Will The Dragon Fly out of the ‘Middle Income Trap?’
Akshat Joshi – Student, Kautilya
China is among the world’s fastest-growing economies. Post-1990s, China witnessed unprecedented growth. The two main reasons are foreign investments and increased productivity which led to high exports. As a result, China has done exceptionally well in eradicating poverty. The GDP per capita of China increased from $300 in 1990 to $12,556 in 2021. After its golden decades, the question arises- “Will China become a high-income economy, or will it fall under “The Middle-Income Trap?”
The middle-income trap (MIT) is an economic condition of any nation where the growth tends to flatten out. In fact, as per the world bank report, out of 101 middle-income countries in 1960, approximately 13 became high-income by 2008 based on per capita income level. The countries affected have a common pattern where these countries progress from low-income countries to middle-income countries. Economic reforms, investments, and other monetary and fiscal policies are some instruments to tackle MIT.
This paper will examine three reasons why countries fall into Middle Income Trap and how China might avoid falling into the trap due to various measures being taken by the country.
I. Rising Cost of Labour
China is a labor-intensive market. It relies on its export and manufacturing sectors. The data shows that the labor force in China grew at a much faster pace during the 1990s as compared to the 2000s. This is because labor becomes less cheap as the country’s income increases. As per WHO, “China has one of the fastest growing aging populations in the world. China’s population of people over 60 years old is projected to reach 28% by 2040, due to longer life expectancy and declining fertility rates.” China may face a labor shortage and expensive labor in the next few decades. This might hamper China’s manufacturing sector and exports, resulting in China falling under the middle-income trap. To counter this, China has already started investing in training sectors. These investments are primarily made for Skill development. However, with increased per capita income and people’s long-held perceptions that blue-collar work is inferior and for people with a poor education might be something to be concerned about. The Chinese ministry of education estimates- “by 2025, there will be a shortage of nearly 30 million workers in the manufacturing sector.” A lot of laborers migrate from rural to urban areas. With time, the surplus labor supply from rural to urban areas starts to fade, and countries hit the bottom where the labor supply shrinks, and wages begin to increase. This might result in China losing its competitiveness, which may start decelerating its economic growth.
II. The slowdown in productivity or Labour Efficiency
This is likley to happen if the country does not invest in its human capital. Health and education are the primary reasons for it. Quality of Education is directly proportional to efficiency. Human capital promotes both equity and economic growth. So, does China invest enough in Human Capital? Between 2000 to 2019, China spend 4.5% of its GDP on health. China’s spending on education as per their GDP was 1.9%, which increased to 3.6 in 2020. Government spending in these two sectors is growing, which is good for China’s long-term growth. Countries also fall into the trap because of low productivity and low investments in innovation and technology. According to the 2020 Global Innovation Index, “China is now the 14th most innovative country in the world, a major improvement on its 43rd ranking just ten years ago.” China have done enough innovations and has the latest technology to help it not fall into the middle-income trap.
III. Institutional Failure
The middle-income trap could also be due to institutional failure. These institutions involve governments, bureaucracy, central banks, civil societies, researchers, markets, etc. Sometimes these institutions fail to cope with rapid growth. Institutional stability is the bedrock for development in the country. A lot of times, hindrance provided by bureaucracies or politics decelerates the growth of any economy. China which has a lot of control over its market, relies heavily on the administration to check on its private sector. For China to not fall under the middle-income trap, it must empower its private sector’s economic power and participate in global business. China should bring institutional reforms focusing on economic freedom, financial stability, and intellectual property rights. Policies and mechanisms should protect individuals, private players, and foreign enterprises.
China is a developing country that has got most things right in the past three decades. China should not get into a middle-income trap if they do the following things right-
- Monetary and Fiscal policies that support long-term growth. China should have solid macroeconomic stabilization policies.
- The quality of governance. This includes ease of doing business, freedom to business, alignment with global standards of industry and production, an intelligent legal system, growth-oriented visionary leaders, and control of corruption and red tapism.
- Investing in human capital. Increasing the quality of health and education.
- Continued investment in skill development. Focused investment in technology and innovation to increase productivity and mitigate the risk of an aging population.
- Institutional reforms to encourage equitable growth and to keep a check on corruption.
*The Kautilya School of Public Policy (KSPP) takes no institutional positions. The views and opinions expressed in this article are solely those of the author(s) and do not reflect the views or positions of KSPP.