Part 2: How the Middle Income Trap Could Catch China

When a country cannot move from middle to high income, it might be caught in the middle income trap. The tough part is deciding why…and then getting out.

Where are we going? To deciding whether China has to worry about the middle income trap.

The Middle Income Trap

It is possible that most fast growing middle income economies have to experience a slowdown. After all, the beginning is the easy part. Move from the farm to the factory. Produce textiles or shoes or clothing. Keep wages low and exports cheap.

Then it gets tougher because the next stage requires more innovation, investment and entrepreneurship. It requires what might be an unsustainable investment surge. As a result, Japan went through two growth spurts that were separated by stagnation. Somewhat similarly, Israel, the Netherlands, Estonia, Denmark and South Korea also had middle income slowdowns.

A Possible Role for Inequality

Some economists hypothesize that inequality could keep a country in the middle income trap:

From: “Will Inequality Lead China to the Middle Income Trap?” (UN)

If inequality does contribute to middle income trap problems, then higher Gini Coefficients (below) for China, South Africa and Brazil do not bode well. (The y-axis has the Gini numbers that show more inequality as they rise.)

From: “Will Inequality Lead China to the Middle Income Trap?” (UN)

Our Bottom Line: China

Looking at the middle income trap, the World Bank cities nine areas that will propel or constrain growth:

• trade and technology
• ideas and innovation
• finance and risk
• cities and livability
• cohesion and inequality
• corruption and accountability
• demography and aging
• entrepreneurship and startups
• external commitment and regionalism

Economist and Washington Post columnist Robert Samuelson told us in March 2014 that  China was in the trap. His reasons? China probably cannot sustain a high growth rate. It cannot continue to depend on export-led growth without more consumer spending and a services sector. There are housing bubble problems that will ripple to steel, building materials, banks and other lenders.

Furthermore, UC Berkeley economist Barry Eichengreen and two other scholars suggested in a 2013 paper that China could be constrained by a high old age dependency ratio and its exchange rate policy. On the other hand, they say China’s economic growth could be boosted by a sufficiently educated population and the high tech products in its exports mix.

So where are we? We have lots of variables and no firm conclusions. Just what we should expect for China.