China could soon become a high-income country

VSHINA IS HAUNTED by the specter of the ‘middle-income trap’, the notion that emerging economies climb rapidly out of poverty only to get stuck before getting richer. “In the next five years, we have to be especially careful not to fall into the trap of middle income,” Chinese Premier Li Keqiang said in 2016. Lou Jiwei, then Chinese Finance Minister, once put the chances of China becoming trapped. at 50%.

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The trap was named by Homi Kharas and Indermit Gill, two economists, in 2006, when they were both at the World Bank. This raises an obvious question: what counts as middle income and what would be considered above it? Mr. Kharas and Mr. Gill have adopted the bank’s own income classifications. These were created in 1989 when the bank drew a line separating high-income countries from the rest. The line was to accommodate all countries that were then considered “industrial market economies”. It was drawn at a national income per person of $6,000 at 1987 prices, just low enough to include Ireland and Spain. This line is now $12,695. It increases at the rate of a weighted average of prices and exchange rates in five major economies: America, Great Britain, China, the euro zone and Japan. Eighty countries reached this threshold in 2020, three less than the previous year. The pandemic has relegated Mauritius, Panama and Romania to the intermediate division.

Despite the fears of its leaders, or perhaps because of them, China is now on the verge of becoming a high-income country by this definition (see chart). Based on the latest available forecast from Goldman Sachs, we calculate that China could cross the line next year, helped in part by its strong currency. (The transition wouldn’t be officially announced until mid-2024, when the World Bank updates its classifications based on the previous year’s data.) If we’re right, then 2022, the year of the tiger, could be China’s last as a middle-income country. It will be a bigger cat later.

The threshold, of course, is arbitrary. Several countries (including Argentina, Russia, and even Venezuela) passed it to fail or fail in subsequent years. A sustainable exit from the middle-income trap requires a more fundamental transition. Countries at this intermediate stage of development may encounter various pitfalls. They may face diminishing returns to capital. They generally lack the workers to leave agriculture. And they must invest heavily in education, beyond the basic schooling a factory worker needs to follow instructions. The truest test of a high-income country is how well it copes with such threats to its growth. How does China fare on these three counts?

China continues to accumulate capital at a breakneck pace. She invested 43% of her GDP in the five years preceding the pandemic. High-income countries averaged only half that percentage. But China’s high investment rate may not be as sterile as is often assumed. Just as its investment remains high by wealthy country standards, so does its GDP Rate of growth. Indeed, the ratio between its share of investment in production and its rate of growth (sometimes called the ratio of capital to additional production, or ICOR) still looks favorable relative to high-income countries.

What about other sources of growth? In its annual review of the Chinese economy, published on January 28, the IMF noted with concern that China’s “total factor productivity” growth, which measures changes in output that cannot be attributed to more capital or labor, has fallen over the past decade, compared to ten previous years. She attributed this slowdown to “a blockage” of structural reforms, in particular of public enterprises. “The momentum of the market has lost momentum recently,” he argued. But this kind of productivity is notoriously difficult to measure. And according to an indicator from the Conference Board, a business group, it is growing significantly faster in China than in high-income countries (see chart).

The structure of employment in China still differs markedly from that of more prosperous countries. Surprisingly perhaps, the share of its construction labor force is below the high-income average. The percentage in manufacturing industry is higher (19% compared to an average of 13%) and the share still in agriculture is much higher – around 25% compared to an average of 3% for high earners. From a certain point of view, this residual rural labor force is cause for optimism. If China can achieve high income levels with a quarter of its workers stuck in agriculture, imagine what it will do as they escape to more productive jobs? The concern, however, is that these workers have not left the farms because they cannot. Maybe they don’t want to give up their rights to communal land. Or maybe they are too old or poorly educated to take advantage of the best opportunities in the cities.

China’s stock of human capital is indeed worrying. According to its latest census, its adult population had an average of 9.9 years of schooling in 2020. That would put it near the bottom of the heap of high-income countries, which have 11.5 years on average, according to Harvard’s Robert Barro and Jong-Wha Lee of Korea University.

The high income trap

This problem can only be solved one cohort at a time. Older Chinese citizens grew up in a much poorer country and were educated accordingly. A child entering the Chinese school system now can expect to receive 13.1 years of education, according to the World Bank. Quality does not yet match quantity: based on children’s results on standardized tests, 13 years of schooling in China is equivalent to less than ten years in a country like Singapore, the bank calculates. Nevertheless, things have improved.

The “stock” of human capital therefore reflects China’s impoverished past, but the “flow” of investment in new human capital is more worthy of a high-income future. The problem is that this costly and time-consuming investment deters parents from having children, a demographic impasse unfortunately characteristic of many wealthy regions of the world. China’s population grew only 0.03% last year. Judging by Japan’s experience, an aging and declining population can contribute to depressed spending, low growth and low interest rates. Chinese policymakers now have to worry about another kind of trap.

Read more about Free Exchange, or column on the economy:

Quantitative tightening is no substitute for higher interest rates (January 29)
Economists revise their views on robots and jobs (January 22)
Will remote work persist after the pandemic? (January 15)

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This article appeared in the Finance & Economics section of the print edition under the headline “The High Kingdom”

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