Zhenyu ,

Anhui Longcom IOT Co., Ltd., Hefei 230000, China

AbstractThe middle income trap is an objective challenge faced in the development of the economy. There is provision in both the amount and time. It is worth studying why some Latin American countries have fallen into this trap for decades. This paper analyzed the causes for the middle income trap of Latin American economies. On this basis, it came up with recommendations for China’s leaping paths, including accelerating the structural reforms on the supply front to promote industrial transformation and upgrading, deepening the reform and increasing the efficiency with institutional innovation as the core, protecting legitimate property rights, reforming the income distribution, combining accurate poverty alleviation, narrowing the gap between the rich and the poor, performing administration according to laws, vigorously developing education, expanding the opening up, and keeping sustainable growth, so as to successfully leap over the middle income trap.

Key wordsMiddle income trap, Economic growth, Institutional innovation, Targeted poverty alleviation, Expanding the opening-up

1 Introduction

The middle-income trap is an objective challenge faced by most economies. In 2011, China entered the middle-income stage. Due to restriction of domestic and foreign development patterns, the growth rate of China is declining and economic development is faced with challenges, so the risk of falling into the middle income trap is increasing. As to whether China will fall into the middle-income trap, different scholars have different opinions. In 2015,People’sDailydiscussed issues such as how China can leap over the middle income trap. A more accurate definition of the connotation and characteristics of the middle-income trap and a clear understanding of causes for this trap are the basic preconditions for exploring China’s path to leap over this trap. In 2007, in the articleAnEastAsianRenaissance:IdeasforEconomicGrowthissued by the World Bank, the middle income trap was first introduced to warn new economies in East Asia, that if their development will not bring the scale economy effect, they would fall into the middle income trap like Latin American countries. Not all economies that enter the middle-income stage will fall into the trap, but most of them will not be able to leap over and fall into it, and some will not be able to leap over the trap for as long as 60 years. This trap is an objective challenge in the process of economic growth. Its basic connotation lies in the fact that the economy’s staying in the middle-income stage exceeds a certain time limit and cannot leap over the trap and enter into the ranks of high-income economies. In essence, it is an issue of economic growth.

The middle-income trap has two dimensions: amount and time. According to the World Bank’s 1987 grouping criteria, the per capita gross national income (GNI) of 976-3 855 USD was classified into the lower and middle income group, 3 856-11 905 USD was classified into the upper and middle income group, and those exceeding 11 905 USD were classified as high income group. This is a dynamic classification standard. In some studies, the per capita gross domestic product (GDP) was taken as the standard, and the boundary values were roughly the same.

Ahtukoralaetal. used the purchasing power parity method of economic historian Madison to estimate the per capita GDP of countries and constructed a catch-up index (CUI) relative to the US level[1]. They defined countries with aCUIgreater than 55% as high-income countries, andCUIbetween 20% and 55% are middle-income countries, and below 20% are low-income countries. In 132 countries that were compared, 32 countries were defined as middle-income countries in 1960 and 24 countries were middle-income countries in 2008. Such method confirms to some extent the existence of middle-income trap. Data indicate that about 50% of middle-income countries have a chance of falling into the middle-income trap. Even if there are inter-group flows, the probability of a downward trend is even greater, so the difficulty of leaping over the middle income trap is great.

The middle-income trap emphasizes the time, mainly characterized by too long middle income stage and difficult to leap over this stage. Studies have shown that if an economy stays at the middle-income stage for longer than 30 years, it is deemed as falling into the middle-income trap. Before the 21st century, countries that were struggling in middle-income countries and failed to achieve a successful transformation of their growth model are deemed as falling into the middle income trap. The phenomenon of middle-income trap is not absolutely the same. Based on the assumption of diminishing marginal returns to capital, the early economic growth theory expected that countries with low per capita income levels at the start of catch-up could achieve higher economic growth rates and gradually form a convergence of per capita income level. However, these inferences are not consistent with the actual development situation of the world economy. In fact, the middle-income trap is often used as a synonym of Latin American trap. It focuses mainly on the consequences of falling into the middle-income trap and less on the causes of falling into the trap.

2 Causes for the middle income trap

The middle income trap is not a general economic law, but it is an objective economic phenomenon. In the whole world, leaping over this trap is not easy. The decline in economic growth in Latin American and other economies, and even long-term lingering, is a reflection of lack of motivation, backward development mode, and inappropriate economic strategies.

2.1 Lack of growth impetus directly leading to falling into the trap

The slowdown in growth only manifests the economy’s falling into the middle-income trap. Its essence lies in its lack of economic growth impetus. New economies generally experience three stages: factor-driven, investment-led, and technological progress and innovation driven. If there is slowdown or even long-term lingering in the first two stages, especially at the second stage, it means falling into this trap. At the middle income stage of Latin American countries, shrinking external demand and insufficient domestic demand have made the economic growth lose a great engine. Due to rising labor wage costs, the comparative advantage of labor-intensive industries at the low-income stage has been increasingly lost, and low-end products lack international competitiveness. They have not yet possessed the comparative advantage in technological innovation, lacked the international competitiveness of high-end products, and their exports were depressed. Domestic demand is constrained by the problem of income distribution, the disparity between the rich and the poor and the lack of domestic consumer demand, and sluggish growth are main causes for economic downturn. In this dilemma, Latin American countries have to stay in the middle income stage for a long time.

2.2 Backward development methods and inappropriate economic strategies being the underlying causes

Economic development strategies of developing countries generally rely on the export arrangement of raw materials and primary products, followed by import substitution then export-oriented strategy. The extensive development of internal resource-intensive consumption lacks long-term momentum and is not sustainable. According to Marx’s labor value theory, high-end products have high content of science and technology, contain complex labor and a large amount of commodities, while labor-intensive and other low-end industries have low technological content, low industry barriers. Besides, supply often exceeds demand, and part of social labor time is wasted, these resources or labor-intensive low-end products are bound to be sold below their market value, and will eventually be occupied by competitive industries with higher labor productivity. The mechanism of "smile curve" (Fig.1) also shows the disadvantages of being at the low end of the value chain and producing low-end products. In the context of economic globalization, if developing economies can only engage in product assembly and manufacturing at the lowest end of the value chain, and the industry is in a backward state for a long time, they will fall into the economic attachment to advanced economies. In this passive state, the lack of economic growth in developing countries will make them difficult to leap over the middle income trap[2].

Import substitution industrialization strategy distorts the market and hinders technological progress. At the early implementation stage, this strategy had promoted the economic development to a certain extent. However, measures such as foreign exchange control and prohibitive duty distorted the market price and wages, leading to wrong allocation of resources, unfair income distribution, and social instability, consequently leading to vicious circle and economic stagnation of Latin American countries. The long-term implementation of the import substitution strategy is one of the reasons for falling into the trap. The export-oriented strategy relies on external demand. Once external demand shrinks, exports will slow down, economic growth will be hindered, labor wage costs are increasing, and they lose their comparative advantages and are difficult to sustain.

Fig.1 Smile curve

No matter it is factor-driven, investment-driven or innovation-driven, the effects are declining, and it needs kinetic energy to sustain growth before reaching the marginal extreme value. Combined with the analytical framework of economics, Fig.2 illustrates two big transformations from low level poverty to high income stage, higher stage may be entered only through realizing economic transformation[3]. At the middle income stage, it is required to break through the bottleneck of economic growth and avoid pitfalls. The necessary condition is realizing economic growth from the past factor input and resource flow reconfiguration to total factor productivity and labor productivity improvement. It is required to make effort to realize this qualitative change and build economic growth on the basis of innovation-driven economic development with long-term sustainability[4]. Therefore, we always stress the need to change the mode of economic growth.

2.3 Unfair income distribution and disparity between rich and poor indirectly leading to falling into the trap

In the 1960s and 1970s, Latin American countries developed rapidly and most of them entered the middle-income stage. Consistent with the Kuznets Hypothesis, Latin American economies had a wide gap between the rich and the poor at this stage, the intensification of social conflicts, conflicts between the classes, and political changes and social turmoil, seriously jeopardize the healthy development of these economies. Vested interest groups would fight against reforms, which seriously hindered the implementation of measures to narrow the income gap[5]. Only through establishment of a new government, can it achieve fundamental changes to reduce income disparity. When established, new government implemented a fiscal policy to raise the income level of low-income people to narrow the income gap, but it did not support the corresponding financial strength. The deficit also caused great financial pressure, the policy was unable to support the technological innovation of enterprises and hindered economic development[6]. Driven by populism, the new government blindly copied the welfare system of developed economies, leading to a rising fiscal deficit[7]. Financial pressure led to galloping inflation and people’s resentment. New government was forced to leave office, and failed to care about stable economic growth. The superposition of the above-mentioned multiple causes will lead to slowdown in the middle-income stage. If the economic growth rate is greatly reduced, if the nature of the problem is misidentified, the policy will deal with the problem and even cause artificial distortions, and slowdown may deteriorate into stagnation. If the reason for the deceleration is that the potential output capacity declines, and the policy stimulates growth in terms of demand, it will lead to a series of distortions and adverse consequences. For example, distortions in the prices of factors of production, inflation bubbles, overcapacity, and zombie companies that have generated inappropriate protection have led to economic stagnation, institutional rigidity, and economic growth that are difficult to overcome.

Fig.2 Turning points and breakthrough strategies for economic growth

3 Recommendations for China leaping over the middle income trap

It is easy to see that the essence of the leaping over the middle-income trap is still the issue of sustainable and healthy economic growth. Under the constraints of international and domestic market conditions, constraints on resources and the environment, and population aging, to leap over the middle income trap, China must promote steady growth and keep steady growth.

3.1 Keeping moderate growth is a necessary condition for leaping over the trap

To get rid of the middle-income trap, development is still a top priority. China’s growth rate must be higher than that of developed countries and keep a relatively high per capita GDP growth rate. Calculated at 30 years, China experienced 12 years at the lower middle-income stage. Starting from 2010 when China entered into the upper middle income countries with per capita GDP of 4 561 USD, China’s would take 18 years to walk out of the upper middle income stage. Taking the lower limit of high income (12 745 USD) issued by the World Bank, China needs keeping 5.8% growth rate of per capita GDP for 18 years to leap over the middle income trap. The 13th Five-Year Plan clearly set forth making effort to leap over the middle income gap and formulated the economic growth rate of 6.5% in the next five years as the development goal. This is very scientific and reasonable. And the realization of this goal is highly correlated with whether China is able to leap over the middle income trap.

3.2 Realizing the transformation of growth mode and promoting the upgrading of industrial structure

According to the World Economic Information Network, China’s per capita GDP in 2017 was 9 481.88 USD, ranking the 70th in the world, and it has already reached the intersection of the period leaping over the middle income trap. To keep growing, the old mode is difficult to sustain, it is recommended to overcome the path dependence, transform the development mode, promote the upgrading of industrial structure, and explore new growth sources. As for the industry selection, it is recommended to bring into play the comparative advantage, and formulate pertinent policies in a targeted manner. According to Lin Yifu’s recommendations, catch-up industries should be combined with actual situations, with reference to the experience of countries with similar endowments and one time faster than China’s development. It is recommended not to aim too high, try to use countries with GNI higher than five times of China’s growth rate as samples. The government should provide policy support for curve road overtaking industries. To realize upgrade of different industries and upgrade within the same industry, it is recommended to march from the bottom to the top of the industrial chain. New areas must seize the commanding heights of the industrial chain. It is recommended to introduce a competition mechanism, vigorously promote the public-private partnership (PPP) mode, increase the production efficiency of state-owned enterprises, speed up the transformation and upgrading of industrial structure, and promote sustainable economic development. Besides, it is recommended to promote the coordinated development of regions and create more urban clusters to help realizing successful leap as soon as possible. Also, it is required to be vigilant to avoid excessive urbanization of Latin American countries.

3.3 Making the market play a decisive role in allocation of resources

Those who have taken the lead out of the middle-income stage are also those implementing the market economy. History has proven that the socialist market economy should also rely more on the market system. In the crucial period of marching towards high income, it is required to stick to the market economy system, get rid of non-market economy behaviors such as excessive macro-interventions and restriction of unfair competition[8]. It is required to stick to market-oriented deepening of reforms, allow decentralization between governments, and grant power to the market, to make the market play a decisive role in allocation of resources.

3.4 Looking for innovation areas of the supply front

After disappearance of demographic dividend and crossing the Lewis turning point, the decline in China’s economic growth is the natural result of drop of the potential growth rate, instead of the impact of the demand factor. If it is limited to the demand level, it will not adapt to the practice of economic development in the new period. As shown in Fig.3, consumer demand has been upgraded to the "stage of pursuing"[9]. In the context of very high consumption demand for life quality, if the supply front factors such as institution still stay at the food and clothing stage it is naturally not able to meet the requirement of promoting economic growth.

The goal of supply front reform is to achieve the long-term development through the reorganization of factors, optimizing the allocation, improving total factor productivity. Health, safety, environment, education, infrastructure, and scientific research are key elements of the supply front reform. The supply front reform should properly allocate resources to industries related to these six elements, to promote long-term sustainable development. For example, if the supply front can supply a large number of high-quality general practitioners for families, the distorted health care demands will be released. At present, priority should be given to the following areas: loosen the access, deepen the reform of monopoly industries, promote flow and optimal allocation of elements between urban and rural areas, and promote equalization of basic public services; firmly set up the concept of revitalizing the country through manufacturing, and take the entity economy as the foundation, and the financial industry should return to the essential attribute of serving the entity economy, to prevent the risk of focusing on virtual but separating from real situation, and prevent the risk of large economic fluctuations.

Fig.3 Schematic diagram for the binary dimension of consumption upgrade

The fundamental purpose of actively promoting the structural reform of supply front is to raise the medium and long-term growth potential. It is recommended to carefully implement the measure of "cutting overcapacity, destocking, deleveraging, reducing corporate costs and shoring up weak spots", make effort to increase the labor productivity, total factor productivity and potential growth rate, and explore the modern long-term administration mechanism with Chinese characteristics.

3.5 Leading path being the institutional innovation

According to the neoclassical growth theory, the contribution rate of technological progress is up to 85.71%; according to the endogenous growth theory, the dissemination of knowledge, the accumulation of experience, and the promotion of human capital promote the continuous growth of the economy. But, what is the driving force of technological progress? What is the power of R&D and what is the support of protection of R&D achievements? In fact, the real source comes from the institutional innovation. Under the planned economy system, even though people are equipped with modern high-tech agricultural production tools, they will not be able to earn much more, and they will not obtain the effect of vigorous economic growth after the reform and opening-up system has been innovated. In this sense, the institution is higher than technology. The main mission of the institutional designers is to give more incentive to technology creators[10]. It is recommended to establish the system of encouraging innovation, rather than plan to make innovation. The institutional innovation is the core of reform, thus it is recommended to booster scientific and technological innovation through institutional innovation.

Property right is the core of ownership. It is necessary to establish a modern property right system with clear property ownership, well defined power and responsibility, strict protection and smooth circulation. It is recommended to strictly protect legal private property rights, encourage competition and honest work, avoid the tragedy of the commons, and make the resource allocation promote the economic development in a more efficient manner. Entrepreneurs with great talents and wisdom are scarce resources of the society. To encourage innovation, it is recommended to carry forward the entrepreneurship. From the allocation driving to innovation driving, it is recommended to make institutional reform and encourage innovation, and energetically protect the property right, so as to stimulate the enterprisers.

Common experience of countries that have successfully leaped over the middle income trap is to attach importance to increasing the national income, successfully realized the improvement of income allocation structure. Such experience is worth learning from China. Besides, it is necessary to improve the revenue growth mechanism, build a comprehensive social security system, increase the income of residents, and make effort to achieve "two synchronizations." In addition, it is necessary to respect economic laws at specific stages of development, but not excessively stress the income distribution. Excessive stressing of the income distribution is a main reason for Latin American countries falling into the middle income gap. If simply pursuing the fairness in financial and fiscal means through going beyond the development stage and evading difficult problems such as the reform of government functions, or even blindly catching up with the welfarism, it is very likely to fall into the middle income trap. This high-profile pursuit is politically tempting. It can obtain support of public opinions. It is the same in all countries, so it should be noticed. According to historical experience, the consequences of egalitarianism will be common poverty. The welfare catch-up based on the lack of economic catch-up is a castle in the air. This stage is the key period for the economy to catch up and seek to ascend to the high-income ranks. It is required to steadily match the corresponding welfare arrangements on the basis of unswervingly and rationally implementing the catch-up strategy. Conversely, letting populism and welfare catch up with each other will lead to imbalance and will be detrimental to the sustainable economic development.

Furthermore, it is recommended to promote administration in compliance with laws. To leap over the middle income stage, government is indispensible, and the key is how to bring into play active role of government. It is recommended to implement a series of reforms, including further simplifying institutions, establishing a service-oriented, highly efficient and clean government, and create policy environment favorable for innovation through the construction of legal and public service platform[11]. After entering the upper middle-income stage, the central government has put forward a strategy for governing the country in compliance with laws. This requires that the ruling party’s political ideas must pass the legal procedures before becoming the state will. The core of governing the country according to law is administration in accordance with the constitution. The primary task is to administrate according to law and gradually "putting power in the cage of the system".

3.6 Leaping over the middle income trap inseparable from the targeted poverty alleviation

Efficiency is the life of the economy. In a sense, efficiency is also a manifestation of fairness, but efficiency is not the whole part of fairness. According to the new common understanding, China’s reforms should pay more attention to achieving common prosperity in an equitable manner, instead of just focusing on the GDP.

In the period of leaping over the middle-income stage, China should use the market economy system to achieve efficiency, help the poor, take advantages of the common prosperity of the socialist system to safeguard fairness, and create a new historical model that successfully leaps over the middle-income stage. According toChina’sPoliticalGainsandLossesinHistorywritten by Qian Mu[12], the Tang Dynasty’s sharecropping system paid attention to planned distribution of the lower classes, while free development of upper classes. For this case, it seems that people in the Tang Dynasty were much clever, they allowed you to become rich, and not allowed you to live in poor conditions. Such practice of no upper limit and securing the minimum conditions is the result of superb wisdom of the economic system of the Tang Dynasty. The economic function that the government must perform is to provide public goods and give social protection to vulnerable groups in the economic development. Between setting the upper limit and guaranteeing the minimum living conditions, neither setting the upper limit nor guaranteeing the minimum living condition is natural state of laissez-faire, and its drawback is market failure; setting the upper limit and guaranteeing the minimum living conditions are the illusion of the planned economy; setting the upper limit without guaranteeing the minimum living conditions is the policy in the feudal autocracy; only setting the upper limit with guaranteeing the minimum living conditions is the ideal and lasting measure.

Since the Eighteenth National Congress, President Xi Jinping has repeatedly emphasized that a moderately prosperous society in all respect is to benefit 1.3 billion people, regardless of region, and not allow one person to be left behind because of poverty. This is consistent with the wise arrangement of "allowing you to become rich and not allowing you to live in poverty"[12]. The poverty alleviation should change from extensive poverty alleviation to targeted poverty alleviation. In China, there are still 7.017 × 107 poor people. To realize the goal of shaking off poverty by 2020, it should reduce 1.000 × 106 poor people every month, the situation is pressing and the pressure is tremendous. For this goal, it is required to change the extensive poverty alleviation to targeted poverty alleviation, stick to the principle of time serving the quality, make effort in the precision, and make pragmatic work.

Poverty alleviation through education is more important for improving the quality of human resources. Thus, it is recommended to strengthen the awareness of poor people for poverty alleviation and spiritual poverty alleviation, and carry out poverty alleviation through education. High-level formal education is positively related to high-income and low-unemployment rates. Therefore, it is required to vigorously develop higher education. Raising the educational level of workers is an inexhaustible source of real sustainable long-term economic growth, which has been demonstrated by countries that have successfully leaped over the middle income stage. In addition, with the aid of the opportunity of One Belt One Road Initiative, it is recommended to steadily push forward the internationalization of RMB, so as to leap over the middle income trap as soon as possible.

4 Discussions

In essence, the middle income trap is a sustainability issue of economic growth. It is required to keep a certain speed of development to achieve leaping. The causes for the middle income trap mainly include the lack of economic growth power, backward development method, failure in transformation, large income gaps, blind welfare catch-up, and political and social instability.

In 2011, China entered the middle-income stage. Due to restriction of domestic and foreign development patterns, the growth rate of China is declining and economic development is faced with challenges, so the risk of falling into the middle income trap is increasing. In view of the current situations, we came up with recommendations for China’s leaping paths, including accelerating the structural reforms on the supply front to promote industrial transformation and upgrading, deepening the reform and increasing the efficiency with institutional innovation as the core, protecting legitimate property rights, reforming the income distribution, combining accurate poverty alleviation, narrowing the gap between the rich and the poor, performing administration according to laws, vigorously developing education, expanding the opening up with the aid of the One Belt One Road Initiative, and keeping sustainable growth, so as to successfully leap over the middle income trap.