Adjusting the Distribution of National Income to Avoid the “Middle-Income Trap”

From: English Edition of Qiushi Journal Updated: 2012-03-31 13:36
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 China’s status as a middle-income country was firmly established in the year 2010 when the country’s GDP per capita exceeded the US$4,000 mark. Despite this, however, the emergence of increasingly prominent social issues in China has prompted much thought and discussion over whether China will fall into the “middle-income trap,” and how it can avoid this from happening.

 I. The “middle-income trap” of modernization

 The experiences of various countries show us that a country’s modernization can be roughly divided into the following three stages: the first stage is the transition from a low-income economy to a middle-income economy, when a country manages to shake off poverty through the process of an economic take-off. This is a stage in which people universally benefit from rapid economic growth, social development thrives, and vitality goes hand in hand with stability. The second stage is the transition from a middle-income economy to a high-income economy, during which profound changes occur to economic and social structures. This stage is characterized by the existence of development opportunities alongside prominent conflicts. Therefore, while the right moves may bring about successful economic transformation and steady social development, the wrong ones may lead to economic stagnation and prolonged social turmoil. The third stage is the high-income stage, also known as the developed stage, which is characterized by the realization of modernization and the mature operation of society and the economy.

 Qiuke, a villager in Lancuoma Village, Mai’erma Township, Ngawa County, Aba Tibetan and Qiang Autonomous Prefecture, Sichuan Province, pictured in his permanent home on December 8, 2011. In an effort to improve the living conditions and resolve the practical difficulties of people in Tibetan areas, the government of Sichuan Province launched a scheme to build permanent houses for herders and provide them with new tents in 2009. / Photo by Xinhua reporter Dang Wenbo

 In 2007, the World Bank introduced the concept of the “middle-income trap” in its report “An East Asian Renaissance.” The middle-income trap refers to a situation in which an economy who has entered the middle-income stage is neither able to sustain its previous growth pattern nor able to fully break away from it. The result is that the country experiences prolonged economic stagnation and is unable to move forward.

 The experiences of many countries over the past few decades have shown that emerging economies tend to progress rapidly through the take-off stage of US$1,000-3,000 after escaping the “poverty trap” of US$1,000. However, once the GDP per capita reaches US$3,000-5,000, complex economic, social, political and technological challenges begin to emerge, and conflicts built up during the process of rapid development erupt in quick succession. With the intertwined emergence of numerous problems, such as slower or stagnant economic growth, the widening gap between the rich and the poor, unemployment, rampant corruption, the loss of beliefs, democratic turmoil, social turbulence, over-urbanization, struggling financial systems, and insufficient social services, a country may find itself in a prolonged predicament from which it is unable to escape. In some countries and regions, such as Mexico, Brazil, South Korea and Taiwan, the ruling parties which once led their societies through rapid economic growth were powerless to consolidate their ruling positions, eventually being ousted from power despite having created economic miracles. The “middle-income trap” has almost become a curse of emerging economies, preventing them from progressing to the next stage of development.

 II. China has entered a period of increased social conflict

 Over more than three decades of reform and opening up, China, a large developing country with a population of 1.3 billion, has created an unprecedented miracle in the history of world development. China has managed to sustain its rapid economic growth, social vitality, and political stability, a trend which reached a relative climax with the successful holding of the Beijing Olympic Games in 2008. However, the impact of the international financial crisis has caused China’s difficulties in economic development to increase substantially, and various social issues have become much more pronounced.

 Economically speaking, the pitfalls of China’s imbalanced, uncoordinated and unsustainable development have become increasingly prominent, and China is coming under increasing pressure to transform its pattern of economic development as various conundrums emerge. In essence, these problems point to a predicament in which China is neither able to sustain the mode of development it has previously relied on nor able to discard it in the short term. Considering the fact that no risks are greater than economic risks, China’s overbearing task is to ensure economic stability. 

 From a social perspective, conflicts among the people have occurred frequently and in various forms. Many issues of great public concern have yet to be effectively resolved, and there is significant public dissatisfaction over corruption, the unequal distribution of wealth, high housing prices, rising goods prices, food safety, and the infringement of personal rights and interests. In the Internet age, there have been numerous cases of isolated incidents triggering large-scale public disturbances and even social turmoil, and these risks are enormously difficult to guard against.  

 In regard to ideology and politics, both rightist and “leftist” tendencies of thought have emerged. Rightists oppose the leadership of the CPC and the socialist system, advocating the emulation of Western models in China, while “leftists” oppose China’s reform and opening up policies, advocating that China should resort to its former policy of isolation, and even launch another “Cultural Revolution.” Rightist trends of thought have become the major threat under the backdrop of current internal and external environments. 

 Internationally speaking, a so-called “wave of democratization” has spread rapidly under the orchestration and influence of Western countries, resulting in the prevalence of “street politics.” Moreover, Western hostile forces are stepping up their efforts to westernize and divide China.

 However, in spite of numerous adverse conditions, it should be noted that social stability is prevailing in China, which is mainly attributable to the fact that China’s economy is still growing, and because the majority of the population are still optimistic about the future prospects of China’s development. In addition, the Party and the government have given people hope by responding actively to issues of great public concern. This is a rare situation that puts China in an ideal position to address problems, prevent risks, and overcome difficulties. Therefore, the Chinese government needs to take the necessary precautions to prevent China from falling into the “middle-income trap.” It must view issues in the context of overall strategies and policies for national development in order to plot a safe path forward. 

 III. “Making the pie bigger” and “dividing it fairly”

 China has captivated the world with its incredible achievements in development. However, the basic reality that China is still in the primary stage of socialism, and will remain so for a long time to come, has not changed, nor has the principal contradiction in Chinese society—the disparity between the ever-growing material and cultural demands of the people and our backward level of social production. Therefore, development is still the key to the resolution of all of China’s problems. What we require is scientific development, namely, development that is comprehensive, balanced, sustainable, and oriented towards the people.

 Economic development should not just imply rapid growth, but also rational distribution. In other words, not only should we make the pie bigger, we should also share it out fairly. Constant economic growth lays down the material foundation for distribution, while rational distribution provides a long-term driving force and a stable social environment for economic growth. The rational and effective allocation of resources in production and distribution is an important precondition for the establishment of a virtuous cycle in economic development. Therefore, resolving the issue of income distribution does not contradict our commitment to the notion that development is the absolute principle; on the contrary, it is essential to the application of the Scientific Outlook on Development and the transformation of our pattern of economic development.

 Distribution is an important aspect of social relations of production. If relations of distribution are not handled correctly, relations of production as a whole will be unable to effectively meet the needs for the development of productive forces. Equality and justice, as essential requirements of socialism, are both manifested in relations of distribution. The socialist system of distribution is founded on the principle that work must be the predominant determinant of distribution, and if this cannot be done, the realization of common prosperity will be impossible. Therefore, the issue of distribution is not just about the positive operation of economy, but also about whether China truly adheres to socialism.

 The initial breakthrough in China’s economic reforms was made in regard to income distribution. The major policies of abolishing egalitarianism and encouraging some people and some regions to become rich first did a great deal to motivate the working people and liberate the productive forces of society. In essence, the reform of the public sector of economy in China’s urban and rural areas was an attempt to adjust relations of distribution without changing the predominant role of public ownership. A fundamental reason why developed Western countries have been able to maintain social stability on a long-term basis lies in the fact that they have made constant adjustments to the distribution of income. Through the implementation of policies to ensure high welfare, high earnings, and high consumption, these countries have been able to effectively mitigate class conflicts without making drastic changes to the system of private ownership. The employees of large transnational corporations of capitalist countries, much like their counterparts in China’s state-owned enterprises, do not personally experience corporate ownership. Instead, they are motivated by a distribution system which ties their income to their job performance, and this is where the vitality of corporate operation comes from. In summary, relations of distribution can play a prominent role in relations of production without changing the system of ownership. They are crucial to the reform and adjustment of relations of production in order to continuously liberate and develop productive forces and promote the overall progress of society.

 Deng Xiaoping, the chief architect of China’s reform and opening up, afforded much thought to the issue of distribution in his later years. He was far-sighted enough to point out that: “How do we make 1.2 billion people rich? How should wealth be distributed once they have become rich? These are both serious issues. The question of distribution will be more difficult to solve than the question of development. Distribution is a big issue. Though we are eager to prevent polarization, the fact of the matter is that polarization is something that occurs naturally at a certain stage of development.” Deng Xiaoping also stated that: “The country is certain to run into trouble if a small minority acquires too much wealth while the majority has too little. Unfair distribution will lead to polarization, and after a certain period of time, this will start to cause problems. This is a problem that must be resolved. In the past we put development first, but the way things look now, we have as many problems as we did before we developed.”

 Following the founding of the People’s Republic of China, the relationship between accumulation and consumption was generally handled in accordance with the principle that “We must attach importance to both subsistence and development.” However, in reality, high accumulation and low consumption has been a long-term problem. Since the launch of reform and opening up policies, a long-term imbalance between investment and consumption has persisted, with the rate of investment remaining high while the ratios of consumption and resident incomes to GDP have continued to decline. Despite this, however, we must acknowledge that under specific historical circumstances, this was both an inevitable and a rational approach, one that resulted in the constant and rapid development of the Chinese economy. However, the consequences of this approach are now emerging: low consumer spending has become the biggest worry of the Chinese economy, and China’s current pattern of development is becoming increasingly difficult to sustain.

 In recent years, the Chinese government has repeatedly emphasized the importance of devoting greater efforts to ensuring and improving the well-being of the people. On this basis, a series of relevant policies and measures have been adopted, and expenditure in this regard has increased on a yearly basis. However, the tendency for local governments and enterprises to overemphasize accumulation and growth whilst neglecting consumption and distribution, a mindset which has developed on a long-term basis, has yet to be fundamentally changed. Some leading cadres at the local level still regard rapid development as the top priority. Preoccupied with GDP ranking, fiscal revenue, urban appearance, high speed transportation and infrastructure, they are yet to place the improvement of public well-being high up on their agendas. If this notion of development cannot be changed, we will stand no chance of transforming our pattern of development.

 IV. The distribution of income is the key to avoiding the “middle-income trap”

 Looking at the experiences of various economies, we can see that while some economies have been unable to free themselves from the “middle-income trap,” there are also cases where economies have managed to surmount it. Latin America falls into the former category, with 28 of its 33 economies being middle-income economies. These countries have been caught in the “middle-income trap” for an average of 37 years, while Argentina has been a middle-income economy for as long as 50 years. In stark contrast to Latin America are Japan and the “Four Asian Tigers” (Singapore, South Korea, Hong Kong and Taiwan), whose rapid development was dubbed “East Asia Speed.” All managed to achieve the leap from middle-income to high-income within the space of 20 years, with South Korea making the transition in just 8 years. While there are many reasons for these stark differences, the extent to which these economies addressed the issue of income distribution was one of the most fundamental factors.

 In the 1970s, the Gini Coefficient of Latin American economies reached 0.44-0.66, while Brazil’s Gini Coefficient was still as high as 0.64 by the end of the 1990s. Latin America is generally regarded as having the most unequal income distribution in the world. Extremes between rich and poor are commonplace in some Latin American economies, where there are sharp contrasts between the luxurious areas where the affluent live and the shanty towns of the poor. Polarization has led to a highly unstable inverted T-shaped social structure, resulting in continued social and political turmoil that has taken a serious toll on economic development. With the introduction of neoliberal policies represented by the “Washington Consensus,” these economies once assumed that the resulting economic growth would lead to an improvement in social conditions. However, this approach not only failed to mitigate polarization, but actually made it worse. Since the turn of the century, public demand for social equality and widespread opposition to polarization has fueled the rapid rise of left-wing forces in Latin America, with most Latin American economies now being ruled by left-wing parties. Despite this, however, 32.1% of the population in Latin America was still living in poverty at the end of 2010.

 In contrast, Japan and the “Four Asian Tigers” maintained a tight focus on the even distribution of wealth during the course of their respective economic booms. In the 1960s, when the annual growth rates of Japan’s national economy and central government revenue were 10.9% and 16.3% respectively, Japan seized the opportunity to establish a social safety net that covered all of its citizens. Moreover, by implementing a plan to double national income, Japan was able to increase the wage earnings of all social classes and establish a mass consumer society, which laid down the foundations for its sustainable economic development. In the 1970s, South Korea began to carry out the “New Community Movement” to significantly increase rural incomes. In the 1980s, it launched four basic welfare plans covering income, medical care, education and housing, which led to the simultaneous increase of both urban and rural incomes. From the 1960s to the 1980s, the Singapore government gave priority to employment and high-quality public housing. During the 1990s, it set up a healthcare fund, an Edusave fund, and public assistance subsidies, which were primarily funded by government contributions. Taiwan’s Gini Coefficient dropped on a constant basis during 20 years of rapid economic growth, with the proportion of wage income in national income increasing from 40.8% in 1951 to 60.8% in 1979. There is a great deal that China can learn from both the positive and negative experiences of these economies.

 V. The likely positive effects of adjustments to national income distribution

 Resolving the issue of income distribution is essential for the next step of China’s development. Whilst continuing to “make the pie bigger,” we must devote more energy to the matter of “dividing the pie fairly,” and commit ourselves to adjusting the distribution of national income. By devoting a larger proportion of the “pie” to the improvement of public well-being, we will significantly raise the income and consumption levels of urban and rural residents, and in particular average workers, and effectively narrow the income gap. There are many advantages of this approach, and even the possibility of huge positive effects.

 1. Political effects

 Significantly increasing the incomes of urban and rural residents, and in particular average workers, would allow us to effectively narrow the income gap. Doing so would not only serve to mitigate social conflicts rapidly and significantly, but would also be met with a high level of public support, thereby bringing about huge political benefits. Therefore, this is a fundamental step for the implementation of the Scientific Outlook on Development, which puts people first, and building of a harmonious socialist society. It is a practical way for us to demonstrate that development is for the people, dependent on the people, and beneficial to all the people. Moreover, it is also an inherent manifestation of the Party’s tenets of putting the people first and governing for the people, as well as the principle of common prosperity through socialism. Doing so would be certain to enhance the affinity that draws the Chinese people to the Party, and further consolidate the political foundation for common endeavors between the Party and the people. In addition, this would be the best response to doubts from all over the world about China’s mode of development.

 2. Economic effects

 We should realize that there are a number of economic problems that could emerge as incomes increase by a large margin. For example, we will face the task of keeping inflation under control while incomes are rising. The increase of incomes will inevitably increase the risk of inflation, and the positive effects of any increase in income will be compromised if prices rise at the same time as incomes. Secondly, we will face the challenge of raising rural incomes as wages in urban areas increase. If we are unable to increase rural incomes when urban employees are enjoying universal wage increases, the gap between urban and rural incomes will become even larger. Thirdly, we will face the problem of maintaining our economic competitiveness as wages rise. Increases in wage levels will inevitably increase the operating costs of enterprises, which could undermine the competitive edge of not just these enterprises, but even the Chinese economy as a whole. Fourthly, we will face the problem of encouraging business ventures while trying to inhibit excessively high incomes. The regulation of excessively high incomes through taxation is an important means of narrowing the income gap. However, this might discourage entrepreneurs and people wishing to start their own businesses, making them anxious about the volatility of state policies.

 These problems must be taken seriously and handled appropriately in an effort to keep risks and costs to a minimum. However, upon weighing up both the advantages and the disadvantages, we will find that allocating a larger proportion of the “pie” to the improvement of the public well-being will come to have far-reaching benefits. First, the huge potential for China’s future development lies in its domestic markets, and domestic demand will be the long-term foundation for the sustained development of the Chinese economy. Therefore, as if starting up an engine, the drive provided by higher levels of mass consumption will unleash the inherent impetus for development and creativity that is locked within Chinese society. Whereas the main task of China’s economic reforms over the past three decades has been to develop the socialist market economy, the focus of our economic reforms hereafter should be shifted towards the development of a “mass consumption society,” or in other words, a moderately prosperous society of a higher level. This is essential if China is to achieve the fundamental transformation of its pattern of economic development. It is the key to the resolution of various deep-rooted problems in the operation of the economy, the foundation for the building of a harmonious socialist society, and the only way for China to achieve modernization. Second, though reductions in investment might lead to a temporary slowdown in economic growth, thereby increasing employment pressure, higher levels of consumer spending will stimulate the development of service industries, which will be able to absorb large numbers of workers. Therefore, the likelihood is that this will not adversely affect employment, and may actually serve to reduce employment pressure. Third, though wage increases are likely to increase the operating costs of enterprises and weaken their international competitive edge, this is a price that must be paid. We will be able to use this situation to compel the transformation and upgrade of China’s industries, which will exert a compensatory effect. Fourth, enhanced levels of income and consumption imply the pursuit of higher standards of living, which means that higher requirements for the quality of products and the environment will be exerted through market forces. This trend will drive forward the transformation of China’s pattern of economic development, stimulate innovation and the upgrading of industrial structures, promote the development of a resource-conserving and environmentally friendly society, and also serve to resolve the issue of food safety, which has long plagued Chinese society, as fake and shoddy goods will lose their markets. Fifth, increasing incomes will lead to more spending on cultural products and promote the development of the cultural industry, thereby creating new avenues for economic growth. In summary, the positive effects of the adjustment of distribution on economic development could be huge and far-reaching. We have no way of completely ascertaining the full extent of these effects at present.

 3. Social effects

 Many of the social issues which are plaguing contemporary China are closely related to the gap between the rich and the poor. These issues include: the spread of corruption to all sectors of society; high crime rates; the persistence of social evils such as pornography, gambling and drugs; the swindling, production and trade of fake goods; the lack of integrity and the decline of morality; the frequent occurrence of conflicts, mass public disturbances and especially incidents where the interests of participants are not directly involved; hate towards government officials and the wealthy; and the rash mentality that is present in almost all social strata. Social realities, such as a startling gap between the rich and the poor, the emergence of a minority who has become rich overnight, and a gaping divide in consumption levels, have exerted a strong impact on the social mentality and created widespread mental anxiety. As a result, many people are eager to pursue quick and easy success, willing to gain by cheating or through force, or act recklessly to vent their grievances. It can be said that polarization and the huge gap between the rich and the poor is the root cause of the numerous social problems that we are facing. Without eliminating the root cause, we cannot expect to achieve positive effects through ideological education and social management alone.

 China is not the only country that has faced such problems. In fact, other countries have experienced similar problems during the course of their development. The experiences of developed countries tell us that in order to make it through this stage of conflict smoothly, it is essential that we foster a large middle class and develop a social structure in which middle income earners represent the majority. This structure, referred to as the “bell curve,” is characterized by being more stable, more harmonious, and conducive to the long-term stability of the country.

 VI. Giving priority to the improvement of public well-being to encourage people from all ethnic groups to strive for better standards of living

 At the Seventeenth National Party Congress, the idea of “middle income earners accounting for the majority” was presented as a new requirement for the building of a moderately prosperous society in all respects. This is a highly important requirement, and prompt action must be taken to ensure that it is fulfilled. Our efforts to adjust the pattern of distribution should be approached with a sense of urgency, and no time should be lost in the formulation of a relevant road map and timetable. While seeking to make steady progress in the adjustment of our income distribution, we should also place emphasis on the importance of making significant progress over the next few years, as this will ensure that we are able to establish a moderately prosperous society at a higher level and achieve a “bell curve” social structure by the year 2020. We need to set the improvement of public well-being as a principle for development, and identify the adjustment of national income distribution and the appropriate tilting of social wealth towards the improvement of public well-being as a major policy, so as to greatly encourage the public to strive for higher standards of living.

 Adjustments to the pattern of distribution require top-level design. This consists of establishing an appropriate ratio between investment and consumption, or in other words, dividing the “pie” well. We must be resolute in our commitment to allocating a larger proportion of the “pie” to the improvement of public well-being, even if this means sacrificing a degree of GDP growth, canceling certain projects, or postponing the construction of certain high-speed railways and roads. We also need to engage in meticulous research and design schemes, formulate systematic policies through in-depth study, carefully consider and address the development requirements of all sectors of society, and balance out various interests rationally so as to embody social equality and justice and motivate all sectors of society. Doing so will allow us to put equal emphasis on “making the pie bigger” and “dividing it fairly,” and truly form a pattern of distribution that is rational and orderly.

 A large proportion of the “pie” for public well-being should be allocated to the social safety net. This is a practical choice for China, who, unlike other middle-income countries, has a dualistic, urban-rural structure and an urbanization rate of less than 50%. Considering that more than half of China’s population still lives in rural areas, we will be in no position to increase the incomes of other social strata if rural incomes cannot be increased or are not increased adequately. The increase of rural incomes cannot be done by dramatically increasing the price of agricultural produce, as this would lead to an overall increase in goods prices. Instead, we need to increase rural incomes by providing various types of government subsidies in agriculture and increasing the wage income and property income of rural migrant workers in urban areas. A prominent manifestation of our unequal distribution at present is the lack of order in income distribution, with “off-the-books income,” “disguised income” and even illegitimate income existing in large numbers. Although it will be very difficult to rectify and regulate the distribution of income, if we adopt an indulgent attitude, the problem will become worse. This is exactly why we should regard improving the social safety net as the focal point of our efforts to benefit the general public and raise the overall standard of living, particularly in rural areas. Currently, China’s social safety net is still incomplete with a number of problems to be resolved. In addition to raising minimum standards of living, the focus of our efforts to build a social safety net covering all urban and rural residents should be housing, education, medical care, and pensions. Efforts in housing, in particular, require that we re-establish a system for the provision of housing support. In addition to expanding the coverage of this safety net, we also need to raise the standard of the benefits that it provides, as this increase will make it much easier for distribution to be regulated.

 Only by increasing overall wage levels by a significant margin and tilting income distribution in favor of average workers can we establish a mass consumption society and harness the internal driving force for the sustained and steady growth of the economy. Wages are the main source of income for average workers. Given that China is a socialist country whose income is distributed on a work basis, there is no way that we can justify low wage income on a long-term basis and the constantly shrinking proportion of labor remuneration in the primary distribution of income. Any talk of controlling or narrowing the gap between the rich and the poor is pointless if the income level of average workers is not raised. In light of the fact that the wage incomes of rural migrant workers have now become the main source of rural incomes, accounting for over 50% of rural incomes, wage increases will also be beneficial to rural residents.

 It is common for a society to be more worried about inequality in wealth distribution than lack of wealth. Therefore, the focus of our efforts to adjust the pattern of distribution must be directed towards narrowing the gap between the rich and the poor. As a fundamental mechanism of the state, the tax system is a fundamental means of adjusting income distribution. Though taxation has contributed significantly to the Chinese economy, the tax system is still in need of improvement. There are many problems in regard to tax collection and management, and one of the most prominent is the lax taxation of high income earners. Many people have become rich extremely rapidly, not through hard work, but by speculating in real estate and stocks, evading taxes, gaining possession of resources at low prices, and doing business in industries that make colossal profits. Since their money has come too easily, they have no qualms about spending it, but they tend to do this on extravagant consumption instead of investing in industry. For this reason, it is perfectly justifiable that we impose high progressive taxes on these people and enforce them stringently. Rich people should be sensible about their wealth. They should realize that the polarization of rich and poor will not be of any benefit to them, and that their fundamental interests lie in a harmonious and stable society. The only way that they can genuinely win the respect and protection of society is by paying taxes in accordance with the law, investing in industry, donating to charity, and taking other measures to repay society. Tax departments are among the most important law enforcement organs, and the one that needs to be strengthened most urgently. They require a larger contingent of well-trained staff in order to comprehensively raise their level of law enforcement. At the same time, we need to constantly improve our tax system and tax laws, and use tax as a means of promoting greater equality in incomes.

 China is currently at a very crucial stage of its development. As long as we adhere to the leadership of the CPC, remain committed to the path and the system of socialism with Chinese characteristics, formulate and implement the correct strategies and policies, and come together in a common endeavor, there is absolutely no doubt that we will be able to overcome all difficulties and obstacles, successfully surmount the “middle-income trap,” and welcome bright prospects for national rejuvenation and the happiness of the people.


(Originally appeared in Red Flag Manuscript, No.18, 2011)

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