China could be caught in ‘middle-income trap’

On the highway of economic growth, China has been racing at supersonic speed for some 30 years. But economists now reckon that China faces a speed-bump on that road, which could slow it down considerably — and even ensnare it in a ‘middle-income trap’.

The ‘middle-income trap’ is a reference to the challenge that countries rising up from the ranks of the very poor face in moving further ahead owing to loss of competitiveness from the end of the ‘cheap labour’ model of economic growth. 

Low labour cost is a cornerstone of China’s emergence as the global manufacturing hub, point out Huang Yiping at the China Center for Economic Research and Jiang Tingsong at the Centre for International Economics. “But the history of economic development suggests that no country can rely on cheap labour forever.”

China, they note, is approaching “the Lewis turning point” — he point of transition from a labour surplus economy to a labour shortage economy. Such a transition often signals the beginning of more rapid wage increase, and therefore has enormous implications for economic growth and economic structure.

Over the past year, wages have risen in many Asian countries considered to be “cheap sources of labour”, including China, points out Nomura’s chief Asia strategist Sean Darby. The most important long-term implication of this is that “while rising wages should help to boost consumption, they will also mean a loss of competitiveness for companies.” China and many Asian companies “may lose their export edge not just from an appreciating currency but
also from a loss of competitiveness.”

Darby reasons that if US monetary conditions remain loose and Asian authorities prioritise growth over inflation, it won’t be long before a combination of an appreciating local currency and rising costs “squash the competitiveness of exporters.” For many countries, the rise in employee costs and higher operating costs are the first sign that the economy is moving towards the ‘middle-income trap’.

Many economies find it difficult to move up the value-added product chain: South Korea managed to make that leap, but Malaysia — and parts of Latin America and West Asia — were ensnared in the ‘trap’.
What really trapped many Latin American and West Asian countries was lack of innovation capability,” notes Huang. “They failed to move up the industrial ladder beyond resource-based activities.” That, he adds, could be the real tests for China. “The government has set its sights on high tech and high value-added industries to carry Chinese growth forward. But there are still huge gaps in China in the areas of education, research and development, financial services, and legal protection.”

Darby reasons that with the world losing its ‘demographic dividend’ while China is experiencing the loss of its ‘cheap labour dividend’, the global economy “is set to experience a profound change in wages within the developing world.” The question that investors should be asking themselves, he notes, is whether Asia and particularly China are falling into the ‘middle-income trap.’

Huang points to the implications of such a development for projections about China’s economic growth in the years ahead. “Whether or not China can avoid the ‘middle-income trap’ will eventually determine if China will really overtake the US to become the world’s largest economy in the coming decades.”