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Will China Escape The Middle Income Trap?

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Orville Schell   and Peter Schiff contend that China’s brand of state-directed capitalism has the resilience to come out on top of the global market.  Ian Bremmer and Minxin Pei put their money on the American model despite its faltering in recent years.

Where do you stand?  

Intelligence Squared U.S., in partnership with Slate, promises provocative, insightful discussion of this timely question as Schell and Schiff square off against Bremmer and Pei to debate whether “China Does Capitalism Better than America.”  ABC News’s John Donovan will be moderating the March 13th event at NYU’s Skirball Center, and a live audience will vote to determine the winning team. 

A word of warning for anyone staunchly embedded on one side of the Chinese vs. American capitalism debate: according to its mission statement, Intelligence Squared aims to “to transcend the toxically emotional and the reflexively ideological; and to encourage recognition that the opposing side has intellectually respectable views.” It was also voted one of Forbes’s “Top Five Podcasts to Change Your Mind.”  

Attend in-person or tune in via live stream – then let us know what you thought.

Though this upcoming discussion sounds fascinating, I actually think framing the issue as a face-off between China’s state supported capitalism versus the US’s more freewheeling version is the wrong question. To me, the most important question is whether China will have what it takes to surmount the middle income trap.

I was on a panel this past weekend at the Wharton China Forum 2012 and while there I had the opportunity to listen to a great lecture by world-renowned economist, Augusto Lopez-Claros. I asked Professor Lopez-Claros whether he thought China would be one of the rare countries that breaks through the middle income trap and his answer was a resounding “it’s possible.” He then went on to note how only five countries have really done that and become developed: South Korea, Japan, Singapore, Hong Kong and Chile. I’m not even sure Singapore and Hong Kong are even large enough to count. I am not prepared to say that China will not be able to burst through the middle income trap, but I will say that I think those who just assume that it will are ignoring all sorts of things.

Will China ever become a developed country? If you think it will, what do you think China has that that will enable it to do so? Conversely, if you think it will not, please explain why you think that. 

  • MHB

    Socialism is the saviour of capitalism – whether it be by placating those on low incomes with a welfare state, by running state-owned industries or by nationalising losses.
    The greatest attribute of capitalism is its facilitation of re-invention. When one industry becomes obsolete, capital is reallocated elsewhere by consumers and businesses working together ‘organically’.
    Can the China model react quickly and precisely enough to make the change from the ‘middle-income’ level to a developed economy? Is the government now too cumbersome? The China model worked thus far – with capital intensive industries – can it work in more diverse and complex industries?
    In favour of the China model, the government has (according to the quoted Economist article) recognised the problem and has addressed it in the five-year plans. Will that be enough?

  • http://chinacopyrightandme.wordpress.com Rogier Creemers

    Obviously, this is the $64.000 question, and anyone who has a definite answer would make millions with it. I’d say it’s not impossible, but that we should first have a better idea about what “developed country” means. Do we base this in quantitative consumption? If we just look at energy and transportation, it’ll be impossible for China to get to US or European levels of car ownership, if only because of the increasing price and scarcity of oil. Also, in urban areas, the sheer space needed to park them, as well as congestion would seem to be a further disincentive. Obviously, technology might improve, but we’ll also need alternative modes of lifestyle and consumption suited to the Chinese demography and social geography.

  • Twofish

    Japan is an example of a “high income trap.” If you want to see middle income traps, then Mexico or Thailand would be a better example. For that matter, the US may have gotten caught in a high income trap.
    I’m pretty optimistic that China will avoid the middle income trap because, there are parts of China that are middle income or high income (Hong Kong) and they haven’t run into any obvious limits that I can see. It’s worth noting that four of the five areas that have broken through the middle income (and I’d include Taiwan) are bordering or part of the PRC.
    The other thing is that Japan is a odd case, because it got rich pre-WWII, and if you want to count Japan as “successful” then you ought to also count Germany and Western Europe. The other point is one of time scale. Western Europe managed to get rich by growing at 2-3% year, but it did that for 100 years.

  • Twofish

    The other thing is that it’s not either/or. People are talking as if there is some single universal model of economic development, when there isn’t, and a lot has to do with local conditions. India and China have radically different economic structures, but both seem to work.
    Also it’s not a zero-sum game. It’s in China’s interest that the US have a healthy economy, and it’s in the US national interest to make sure that China has a healthy economy. There’s no reason to think that policies that work for the US economy can be copied to work for China, and vice versa.

  • gnikivar

    Hi, first time commenter here. Apologies for the length because this is something I’ve thought a lot about.
    Anyways, a couple of things to point out. I wouldn’t count Chile as having escaped the middle income trap. Chile has a per capita income of 16,000, despite being very resource rich. More than 2/3 of its exports are minerals. As far a little countries are concerned, I’d add Malta and Greece. Until the 1990s, they grew at East Asian rates and though the rates of growth have slowed down, the economic achievements are genuinely impressive.
    To the substance of this point. People often think of East and South East Asia as part of the flying geese with Japan at the lead. Taiwan and Korea have more or less caught up with Japan but it looks like Malaysia, Thailand and Indonesia somehow got lost. They’re converging with a developed world, but not at a particularly rapid rate. I did a study that uses Dani Rodrik’s prody (a measure of export sophistication) and looked at the size of “innovative countries” and it really looks like southeast Asia got lost. Export growth in recent years has been most rapid (especially in Indonesia) in rubber, and palm oil while high value export industries fled to China. Singapore escaped the middle income trap partly because has a decent number of highly innovative high tech firms, but mostly because its been flooded by FDI of innovative western firms and because it can accept the most highly skilled immigrants from around the world. However, for China to do that, it would have to take more take more than 15 times than total global FDI. Clearly an impossibility. Hong Kong is two sui generis to even begin to compare.
    So the question becomes, how is Malaysia and Thailand different from Korea and Taiwan. What strikes out as the most important difference is innovative capabilities. Neither Thailand, Indonesia or Malaysia have very many truly globally innovative corporations. You’ve got a few oil and petrochemical producers that take advantantage of natural resources and a few banks and airlines. According to my measure of number of innovative corporations, these countries were between 10 and 20 and the rate of growth in this area wasn’t particularly impressive. Korea and Taiwan on the other hand were at around 1700 and 2800. The US was at 3300, and most European developed countries (with the exception of the southern European countries and Ireland) were between 4000 and 1000.
    China, by my measure (which was constructed to be generous to poorer countries. A textile factory in Haiti would have been considered innovative, while it wouldn’t have been in Japan) China was at 20, in the south east Asian area but growing at a phenomenal rate. China has a few massive banks and natural resource companies but those don’t really count as innovative. China also has mid major companies in telecommunications equipment like ZTE and Huawei, computer hardware producer Lenovo, Haier in white goods etc. These companies are globally compettetive and in a decade may very well be near the top of the food chain. Other Chinese company’s positions are a lot harder to interpret. You’ve got car companies like SAIC, Geely and heavy equipment producers like Sany and Zoomlion. However, these companies rely primarily on Chinese markets, and government protections and subsidies. Maybe they’ll grow into world class companies, or maybe they’ll be expensive albatrosses. Its hard to say one way or the other.

  • gnikivar

    Sorry, I hit submit before I meant to.
    So the question becomes why do some countries have developed major indigenous innovative capacities and others haven’t. One of the most straightforward answers is ethnicity. I think any explanations based upon racial distinctions in innate intelligence are a load of crap and I’ll reject them out of hand. However, maybe there’s something special about Chinese culture, a Confucian ethic, a respect for education etc. that allows them to enter high tech fields more easily. There certainly an unnerving correlation between percent Chinese and level of economic development in East Asia. I’m for reason I won’t go into detail because this post is reaching book length, go into detail about why I’m skeptical about this.
    A second explanation hinges on the quality of government and industrial policy. South Korea, Japan and Taiwan had autonomous states led by technocrats who were fully committed to economic development. They channeled resources to world class companies and built them from the ground up into world giants. In South East Asia, economic development was based upon FDI. As soon as cheaper options were found, they moved away. Thailand and Malaysia may have had unusually high quality logistics and infrastructure given current wages, but China did all of that more better.
    Another explanation is the traditional neoliberal explanation. Korea and Taiwan had medium quality governance when they were low income countries and so saw rapid growth has they reached medium income. However, governance never got above middle level in Malaysia. You’ve got constant instability in Thailand, a UMNO based elite that creams off the top of legitimate business profits in Malaysia, and debilitatingly massive corruption throughout Indonesia. The bureacuratic elites through State-Owned corporations, pointless fees and regulations keep busines down. Korea and Taiwan today have more or less first world qualities of governance today, and have adopted free market policies to the same extent as western countries.
    So where does China fit into all of this? One hand you’ve got support for innovative Chinese companies, the setting or real performance standards and autonomous and highly technocratic bureaucrats and the NDRC, Like Japan’s MITI or Korea’s EPB planning it all. On the other, you’ve massive state owned conglomerates that have no real oversight beyond the SASAC, and a rising class princelings and other hanger extracting rents off the back of hardworking Chinese. For better or force, China is so big a country and so complicated its hard to situate it into these narratives. My own guess is that China will eventually get caught in the middle income trap, but much further up the food chain. Per capita income will slow down as it reaches GDP PPP per capita around 20,000, a level similar to the eastern European nations.
    Once again, apologies for the loghorea and feel free not to post if this too much / off topic.

  • Bill Rich

    China has already escaped the middle income trap. China has created the greatest super rich classes and beyond already. There is no limit to China’s ability to create personal riches for their powerful. Why worry about the middle income ? It’s getting rich on the backs of the poor.

  • http://www.yahoo.com anonymous

    gnikivar – nice post. u have a blog i can read?

  • http://Www.inpraiseofchina.com Godfree

    No. There are two reasons why it won’t escape:
    1. Party policy, oft-repeated, is to establish a “moderately prosperous nation”. Not a rich one. In support of this policy, this month the CCP introduced the GINI coefficient as a provincial success metric, the first national government to do so. This goal alone will promote moderation (as it is intended to do) for the next 30 years.
    2. There’s not enough resources on or in the planet to afford rich-country living standards for 1.3 additional people.
    To the visitor of the future China will certainly LOOK magnificent and futuristic, but its personal incomes will be merely comfortable for 90% of its people, which will be a sufficient accomplishment.

  • http://www.bystandermedia.com Paul Maidment

    The key question is actually, can China can continue to develop its economy rapidly without institutional reforms, particularly in respect to the rule of law, governance and accountability. One reason that the middle-income trap appears when per capita income reaches $10,000-12,000 a year (at 2007 prices), is that that is the point at which developing economies tend to stop developing without institutional change. In a one party state like China this is the one and only economic development question that matters. There was a good piece about this, “China’s $10,000-12,000 Question”, http://chinabystander.wordpress.com/2011/01/03/chinas-10000-12000-question/, on China Bystander (full disclosure: a client) early last year. It also pointed up the growing power of the SOE’s as an impediment to reform, a point that appears to be raised again by the World Bank report, China in 2030, due to be published on Monday but already stirring up controversy. I would also recommend a 2009 INSEAD paper by Antonio Fatás and Ilian Mihov, “The 4 I’s of Economic Growth”, http://faculty.insead.edu/fatas/wall/wall.pdf, for anyone wanting to take a deep dive into the $10,000-12,000 middle-income gap.

  • Twofish

    I’m not sure ethnicity has much of an explanation. Any explanation for why China is doing well in 2012 has to explain why it was such a disaster in 1975. For that matter, India is doing very well despite have a very different economic system.
    “Culture” might provide an answer since China has had thousands of years of business tradition, and the efforts to eliminate merchants didn’t last long enough to get rid of them. One reason that China has done better than Russia, is that when DXP let businesses form in the late 1970′s, there were people still alive that could remember how to run a business, and there were also pools of expertise in Taiwan and HK. In Russia, no one alive before the revolution was around to help set things up in 1990.
    gnikivar: China, by my measure (which was constructed to be generous to poorer countries. A textile factory in Haiti would have been considered innovative, while it wouldn’t have been in Japan) China was at 20
    Curiously this ties in with the discussion that I’ve been having with Scott Nova about electronics production. One thing that I like about the electronics markets of the Pearl River Delta is that because it’s dominated by mom-and-pop manufacturing and retail, you end up with a ton of innovation. For example, you have this thing that looks like a USB stick, but it’s both a video camera and projector. In the last month, you have these things that are TV set top boxes. They have wifi, an Android server that will let you download movies from the net, and if you hook up it up, then you can buy a cheap LCD monitor and it becomes a smart TV.
    This is only in the last three months, and one reason I like electronics shopping in China is that every time you go to the market, you see something new and different. So if China can continue this sort of innovation, then I don’t think it has much to worry about. Most of the innovation that happens in China is totally invisible to people in the West. The companies that you hear about in the West are big and rich enough to afford huge marketing budges. The really innovative companies in China as far as electronics go, spend money on engineering and not marketing.
    I’m more worried about the US. You *couldn’t* market these devices in the United States, because a ton of lawyers would crush you. I’m also worried because the US has become a very bad place to be a scientist or engineering, and now people seem to want to lynch bankers. So there is this massive “brain drain” that’s going from the US to China. I can imagine a nation of farmers. I can imagine a nation of shopkeepers. I can imagine a nation of scientists and engineers. I really don’t see how a nation of lawyers and politicians is going to work.
    The issues with “rent-seeking princelings” is an issue, but my observation is that princelings in fact don’t hurt innovation that much because they “rent” that the extract doesn’t kill the company. So what happens one you move up from your market stall is that you have to start putting princelings on your board, but I think one thing that is interesting with China is that there is a “market” for princelings. If the son or daughter of one official demands too much money, then you say no, and find another, and if the government officials in one county demands too much in the form of red packets, you pack up and go to other county. From the point of view of an outsider, it is amusing to see these things being “negotiated.”
    The other thing with princelings is that you end up with a “balance of power”. Company A gets into a conflict with Company B. Company A has the son or daughter on their board or as a consultant. But wait, so does Company B!!! What ends up happening is that the dispute usually gets resolved via business principles.
    To put in crudely, in China there is a “market for political favors” but there isn’t a “monopoly on political favors.” If official A demands too much money, then you pay off official B. What ends up happening is that official A ends up figuring out that his paycheck depends on the health of the business, so official A ends up doing what he can to help the business make money. The lines of control in China are vertical not horizontal. Official A and Official B both report to Beijing, but they can’t cooperate with each other. In fact, if Official A and Official B start talking about how they can cooperate with each other, Beijing sees this as a sign of rebellion, and both officials will be in serious trouble.
    This *isn’t* how it works in the Middle East, Latin America, or most parts of South East Asia. If you annoy official A, then all the officials will try to crush you. The linkages are horizontal and not vertical Since official A knows that he can’t be fired, he is just going squeeze every cent of out your business, and if you end up going out of business, they don’t care.

  • Twofish

    Also political instability feeds on itself, and you see this in Latin America, Thailand, and the Middle East. As long as the economy grows, everyone gets something, and no one cares that much about who gets what. Once the economy stalls, then people start fighting over pieces of the pie, and the act of fighting over things hurts the economy which increases political instability. I think Egypt (unfortunately) has gotten into this trap.
    One other thing is that there is this interesting political dynamic at play in Hong Kong, Taiwan, and South Korea that keeps political disputes from going too far. Basically, everyone involved don’t want to push things too far or else an outside power would intervene and everyone would lose. The KMT and DPP end up screaming at each other, but if you see the sort of massive demonstrations that you had in Eqypt or Thailand, the PRC would intervene and that gives both parties an interest in not pushing things too far.

  • Upandaway

    Whenever I encounter a discussion such as this, I always think of this article, written in 1996. I have edited the quotes somewhat, but before you check out the article, try to guess which country it is refering to. It might not be what you think…
    “Rapid… economic growth was based entirely on one attribute: the willingness to save, to sacrifice current consumption for the sake of future production… Economic growth that is based on expansion of inputs, rather than on growth in output per unit of input, is inevitable subject to diminishing returns.”
    “Hoover criticized official… statistics, arguing that they exaggerated the true growth rate. Nonetheless, he concluded that… claims of astonishing achievement were fully justified: their economy was achieving a rate of growth “twice as high as that attained by any important… country over any considerable number of years [and] three times as high as the average annual rate of increase in the United States.”
    “Wassily Leontief described the… economy as being “directed with determined ruthless skill”–and did so without supporting argument, confident he was expressing a view shared by his readers.”
    The Myth of Asia’s Miracle
    Paul Krugman
    A CAUTIONARY FABLE
    http://media.ft.com/cms/b8268ffe-7572-11db-aea1-0000779e2340.pdf
    It’s a really good article. I’m sure there are others that have written similar things, but I would rank it together with “The Economic Consequences of Peace” for the importance of the subject, and for what it tells us about the future of the world economy.
    Of course, the major difference here may be that China is capitalist? But I would argue that without transparency, capitalism does not work. Creative destruction need a counterbalancing force in the shape of competent and transparent government. I would argue that that does not exist in China today, and is extremely unlikely to ever exist with the current political system in place.
    For all “whataboutists” out there, I would agree that a lot of other countries are lacking in this regard as well, most notably the current situation in the federal and most of the state goverments of the USA. See for example this article:
    http://www.vanityfair.com/business/features/2011/11/michael-lewis-201111
    But for all that, they are still very much ahead. Not least when it comes to corruption and lack of trust which are some of the most inhibiting factors for any economic culture to have.

  • Peter Schiff

    My point is that China’s brand of state directed capitalism is better than America’s brand of state directed capitalism. Neither nation practices true capitalism, such as the capitalism that defined the American economy in the 19th. However, China is closer to what America use to be than is America is now!

  • Twofish

    Krugman’s article is interesting because it looked incredibly prescentient in 1999 after the Asia financial crisis, but it looks much less good in 2012. The main example that he gives for an economy that has stalled out is Singapore, which seems in 2012 to be a horrible example for his point since Singapore is doing very well, and TFP seems to have increased quite a bit since the 1990′s.
    Looking back at Singapore, one problem with these sorts of statistics is the lag effect. If you spend a huge amount of savings on infrastructure, you aren’t going to see the productivity benefits immediately. In the short run it looks like you are just wasting your money, because your spending goes up, but there isn’t an immediate boost in output. You only get the boost in output after a decade or so.
    The other thing is that Krugman’s analysis of the Soviet economy has also been seriously challenged.
    See http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1053541
    The point of this paper is that the Soviet Union *did* experience a period of high increases in TFP in the 1950′s which collapsed in the 1960′s and 1970′s. Popov’s paper is really scary, because if it turns out that the collapse of the Soviet Union in the 1970′s was due to the lack of capital investment in the 1950′s, then the similar lack of US investment in 2000′s is going to cause a lot of long term problems.

  • Verk

    India may be doing well by the standard of the greater middle east. (Which it’s not part of, I know.) But they have China envy, lot’s of it.

  • Upandaway

    @Twofish
    Yours are good points, but I would like to modify a couple of them. The main takeaway from Krugmans article for me is the fact that rapid investment, funded by diligent saving in society, in modern infrastructure and capital equipment in an economy which had little of that before is very likely to grow that economy significantly.
    But at some point this sort of growth experience serious issues in the form of diminishing returns. Beyond that, there need be an increase in efficiency which require better ways of working and organizing the labour force, which require that institutions (be they government, corporate or in the civil society) are ready to reform and adapt to what new requirements continued growth in the economy puts upon them.
    This is not to say that investment in infrastructure is bad. But that just as the USA have a cronic deficit in this regard, even in areas which has a screaming need for investment, China is beginning to aquire a cronic surplus in infrastructure, especially in areas for which there is no demand at all!
    Furthermore, I think there can be huge questionmarks on the durability of certain achivements that China has made in this area: The notorious malinvestment in housing, commercial area, high-speed rail etc. Also one has to wonder what sort of quality that infrastructure has considering how quickly it was built.
    I think China can keep growing for some time yet, if for no other reason that it is so big, and there are such a lot of people still in poverty. At the same time, there seem to be a big issue in finding productive ways of spending money. Is this because of a lack of low-hanging fruit or inefficient allocation mechanisms due to central planning? I would say that both have an influence, but that the inability / unwillingness to reform the latter is the real killer in this equation.

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