Can China Avoid the “Middle Income Trap” without Political Reform?

The World Bank released a report earlier this year warning that China is at risk of falling into the “middle income trap” of much slower or stagnant growth unless it implements a sweeping economic reform agenda. The export- and investment-led industrializing model that has served China so well over the past decade will not perform as well over the next twenty years.  The viability of this model will be undermined by slowing export growth, a shrinking urban workforce, rising costs for energy, water, and other inputs, and overcapacity caused by years of overinvestment.   The 468-page report, “China 2030”, identifies a variety of reform areas that Beijing must focus on to promote  China’s long-term economic development and improve the odds that it will eventually attain high-income status.  These include reducing the role of government in the economy, reforming and restructuring state enterprises and banks, developing the private sector, promoting competition in the land, labor and financial markets, and accelerating the pace of innovation.

There are signs that Chinese leaders foresee these challenges and recognize the need for structural reform.  For several years Beijing has focused its economic planning on “rebalancing” the economy away from exports and investment toward household consumption.  Beijing has also strongly emphasized science and technology (S&T) as a new economic growth driver, devoting a larger share of its GDP to research and development than do other countries with similar income levels.   This might give China a  better chance of sustaining productivity growth even as the drivers underlying China’s rapid growth over the past two decades, such as cheap labor and technology catch-up, are eventually exhausted.

However,   some commentators both inside and outside of China argue that many of the proposed economic reforms have little chance of succeeding without deeper political and institutional reform.  Beijing’s policy process currently favors the entrenched economic elite, which benefits proportionately more from the current model of imbalanced growth.  Vested interests, particularly local governments and state-owned enterprises, oppose key elements of Chinese leaders’ economic reform agenda.  Furthermore, an expected decline in the growth of central-level revenues will likely undercut Beijing’s ability to compensate domestic constituencies on the losing end of any reforms.  To dilute the influence of these interests and create more momentum behind needed reforms, Beijing would need to broaden political participation in favor of lower-income citizens and make the policy process more open and transparent.

This suggests that China’s incoming leaders will increasingly be challenged to balance their desire to preserve the party’s monopoly on power against their interest in safeguarding China’s long-term economic development.  Depending on how Beijing manages these competing objectives, China might see a future in which it can no longer compete in low-wage industries but lacks the ability to move to higher value-added sectors, and the World Bank’s warning would become a reality.

Zachary Riskind is an analyst with the National Intelligence Council’s Strategic Futures Group.

By tgmahnken Posted in GT2030

4 comments on “Can China Avoid the “Middle Income Trap” without Political Reform?

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  4. I tend to agree with this assessment. Moreover, as the economic situation in both Europe and the United States shows, there is a considerable difference between leaders knowing what needs to be done and actually taking action. In the case of China, needed reforms are even more wrenching and threaten the rule of the Chinese Communist Party.

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