The Middle Income Trap

Published on Author reed

“China’s policy makers are already focused on how to change the country’s growth strategy to respond to the new challenges that will come, and avoid the “middle-income trap.” That is clearly reflected in both the 11th and 12th Five Year Plans, with their focus on quality of growth, structural reforms to harness innovation and economic efficiency, and   social inclusion to overcome the rural-urban divide and the income equality gap.”

This quote comes from one of the opening paragraphs of the WorldBank’s 2013 report on China and its economic development, entitled “Building a Modern, Harmonious, and Creative Society.” The Middle income trap occurs for  developing economies when their growth causes wages to raise such that they are no longer competitive with lower cost nations, yet they lack the technological and innovative capacity to compete with the advanced nations.  Realizing the Asian Century says, “such countries cannot make a timely transition from resource-driven growth, with low-cost labor and capital, to productivity-driven growth.”

High growth rates are easier to sustain when countries are underdeveloped because they can improve economic efficiency in the economy relatively easily by shifting jobs from agriculture to manufacturing and by implementing technological advances previously pioneered by other countries, which can rapidly increase GDP. Once developing nations become technologically ‘caught up,’ it is much more difficult to sustain those levels of growth. China is still not close enough to the technological frontier, and it’s wages aren’t high enough to accurately evaluate whether or not it will fall victim to the middle income trap.

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4 Responses to The Middle Income Trap

  1. Manufacturing isn’t an ideal business to be in. The “middle-income trap” is just a component of a bigger manufacturing trap. Manufacturing is a low profit business when compared with designing and retailing. Value added from manufacturing is very low. Take Apple and Foxconn. Foxconn had larger revenue than Apple, however in terms of profit Apple did much better; Apple made $26bn in revenue in 2011 compared with Foxconn’s $3bn. It is essential that China make an effective transition away from a manufacturing to a services economy to take advantage of the wealth associated with higher value added sectors.

  2. In one of my research papers I looked at Walmart’s ability to push down the price it’s manufacturers could charge by using its market share as leverage… “You sell to me or no one”. Walmart then decreases it’s prices which passes on savings to consumers world wide. Walmart tries to cut out the middlemen who increases costs in the supply chain.

  3. My term paper directly discussed China’s industrial competitiveness, as it specifically relates to the furniture industry. China’s furniture industry is heavily reliant on cheap labor, and their ability to develop consumer brands and design pieces is limited. Further, China must import a significant quantity of the timber necessary. They will be in trouble if they cannot retool so that they can export products which are produced by vertically integrated (design, manufacture, brand, sales) companies. The rise of domestic consumers has been extremely important recently, so if we assume export growth is slowing, being displaced by increasing domestic demand, Chinese manufacturing may be ok.

    As it relates to the middle income trap, China struggles across all industries with the same challenges as the GM partnership. It is difficult to accumulate knowledge, and is often slow, provided corporate/intellectual property theft doesn’t occur.

  4. The conundrum reminds me of the Nam article we read regarding the automotive industry in China. Anton writes that “they lack the technological and innovative capacity to compete with the advanced nations.” The cost of labor is no longer a competitive advantage but the country does not yet have the human capital to actively compete with advanced nations…so how does China foster this capability? Probably through restructuring FDI regulations, especially regarding IJVs. The current mandated relationship does not facilitate the transfer of innovative capabilities between Chinese and foreign firms. Although TFP improves, the actual innovation that generates future product growth is not yet present, inhibiting China from realizing a mutually reinforcing, independent, cycle. Once foreign firms have a more direct interest in investing in China, producing Chinese management as a true subsidiary or market segment, the firms will ensure that innovative talent is increasingly garnered, producing a mutually beneficial interaction between China and global industry.