Growing Beyond the Low-Cost Advantage: How the People's Republic of China can Avoid the Middle-Income Trap
The economic success of the People's Republic of China (PRC) over the last three decades has brought with it new challenges. With a per capita gross national income (GNI) of $4,930 in 2011, the PRC has just passed the threshold of upper-middle-income status and it still has a long way to go before becoming a high-income country. But with rising wages and population aging, growth will have to be increasingly driven by productivity improvement through innovation and industrial upgrading - the PRC needs to move from a lowcost to a high-value economy. Moreover, rapid growth has exposed several structural problems, in particular, economic imbalances, rising inequality, resource constraints, and environmental degradation. If not addressed, these problems could hinder PRC's efforts in moving toward a high-value economy and increase the risk of getting caught in what is increasingly known as the "middle-income trap."
Low-income countries possess a large pool of surplus labor that limits wage increases when urban industrial and service sectors expand. Firms employ low-level, established technologies that are easily imported and mastered locally, and compete on low cost. Upon reaching middle income, the pool of surplus labor shrinks and wages rise rapidly. Countries must upgrade industry and services through innovation to improve labor productivity - moving from a low-cost to a high-value economy. If they fail to do so, the economy becomes trapped: no longer able to compete with low-income countries but unable to compete with high-income countries.
Moving from a low-cost to a high-value economy requires a critical mass of firms with strong incentives for innovation, as well as the government to create a conducive environment that includes the following key elements:
- macroeconomic, political, and social stability;
- adequate public investment in infrastructure and human capital;
- a well-functioning market system that provides price signals, encourages competition, protects investors, and promotes trade; and
- a well designed industrial policy.
To avoid the middle-income trap, the PRC needs a development strategy that allows it to grow beyond low-cost advantage and move from a low-cost to a high-value economy. This strategy should include the following agenda:
- stepping up innovation and industrial upgrading by strengthening enterprise incentives for innovation, building an environment conducive for innovation, investing in human capital, and moving toward a knowledge-based economy;
- deepening structural reform, in particular reforms of enterprises, labor and land markets, the financial sector, and the fiscal system;
- developing services and scaling up urbanization;
- reducing income inequality to make growth more inclusive;
- maintaining macroeconomic and financial stability;
- promoting green growth to conserve resources and protect the environment; and
- strengthening international and regional economic cooperation.
'This report offers insightful analysis of key development challenges facing the People's Republic of China now and in the years to come and discusses policy options and concrete measures for addressing these challenges. I am sure these will significantly enrich current policy discussions on the issue of how to avoid the middle-income trap in [the People's Republic of] China and inform policy-making.'- Jia Kang, Director, Institute of Fiscal Studies, Ministry of Finance, People's Republic of China
'The middle-income trap is a highly relevant issue for the People's Republic of China. This report is very timely and will greatly contribute to policy discussions in [the People's Republic of] China and elsewhere.'- Justin Yifu Lin, Professor, National School of Development, Peking University; former Chief Economist, World Bank
- Executive Summary
- Key drivers of the PRC's economic performance in recent decades
- The middle-income trap and policy lessons
- Sustaining the PRC's long-term growth: Challenges and risks
- How the PRC can avoid the middle-income trap: Policy options
- The long-term outlook of the PRC economy