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Overcoming the Middle-Income Trap with Structural Reforms

Politics / Social Issues Nov 07, 2016 - 06:03 PM GMT

By: Dan_Steinbock

Politics According to the World Bank, China is an upper-middle-income country. However, only structural reforms will allow China to surpass the middle-income trap.

According to a recent report by the Chinese Academy of Social Sciences (CASS), China has entered the ranks of the so-called “upper-middle-income” countries. It has triggered a fair amount of interest among those Chinese who are concerned for the middle-income trap; that is, a status quo in which a country attains a certain level of income but gets stuck at that level.


While most observers agree that the pace of transformation has been extraordinary in China, many remain concerned about increasing wealth and income inequality. Others point to to successful industrialization in East Asia - from Japan to South Korea - arguing that improving social welfare will be critical to to avoid the middle-income trap.

These viewpoints are not mutually exclusive. Together, they drive the rebalancing of the Chinese economy and the associated new urbanization and industrial upgrading that seeks to overcome the middle-income trap in the next 10-15 years. But why do many countries get stuck in the trap?

Elusive categories

Actually, China has been among the so-called upper-middle-income countries for a few years. The CASS report relies on the World Bank classification, which groups economies based on gross national income (GNI) per capita. Based on the bank’s method, that generates four categories:

- low-income economies ($1,025 or less)

- lower middle-income economies ($1,026-$4,035)

- upper middle-income economies ($4,036-$12,475)

- high-income economies ($12,476 or more).

In the early days of economic reforms, China was still in the low-income group, which even today features countries, such as Senegal, Haiti, and Afghanistan. In 2008, after decades of investment and export-led growth, China joined the ranks of the lower-middle-income countries, which now include Tunisia, El Salvador, Sri Lanka and the Philippines.

According to CASS, Chinese per capita GDP is currently $8,016 (52,000 yuan). In effect, China joined the ranks of the upper middle-income countries around 2012. As a result, Chinese living standards are approaching those of Turkey, Brazil and Southern Europe. However, these findings should be taken with a grain of salt.

Today’s advanced economies industrialized in the late 19th and early 20th centuries. So they have enjoyed the benefits of wealth and income for a long while. In China and other emerging economies, prosperity is still very new - and thus far, far more fragile.

Potential is not reality

Just because an economy has great potential does not always mean that this promise will be delivered. And yet, that’s what my good acquaintance Goldman Sachs’ Jim O’Neill, who created the ‘BRIC’ concept in the early 2000s, seemed to imply. While O’Neill did wonderful work in promoting emerging economies, analysts focus on abstract data rather than real life.

If the theory had been valid, we would continue to see solid economic progress in China, India, Brazil and Russia - not to speak of the mini-BRICs, such as Nigeria, Saudi Arabia, Indonesia, Iran, Pakistan and so on.

Yet, the reality is that we don’t. The emerging and developing countries have always relied on diverse sources of industrial advantages. Before the global crisis, those BRIC economies that relied excessively on their natural resources enjoyed high growth as long as the prices of oil, gas and commodities continued to soar. Conversely, with the end of the ‘commodities super-cycle,’ the very same nations have taken heavy hits.

What’s worrisome, even if economies diversify their industrial structures and get their policies right, external constraints - including sanctions by Western nations - effectively undermine the benefits of modernization.

In many cases, their economic woes have been compounded by geopolitics and the new Cold War, including the US-EU sanctions against Russia, Washington’s tacit support for the ‘soft coup’ in Brazil, the spread of Boko Haram in and from Nigeria, and huge destabilization across the Middle East.

History matters

It is for these reasons that I have argued, for more than a decade, that the hopes associated with some BRIC economies or mini-BRICs will prove inflated. It was misguiding in the early 2000s to project glorious futures for economies that relied excessively on resource- and commodity-driven growth.

There’s nothing new in this. In 1960, Ghana and South Korea were at similar starting-points and the conventional wisdom was Ghana would inevitably evolve faster than South Korea. Today, GDP per capita in South Korea is $36,600 but below $4,300 in Ghana. What really matters in economic development is not just industrialization but how it actually materializes.

Once, when I met the legendary investor Jim Rogers and we talked about the future of emerging economies, he referred to some BRIC analysts as “number crunchers.” It sounded pejorative but, while Rogers is a commodity expert, he started his career as a gifted historian and knows only too well that numbers without history and context are hollow.

In this regard, China is better positioned to overcome the middle-income trap with a more diversified industrial structure, as long as regional rebalancing can proceed and the external environment remains peaceful.

However, it does not follow that all, or even most emerging economies can follow in the footprints. Success requires structural reforms.

Dr. Dan Steinbock is an internationally recognised expert of the nascent multipolar world. He is the CEO of Difference Group and has served as Research Director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Centre (Singapore). For more, see www.differencegroup.net   

© 2016 Copyright Dan Steinbock - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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