Theoretical Analysis and Reflections on the “Middle-Income Trap”

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 Studying the “middle-income trap” will allow us to gain a penetrating insight into why economies are particularly susceptible to slower economic growth and the emergence of political, economic and social problems after entering the middle-income stage of development.

 I. Distinguishing between the quantitative transition from low income to middle income and the qualitative leap from middle income to high income

 In order to analyze the “middle-income trap,” we must first understand and define the different stages of development. The transition from a low-income economy to a middle-income economy very often takes place when a traditional agricultural economy enters the early stages of industrialization. Although this transition brings about significant changes to the form and contents of production, its nature as a labor-based activity remains largely unchanged. In the same way that traditional agriculture is characterized by repetitive labor, the early stages of industrial production mainly involve introducing and copying the creations and inventions of others, with little self-innovation taking place in the labor process. The transition from a middle-income economy to a high-income economy, on the other hand, takes place when an economy progresses from the early stages of industrialization to the advanced stages of industrialization. As a leap from repetitive labor to creative labor, this transition must be founded on the widespread occurrence of independent innovation. Different levels of repetitive labor and creative labor and the occurrence of qualitative change are distinct to certain stages of economic development. These are the factors that determine the transition to a different stage of economic and social development. Grasping this essential relationship gives us the fundamental means to interpret many of the problems that occur in the middle-income stage.

 In industrial growth, repetitive labor is manifested as extended reproduction. Following advancements in science and technology after the Second World War, developed countries began to restructure their industries at an accelerated rate and export capital and technology abroad. Through an integration of capital, technology, labor and the market, less developed economies were able to utilize their lower labor costs to emulate productive modes that had already been established in developed countries. Due to the absence of complex and creative activities in their production, these economies were able to achieve rapid development and give rise to seemingly miraculous economic growth. However, after entering the middle-income stage of development, some countries failed to realize the nature of their current stage of development. They believed that the transition from the middle-income stage to the high-income stage was a straightforward process of quantitative industrial development, and neglected the qualitative differences that define different stages. Unaware of the deeper issues that lay behind their “miracles,” blind optimism convinced them that the transition to a high-income economy could be achieved in the same way that production could be copied. On this basis, they set out to emulate high-income countries politically, economically, and socially without discretion. However, the result was far from what they expected.

 II. Differences in market policy deriving from capital accumulation and intellectual accumulation

 There are close connections between the middle-income stage and the high-income stage. As such, some economic policies and systems can be adopted in either stage, while others cannot. For instance, the high consumption policies implemented by high-income countries cannot be copied completely by middle-income countries. This is because of differences in the mode of accumulation that arise from fundamental differences in the nature of labor.

 August 30, 2011, World Bank President Robert Zoellick (left) being interviewed by reporters from the Xinhua News Agency at World Bank headquarters in Washington, D.C., U.S. Mr. Zoellick stated that China has made great achievements in economic development over the past decades, providing many lessons for other countries to draw from. At the same time, Mr. Zoellick also said that China needs to change its mode of economic growth in order to avoid the “middle-income trap.” / Photo by Xinhua reporter Zhang Jun

 Social and economic development is dependent on expanded reproduction, whereas expanded reproduction is dependent on economic accumulation. Different methods of accumulation determine different modes of economic operation. Traditional subsistence agriculture mainly relies on the direct accumulation of labor; the middle-income stage, which is characterized by extended reproduction, mainly relies on capital accumulation; whereas the high-income stage, which is characterized by expanded reproduction of the intensive type, mainly relies on intellectual accumulation. Different methods of accumulation lead to completely different economic phenomena, which become the basis for different economic policies.

 In early industrial societies, creative labor has yet to develop in terms of quality or quantity, and repetitive labor still exists on a widespread basis. Therefore, the economic accumulation required for expanded reproduction and social progress can only be acquired through capital accumulation, which means keeping wages down. This not only allows for the fruits of creative labor to be rapidly expanded, but also provides a material basis for the further development of creative labor. On the other hand, however, this also leads to progressively large imbalances between production and consumption, which in turn can result in the outbreak of an economic crisis characterized by surplus production. An important way out of this predicament has been to mitigate conflicts through the expansion of global markets.

 Western countries continued to face a surplus production crisis after the Second World War, albeit to a lesser extent than before. Although the strengthening of macro-control contributed to the mitigation of this crisis, the significant growth in both the quality and quantity of creative labor played a more crucial role, as this fueled rapid progress in the scientific and technological revolution and the division of labor in society, bringing about a series of social and economic changes. Firstly, the significant development of creative labor affirmed technical personnel and white collar workers as the mainstay of enterprises. As the status of intellectual labor was raised by the increasingly sophisticated and complex division of labor, enterprises were forced to pay these workers higher wages in order to remain competitive and ensure normal production, and in turn this led to an increase in levels of consumption. Secondly, the contribution of science and technology to economic growth became increasingly large as the accumulation of monetary capital began to be replaced by intellectual accumulation. Accumulation and expanded reproduction did not suffer with the increasing proportion of consumption; on the contrary, the increase in creations and inventions and the emergence of expanded reproduction of the intensive type as the main form of reproduction actually allowed them to become stronger. Thirdly, intellectual accumulation stimulated improvements in the quality and properties of products as opposed to simply increasing the quantity of products. This served to bring production and consumption into balance, stabilize the market, and allow accumulation to become an important factor in boosting domestic demand. Furthermore, creative labor resulted in the creation of more new products, as well as the continued renewal and expansion of the market. These were all important factors in the mitigation of the crisis.

 Clearly, the middle-income stage represents the early phase of industrial development. In this stage, expanded reproduction is dependent on capital accumulation, while the problem of surplus production is addressed by increasing exports. The high-income stage represents the middle and later phase of industrial development. With the transition from capital accumulation to intellectual accumulation, which results from the development of creative labor, the stimulation and expansion of consumption become feasible policies. However, if a middle-income country attempts to directly copy the practices of a high-income country, it will face the risk of becoming trapped in its current stage of development.

 III. The tendency for incomes and social safety nets to outgrow economic capacities in the middle-income stage

 Incomes and social safety nets can very easily outgrow economic capacity during the middle-income stage, even though there are cases in which they fall behind the pace of economic development. The middle-income stage is characterized by the shift of rural labor to industries in large numbers and the manifestation of industrial production as extended expansion. Firstly, the GDP tends to grow very quickly, with many countries having experienced two-digit growth. Secondly, revenue from taxation also increases rapidly, and may even exceed the growth of the GDP. Thirdly, the profits of enterprises rise rapidly, and significant increases are seen in the incomes at the absolute disposal of companies. Under these circumstances, it is easy to arrive at the conclusion that incomes, social welfare and social safety nets should also undergo relatively large increases. However, these increases in GDP, tax revenue, and corporate profits are in fact the result of greater economic extension, which means that neither the productivity nor the profit per capita in enterprises has actually been increased. Therefore, any increase in the levels of income, social welfare and social safety nets would place enterprises and society under greater pressure. Of course, total expenditure in social welfare will still increase along with the development of repetitive labor and the extended expansion of the economy. This is because the number of people covered by social safety nets will increase as labor relocates from agriculture to industry, resulting in higher total expenditure in social welfare. Some middle-income countries neglected the fact that their economies were still characterized by repetitive labor and extended expansion, and increased their levels of social welfare and social safety nets too early and too rapidly, which put their economies under greater strain. In particular, the problem is that extended economic growth will ultimately be constrained by factors such as labor, land, and the market, causing the pace of economic development to slow down. When this happens, rigid expenditure in social welfare will cause problems to be amplified. The government debt crises seen in some Latin American countries are connected to overly large increases in public expenditure such as social safety nets.

 During the middle-income stage, increases in tax revenue should primarily be devoted to education and key scientific research programs, so as to foster a more educated and capable population and raise the national capacity for innovation. At the same time, increases in corporate profits should primarily be devoted to the development of core technologies and the R&D of new products, so as to raise the added value of products. The rapid development of creative labor must take place before the social division of labor can evolve, before the professional knowledge and skills of laborers can be developed, before the economic status of individuals can be fundamentally raised, and before various social issues can be resolved with ease.

 IV. The tendency for the income gap to widen and social conflicts to emerge in the middle-income stage

 During the middle-income stage, the rapid extension of production in enterprises upsets the balance of the traditional agricultural society, leading to the restructuring of social interests. This situation, particularly when coupled with the widening of the income gap, can easily lead to the emergence of new social problems.

 Firstly, the accumulation of capital through the repetition of labor is the main cause of the widening of the income gap. Production in the middle-income stage is characterized by repetitive labor, extended expansion, and capital accumulation. On the one hand, this mode of production does not lead to increases in the per capita profitability of enterprises, and worker incomes remain at a low level. Therefore, the raising of incomes at this stage would increase the cost of production and reduce the capacity of enterprises to accumulate. On the other hand, extended reproduction means that enterprises make more in overall profits and pay more taxes, which provides conditions for the incomes of certain people to be raised. This is the main reason for the widening of the income gap in the middle-income stage. Whereas in the high-income stage, where rapid changes in the social division of labor have been promoted by creative labor, laborers gradually gain an advantageous position in their contention with the owners of private enterprise, and are able to secure higher incomes on the power of their expertise and technical abilities. Meanwhile, the payment of higher wages does not have an adverse effect on expanded reproduction of the intensive type in enterprises, and there is even the possibility that the gap in incomes will be reduced.

 Secondly, as the extension of production gives rise to faster urbanization and population concentration, social problems begin to spread at a notably faster rate and over a notably wider area than before. Urbanization is not just the product of industrialization; it is a condition for the further progression of industrialization. It is inevitable that urbanization will accelerate the clustering of the population and bring different interest groups into closer proximity to one another. This results in the faster transmission of social problems and the greater risk of instability.

 Thirdly, Western countries have capitalized on the problems of the middle-income stage to magnify social conflicts, pervert the process of political development, and make economic and social issues permanent in the middle-income economies. The developed countries of the West have enjoyed the economic upper hand since colonial times, and this has enabled them to use their excessive profits to reconcile domestic conflicts. In order to maintain their advantage, they have capitalized on the widening income gap experienced by countries in the middle-income stage to wreak economic and social havoc in these countries. Often linking political systems to so-called human rights, they do this by exporting their political systems under the banner of “democratization.” In excessively democratized systems, efforts to reduce the income gap are made not by limiting high incomes, but by increasing the earnings and welfare of low-income groups. However, the outcome is that the capacity to accumulate capital is weakened, the speed of development drops, and thus problems in employment intensify and new risks of social instability emerge. Some middle-income economies have been lured into this democratic trap by its seeming beauty, only to result in economic stagnation and social unrest. The most important thing for middle-income economies to do is to maintain political and social stability, create the conditions for economic development, and make the transition to the intellectual accumulation stage as soon as possible, thereby rooting out the fundamental causes of social instability.

 V. Several reflections

 First, although external conditions are important, it is internal factors that play the decisive role in surmounting the middle-income trap. In appearance, the majority of countries still caught within the middle-income stage are found in Latin America, Southeast Asia and Eastern Europe. None of these countries are allies of developed Western countries, and some have even been engaged in a state of long-term hostility with the West, suffering at the hands of Western interference and even sabotage. None have entered the ranks of high-income nations. However, there are other economies, such as the Republic of Korea and Taiwan, who are close allies of Western countries, and all are located on the “frontlines.” As their development accords to the interests of Western countries, they have received major support from the West. Many of the technologies and products of Western countries are open to them, although the provision of the same is restricted to other economics. Therefore, these economies have found it much easier to accomplish the leap from the middle-income stage to the high-income stage. That notwithstanding, profound internal factors are the essence of why economies fall into the middle-income trap, and these may include institutional problems or major policy mistakes.

 Second, we must give emphasis to both international and domestic initiatives in order to prevent China from falling into the middle-income trap. From an external perspective, given that China is a major country, its entry into the high-income stage is sure to have a huge influence on the global landscape. Some countries are unwilling to see such changes, and will do their utmost to contain and restrict China’s development, and lure us into the middle-income trap. In view of this, other than striving to secure a more favorable external environment through such means as diplomacy, the focus of our efforts must be devoted to domestic factors. Firstly, China is a populous country whose overall level of education and quality of labor are not yet high, which means that repetitive labor will continue to be our major characteristic for a considerably long period of time. Setting out to change this situation, the CPC and the central government have formulated sound strategies for long-term development, but it will take time for the effects to become apparent. Secondly, during the course of economic and social development, we must ensure that policies and directives are formulated and adjusted in line with the requirements of avoiding the middle-income trap. This is the main issue confronting us. We should lay particular emphasis on strengthening coordination in the formulation of economic policies and public policies.

 Third, we need to grasp the main issues in our consideration of domestic factors. Firstly, we must be guided by the correct theory in order to correctly understand our development stage and the essential features of our economy. Secondly, we must identify the key aspects of our initiatives. In regard to the economy, the most important aspects will be international trade, investment, income distribution, social safety nets and consumption, as all of these things will have a bearing on whether or not we can avoid the middle-income trap. Thirdly, we must coordinate our policy-making in these areas and consciously avoid the middle-income trap. Fourthly, through initiatives in publicity and education, we must ensure that cadres and ordinary people are aware of China’s basic national conditions and prevent them from having unrealistic expectations.


(Originally appeared in Qiushi Journal, Chinese edition, No.21, 2011)

Author: Research Fellow of the Development Research Center of the State Council of the People’s Republic of China

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