Will China escape the middle-income trap, or will it see its economic growth rate crash? This debate underlies the concern about how China will disrupt the global system as it approaches global power status. There are strategic policy and investment implications that one can draw from China's growth trajectory.
China could avoid falling into the middle-income trap if it breaks the constraints of population, capital, and productivity on economic growth. Consumption-led growth and industrial upgrading will be two of the key emerging themes in China's structural change story over the next thirty years, during which President Xi Jinping's "Chinese Dream" is supposed to yield some tangible results. The structural switch from quantity growth to quality growth has just begun. The ultimate question is who will benefit from China's transition from being the world's factory to a high-income, high-tech, and consumption-led economy.
China's annual GDP growth has fallen from double-digit rates between 1980 and 2012 to around 7 percent since President Xi Jinping took office in 2013. Growth is now expected to fall below 6 percent in coming years. This declining trend seems to vindicate warnings of the dreaded middle-income trap: the tendency of fast-growing developing economies to revert to a much weaker growth trajectory and stagnate when per capita income approaches the upper bound of the middle-income range between US$6,000 and US$12,000 a year. China's per capita income in 2018 was already US$10,200.
Economic growth is a function of the two factors of production--labor/population and capital--and a residual factor--productivity. As a country grows towards its production possibility frontier which defines the size of the economy, diminishing marginal returns set in. If there is no growth in productivity, overall economic growth will stagnant and eventually decline.
GROWTH CONSTRAINTS RELAXED?
Whether China can break out of the middle-income trap and move to a high-income economy depends on its labor, capital, and productivity constraints. Relaxing these constraints can increase the size of the economy. First, regarding labor, what is less well known about China's aging population problem is that it may not bite for another twenty years. Labor may not, in fact, be a growth constraint as commonly believed.
There are natural demographic dynamics for expanding China's labor force to counteract its contraction under the prevailing static framework. My...