Will China Escape The Middle Income Trap?

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?

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.

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.

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.

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.

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.

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.

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.

@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.