains associated with rapid development and to sustain economic growth.

First, high growth in China has to date been supported by labor so abundant as to be considered inexhaustible. However, as China approaches the stage of full employment in its development process and the aging of its society, sustaining that growth will require a shift from growth based on the expansion of inputs such as labor (extensive growth) to growth based on improvements in productivity (intensive growth). To that end, the government is advancing the "strategic restructuring of the state-owned economy," which effectively permits the privatization of state-owned enterprises and encourages self-motivating innovation and capabilities of companies as well as upgrading the industrial structure.

However, Chinese society is suffering from instability as labor disputes and collective riots occur frequently against a background of a widening income gap, corruption among government officials, and a deteriorating environment. To address these issues, the Hu Jintao Administration has since its inauguration in 2002 been trying to shift development strategies from those focusing on growth exclusively in the past, to those emphasizing equity and the environment. It is doing this under the banner of constructing a "harmonized society." In particular, the government has stressed the eradication of corruption, in addition to five types of harmony, namely (1) harmony between development in urban and rural areas (emphasizing the development of rural areas to improve the lives of farmers), (2) harmony in regional development (supporting less developed areas), (3) harmony between development in the economy and society (increasing employment and enhancing public services such as the social security system, medical services, and education), (4) development where human and nature can harmoniously coexist (emphasizing the conservation of resources and protection of the natural environment), and (5) harmony between domestic development and the opening up to the world (accelerating the development of the domestic market while firmly maintaining a policy of opening up to the world).

Political reform is indispensable

Despite such an excellent policy statement, when it comes to specifics, the envisaged results have not yet been realized. Though there is general agreement on the concepts, working out the details has hit a wall. The reason for this is that when it comes to deciding policies under the current authoritarian system in China, the power elite has a much stronger voice than weaker members of society, such as farmers.

First, the privatization of large state-owned enterprises—which is a key issue for transforming into a growth pattern that is driven by productivity improvements—has been slow. China has started the process with smaller enterprises, and the privatization of large state-owned enterprises, which use their monopoly power to make enormous profits, has stumbled on resistance from vested interests. In particular, following the collapse of Lehman Brothers in September 2008 and the government's announcement of economic stimulus packages totaling four trillion yuan to offset the shock, it has been observed in some sectors, such as infrastructure construction and real estate development, that state-owned enterprises are making ground at the expense of private enterprises, in a reversal of past trends.

In addition, the building of a harmonious society is also facing a rocky road ahead. Although some have suggested that in order to narrow the income gap, farmers should be allowed to own their land, and systems that discriminate against the weak, including the family registration system that restricts the free migration of farmers to cities, should be eliminated, such reforms have yet to be realized. As historian J.E. Acton once said very wisely, "All power tends to corrupt, and absolute power corrupts absolutely," the problem of corruption will not be solved no matter how many eradication campaigns the government launches, unless power is restricted. Also, to solve environmental issues, not only the development of legal systems but oversight of the government, activities by civilian groups and the media, and equitable judgments by the courts are all essential. Yet it is difficult to establish these conditions under the current one-party rule.

Thus political reform is indispensable if China is to transform its growth pattern, create a harmonious society, and avoid the middle-income trap.

The original text in Japanese was posted on May 9, 2011

May 9, 2011