How to escape the middle income trap for China

Recently, Lou Jiwei, the minister of finance, publicly said that there is a great possibility that China will fall into the middle income trap in next 5~10 years, and explained that it is because China enters into the aging society too fast, the wage growth is faster than labor productivity growth and labor market tends to be rigid with excessive protection.

The middle-income trap refers to the stagnation of a country's economic growth after it increases to certain income level (per capita GDP is between $1000 and $12000). At that time, the economy can neither compete with high technology innovation of advanced economies nor compete with cost of low-cost production of low income economies.

Judging from international experience, during 20 years from 1980 to 2000, Argentina grew at an average annual rate of 0.2%, for Brazil it was 0.4%, for Mexico it was 0.7%. South Africa did not increase, but had negative growth, which was - 0.8%. At the beginning of China's reform and opening up, these countries had already been middle-income countries. Though 30 years have passed, these countries are still middle-income countries. Correspondingly South Korea, Taiwan and other economies in Southeast Asia successfully step off middle-income countries, entering the ranks of high-income countries.

Minister Lou suggested a method which is to ensure the free flow of labor force, expand labor supply and enhance the flexibility of the labor market, including encouraging the import of agricultural products, further transferring labor force to cities, household registration reform especially the provinces and cities that agricultural labor force is most willing to settle, adjustment of existing Labor Contract Law for more flexibility and social insurance national co-ordination.

Indeed, these measures focus on the core obstacle of current economic transformation. China's economic growth is weak, because domestic demand stimulation of urbanization is inadequate and the key is still that local governments prefer selling lands and building houses, and the central government always wants to lead labor force to small towns.

But the reality of economic agglomeration is that jobs and economic output increasingly concentrate towards big cities. These cities are just more and more unfriendly to outsiders, allow them to take up an occupation, but not allow them to settle down and move their family to the city. Now the huge gap of GDP per capita between regions shows that it is due to limitation of household registration system, the labor force of backward areas can not improve labor productivity through flow of labor force. It also causes the shortage of labor force in developed areas and the wage rate grows far faster than the rate of labor productivity.

The harm of middle income gap lies not only in growth stagnation but subsequently greater and greater income gap, which is the main reason for long-term stagnation of economic growth. Defeat of Brazil is because Gini coefficient was as high as 0.6. International experience shows that countries successfully entering from middle income countries to high income countries had relatively low Gini coefficient (less than 0.4). The income gap of the countries that did not step over successfully but remained middle-income is great.

With respect to the consistency of the values and consumption preference of the olive-shaped society, too large income gap can easily tear the society. It is not easy to form a consensus in the society and it will cause crowd confrontation. When the government is providing public services, it will easily fall into the debate of high standards or low standards, and it can not meet the basic requirements of the low-income population and poverty population, making compromise and ignoring long-term economic development.

How to narrow the income gap? The prescription is still strengthening free flow of labor force and promoting market-oriented reform. Three major causes of the income gap lie in the gap between urban and rural areas, regional gap and inter-industrial income gap. The gap between the first two is mainly caused by restricted flow of labor force. Farmers and labor force in backward areas is the root of low income. And the gap between industries is mainly because the market-oriented reform is ineffective. In the future, the difference of education level will become an important factor of income gap, which means now the phenomenon that cities limit compulsory education of non household population needs to be banned, but also the enrollment system of higher education institutions should be adjusted, including province quota allocation, taking college entrance examination in different places and so on.

Published in Beijing News | 2015-5-7