Middle-Income Trap

An Analysis Based on Economic Transformations and Social Governance

Zhijie Zheng

• Publisher: Palgrave Macmillan
• Year: 2020
• Print ISBN: 9789811574009
• eBook ISBN: 9789811574016
• Topic: Business
• Subtopic: International Business
• Index: Business

This book explores the essence of the middle-income trap based on two major perspectives, namely "economic transformation" and "social transformation". China has experienced high-speed economic growth for nearly 40 years since the adoption of the Reform and Opening policies. However, China's economic growth has been slowing down significantly in recent years. Has China tumbled into the middle-income trap? This book reveals the essence of the middle-income trap is that a country's economic growth is facing a "double squeeze" in the middle-income stage, while the social structure and system are unsuitable for the new social development stage, which leads to economic stagnation or recession, and the aggravation of social contradictions, that is, the double predicament of economic transformation and social transformation. This judgment is of great value for understanding the problems encountered in the current development of China.

© The Author(s) 2020

Z. ZhengMiddle-Income Traphttps://doi.org/10.1007/978-981-15-7401-6_1

Begin Abstract

1. The Concept and Essence of Middle-Income Trap

Zhijie Zheng¹

(1)

China Development Bank, Beijing, China

Zhijie Zheng

Email: [email protected]

Email: [email protected]

End Abstract

Since the start of China’s reform and opening-up in 1978, it has experienced nearly 40 years of rapid economic growth, with its gross domestic product (GDP) per capita crossing the $1000 mark in 2001, surpassing $3000 in 2008, exceeding $8000 in 2015 and reaching $8123 in 2016.¹ But in recent years, economic growth has slowed down markedly. This is not only a fact, but also a new normal of social consensus. Has China encountered a middle-income trap? Can the development problems encountered by China be explained by the current concept of a middle-income trap and related theoretical framework? And can a reasonable solution to crossing the middle-income stage be found? To answer these questions correctly, we must accurately grasp the essence of the concept of middle-income trap. To understand the essence of middle-income trap, the concept must be reinterpreted in a context that goes beyond the experience of a particular country and a purely economic perspective. This means that the middle-income trap is understood not only as a problem that some developing countries may encounter in their own development, but also as a problem that all countries may encounter in the middle-income stage; the middle-income trap will not only be defined from the perspective of economic growth, but also understood from the perspective of social development.

1 Origin of the Concept of Middle-Income Trap

1.1 The Concept of Middle-Income Trap Was First Mentioned in World Bank Reports

In 2007, the World Bank published two reports on economic growth in East Asia, namely An East Asian Renaissance: Ideas for Economic Growth and East Asia & Pacific Update: 10 Years After the Crisis. In the reports, World Bank experts used economic stagnation in Latin America as a cautionary tale for the economic development of East Asia, and formally introduced the concept of middle-income trap. The World Bank used the concept of middle-income trap to describe the considerably long period of economic stagnation and slow economic development that developing countries fall into after entering the middle-income stage, and attributed the middle-income trap to the consequences of failure to transform the economy: the existing growth factors have been exhausted while new modes of growth have not been formed, resulting in bottlenecks in economic development. Some countries in Latin America and Southeast Asia are considered to be typical examples of countries that have fallen into the middle-income trap. Although there is still debate in the academic community as to whether the concept of middle-income trap is valid and whether it is of universal significance in describing the economic development of developing countries, it is an objective fact that some developing countries encounter development problems characterized by stagnation after entering the middle-income stage.

Historically, the economic development of Latin American countries has been characterized by slow growth. Relevant data show that in the early eighteenth century, the per capita income in North America was almost the same as that in Latin America, but since the beginning of the twenty-first century, the former has been five times the latter. If North America (especially the United States) is unmatched by any other region in its ability to sustain economic growth, making this comparison unfair, then the rapid economic development in East Asia in the twentieth century (especially in the second half) fully demonstrates that the development of Latin America is problematic. Most Latin American countries have joined the ranks of middle-income countries since the early 1970s, but in the 1980s, thanks to a debt crisis, the entire Latin American economy grew at an average annual rate of only 1.2%, and on top of that, currency depreciation and high inflation reduced the real GDP growth rate, with GDP per capita growing by only −1.9%. Especially in the 45-year period from 1963 to 2008, Argentina experienced 16 consecutive years of negative growth. Today, most countries in Latin America are still stuck in the middle-income stage. Most countries and regions in East Asia, on the other hand, made the leap from a middle-income country to a high-income country from the 1970s to the 1990s. Although East Asia was hit hard by the financial crisis in 1997, and many people also predicted that East Asian economies would repeat the fate of Latin America in the mid-1980s by falling into stagnation, but in the decade after 1998, the GDP of East Asian economies grew at an average annual rate of more than 9% and doubled. Since the 1950s, there has been a sharp contrast between Latin America and East Asia in economic development when compared to the United States in the same period. From 1950 to 1998, the ratio of the per capita income of East Asia to the per capita income of the United States rose from 8 to 16%, while in Latin America this figure dropped from 27 to 21%.² Compared with the rapid economic growth in East Asia, economic development in Latin America has almost stagnated or even regressed.

In the second half of the twentieth century, Southeast Asian countries generally experienced a period of rapid economic development. However, in the 10-year period around 2000, these countries experienced a sudden decline in economic growth and then stagnation. It was not until 2005 that the economic development of Southeast Asian countries returned to the 1995 level. Take Thailand for example. Since the 1960s, Thailand has implemented a “dual-track” economic development strategy characterized by equal emphasis on stimulating domestic demand and promoting foreign trade and investment, and has achieved rapid economic development. Since the 1990s, its economy has been growing at an average annual rate of about 8%. In 1995, Thailand’s per capita income exceeded $2500. As a result, the World Bank designated Thailand as a middle-income country. But since 1996, Thailand’s economic growth rate has dropped sharply to 6.9%, the lowest level in the past 13 years. Its current account deficits accounted for 8.3% of the GDP, and inflation rose to 6.2%. Another example is Malaysia, which experienced rapid economic growth from independence until the 1960s. By the 1980s, it had emerged from an agricultural society to become one of the “Tiger Cub Economies” that led the development of the region. But soon afterwards, due to the impact of the Asian financial crisis, its economic development also stagnated. Vietnam has witnessed rapid economic growth since its economic reform in the 1990s. In the last decade of the twentieth century, Vietnam’s GDP grew at an average annual rate of 7.6%. Since the first half of 2007, Vietnam’s inflation rate has continued to rise and its trade deficit has expanded rapidly. As a result, its sovereign credit rating was downgraded, its financial strength was weak, capital fled it, and its currency depreciated substantially.

1.2 The World Bank’s Description of the Middle-Income Trap

According to the World Bank’s 2017 standards, countries with a GDP per capita of less than $1005 are low-income countries; countries with a GDP per capita of between $1006 and $3955 are lower-middle-income countries; countries with a GDP per capita of between $3956 and $12,235 are upper-middle-income countries; countries with a GDP per capita above $12,276 are high-income countries. The concept of middle-income trap describes an important phenomenon in world economic development in the twentieth century where many countries can usually reach the middle-income stage quickly, but only a few countries can cross this stage, because the policy and institutional changes needed to achieve this leap are politically, technologically and socially more challenging.

The World Bank assigns the world’s countries into three income groups: high, middle, and low. It can be seen that in the past half-century, countries in different income groups have been shown to differ greatly in economic development. As can be seen from Fig. 1, measured by GDP per capita, high-income countries have been on a generally smooth, coherent and linear trend in growth; in stark contrast, the economic development of middle-income countries was virtually stagnant before the twentieth century, and only since the beginning of the twenty-first century have they shown a trend similar to that in high-income countries half a century ago when they were in the initial stage of growth; the growth of low-income countries is still stagnant. In the past half-century, high-income countries, middle-income countries, and low-income countries have differed greatly in economic development. This difference is reflected in the following three aspects.

Fig. 1

GDP per capita of countries in different income groups worldwide over the years

(Source World Bank website)

First, the absolute gap in economic development is quite large (see Table 1). In 1960, the GDP per capita of high-income countries was about $1257; the GDP per capita of middle-income countries was about $133; the GDP per capita of low-income countries was about $93; and the GDP per capita of China was only $90. The GDP per capita of high-income countries was 9.5 times that of middle-income countries, and the GDP per capita of middle-income countries was 1.4 times that of low-income countries. In 2015, the GDP per capita of high-income countries was $39,577; the GDP per capita of middle-income countries was nearly $4668; and the GDP per capita of low-income countries was $616. The GDP per capita of high-income countries was 8.5 times that of middle-income countries, and the GDP per capita of middle-income countries was 7.6 times that of low-income countries. From 1960 to 2015, the GDP per capita gap between high-income countries and middle-income countries did not shrink significantly, and the GDP per capita gap between middle-income countries and low-income countries widened significantly.

Table 1

GDP per capita of countries in different income groups (1960–2015) (USD)

Countries	1960	1970	1975	1988	1996	2013	2015
High-income countries	1257	2518	4716	14,654	22,092	39,116	39,577
Middle-income countries	133	195	376	710	1235	4814	4668
Low-income countries	93	133	237	276	264	722	616

Source World Bank website

Second, the economic development of middle-income countries and low-income countries is lagging far behind that of high-income countries (see Table 1). It was not until 1996 that the GDP per capita of middle-income countries reached the 1960 level of high-income countries, and it was not until 1970 that the GDP per capita of low-income countries reached the 1960 level of middle-income countries. Roughly speaking, based on the GDP per capita in 1960, middle-income countries are at least 36 years behind high-income countries, and low-income countries are at least 10 years behind middle-income countries in economic development. The GDP per capita of middle-income countries in 2015 was only equivalent to that of high-income countries in 1975, and the GDP per capita of low-income countries in 2015 was only equivalent to that of middle-income countries in 1988. Thus, based on the GDP per capita in 2015, middle-income countries are at least 40 years behind high-income countries, and low-income countries are at least 27 years behind middle-income countries in economic development. Therefore, from 1960 to 2015, the gap between middle-income countries and high-income countries widened from 36 years to 40 years, and the gap between low-income countries and middle-income countries widened from 10 years to 27 years.

Third, the economy of countries in different income groups grows at very different rates (see Table 1). From 1960 to 2015, the GDP per capita of high-income countries increased by 30.5 times, and the GDP per capita of middle-income countries increased by 34 times, while the GDP per capita of low-income countries increased by only 6 times. It took high-income countries about 15 years and middle-income countries 17 years to go from $1200 to $4800; it took middle-income countries 28 years (1960–1988) and low-income countries 43 years (1970–2013) to go from $133 to $722.

From the World Bank’s statements on the concept of a middle-income trap, it can be seen that the concept is obviously presented using the development of high-income countries as a frame of reference. On this basis, the development of middle-income and low-income countries which pursue a vastly different path of development than high-income countries is considered problematic. The problems faced by middle-income countries are conceptualized as middle-income traps. As can be seen from Fig. 2, since the 1960s, growth in the GDP per capita of developed countries in Europe and America has shown a steady upward trend. In particular, the growth curve of the United States is the smoothest. Other countries have been on a steady upward trend on the whole except for some fluctuations. The significant fluctuations resulted primarily from the 2008 financial crisis and secondly from the 1997 Asian financial crisis.

Fig. 2

GDP per capita of developed countries in Europe and America over the years

(Source World Bank website)

Globally, after World War II, only a few countries and regions, such as Japan and the Four Asian Dragons (China Hong Kong, China Taiwan, Singapore and South Korea), successfully overcame this hurdle in a short period of time to become developed countries and regions (Fig. 3). Japan reached the lower-middle-income level in 1966 and made the leap from an upper-middle-income country to a high-income country from the early 1970s (1972, 1973) to the early 1980s (1981). China Hong Kong and Singapore entered the upper-middle-income stage in the late 1970s and the high-income...

Table of contents

• Cover
• Front Matter
• 1. The Concept and Essence of Middle-Income Trap
• 2. Types of Middle-Income Countries and Lessons Learned from Their Experience
• 3. Problems and Challenges China Faces in the Middle-Income Stage
• 4. Overcoming the Middle-Income Trap Requires Improving the Economic Governance Capability
• 5. Overcoming the Middle-Income Trap Requires Improvement in Capacity for Social Governance
• 6. Participate in Globalization and Explore China’s Development Path
• Back Matter