Watchful eye on the middle-income trap

Policymakers need to bear in mind a number of challenges when drawing up long-term plans for the country's economic and social development

As consumption is determined by income, rising incomes in China mean there is much growth potential for spending on consumption. As people acquire more disposable income, they are willing to spend more on more sophisticated goods and services. At the same time, the growing economy also means more opportunities for foreign companies to expand their businesses, and the enhancing of comprehensive national power, which provides robust support for focusing efforts on important tasks.

Once per capita GDP exceeds $10,000, there will be growing demand for education, healthcare, security and other intangible needs while demand for goods decline. This is something we should bear in mind as we draft long-term development plans to promote evidence-based and orderly national governance.

Having said that, there is also something else that needs to be considered. Many developing countries, such as Argentina, Brazil, Chile, Malaysia, Mexico and Thailand, have found their economies stuck in a rut for years after achieving per capita middle-income status, as a result of their inability to change their mode of development. This is known as the middle-income trap. Based on the World Bank 2015 benchmark, China is now considered an upper-middle income country, and many are concerned that the middle-income trap may be a real possibility for China.

In 2001, per capita income in China exceeded $1,000 for the first time, and it took China another 18 years for per capita income to rise from $1,000 to $10,000. It took Japan 17 years to make the leap, around the same as China, whereas it took the United States and Brazil 36 years each and Russia 41 years. While a simple comparison of numbers means little given the different national circumstances and the time periods, the high speed of China's development is no doubt an accomplishment. However, there are also challenges lurking in the following aspects.

The first is in land and real estate. In the past few decades, local governments in China have profited from selling state-owned land to developers and they have amassed large amounts of construction capital. With the rapid development of cities, the living standards of urban residents have risen, which in turn has driven the transformation and development of rural economies in surrounding areas, attracting rural workers from other parts of China to find better-paid work in the cities. Nowadays, a large part of GDP growth is driven by land-based finance and the real estate sector. When there is no more land to sell, or if the real estate bubble busts, GDP growth will suffer as a result.

The second challenge is in the transformation of economic growth drivers. Economic development during the past four decades since the beginning of reform and opening-up happened largely thanks to concentrating capital and labor in labor-intensive industries that produce low-priced goods. Going forward, if we do not raise productivity through technological innovation, we may see our economic development lose steam, and with it, we may lose the momentum and the ability to overcome challenges at home and abroad.

The third challenge is in product upgrading. According to a study conducted by the Asian Development Bank, the countries that have fallen into the middle-income trap are those whose exports are limited to primary products and labor-intensive products and where little efforts have been made at diversification and sophistication of the above mentioned products.

The fourth risk is in unbalanced development. The Gini coefficient is an indicator of the fairness of wealth distribution in a given country, with 0.4 usually considered the warning level in terms of income gap. In 2017, the Gini coefficient for China was 0.47.Aside from the wealth gap, the gaps between urban and rural areas, between the more developed eastern and less-developed western areas, as well in education and healthcare in China are all risks that may push China into the middle-income trap.

According to estimates by the Research Institute of Global 3E, if the Chinese economy grew at a rate of 6 percent between 2016 and 2020, 5 percent between 2021 and 2030, 3 percent between 2031 and 2050, then its GDP per capita would be $30,600 in 2049 on the 100-year anniversary of People's Republic of China's founding.

But that forecast is based on smooth sailing over the next 30 years. However, the world is going through changes unseen in the last 100 years, on top of which there are uncertainties both at home and abroad, such as the US-China trade conflict and the novel coronavirus outbreak in Hubei province, among others, all of which are putting downward pressure on the economy. This means that we must push for coordinated development in economic, social, environmental sectors in our pursuit of sustainable development.

To do that, the first thing is to improve the efficiency and quality of investment, given the high investment levels China currently has. It is necessary to make the transition from an investment-led growth model to one led by technological progress, and promote the sophistication and diversification of our industrial and export structure.

This calls for skilled workers and highly trained human capital to undertake technological innovation, which means better training and improvements to the education system. It is also necessary to expand the Chinese middle-income group through urbanization. This is because the upgrading of the industrial sector and export depend on growing market recognition and the consumption of high value added-goods and services, which in turn lead to sustainable growth. To keep this positive cycle going, it is essential to continue to increase the middle-income group.

Additionally, due attention must be given to ramp up production and employment to galvanize the domestic market. China should also drive reform efforts that focus on expanding domestic demand to fully capitalize on the economy of scale.

The author is a professor at the College of Policy Science at Ritsumeikan University and the director of the Research Institute of Global 3E in Japan. The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.