The World Bank has just released its detailed report (below), China 2030: Building a Modern, Harmonious, and Creative High-Income Society, which seeks to answer the questions:
Can China’s growth rate still be among the highest in the world even if it slows from its current pace?
And can it maintain this rapid growth with little disruption to the world, the environment, and the fabric of its own society?
The World Bank believes that the export-led model that has delivered the past 30-years of growth and development in China has now run its course and that China can only succeed in becoming a modern, high income country if it implements a six-step series of reforms, namely:
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Market-based reforms, including redefining the role of government, reforming and restructuring state enterprises and banks, developing the private sector, promoting competition, and deepening reforms in the land, labor, and financial markets.
Accelerate the pace of innovation and create an open innovation system in which competitive pressures encourage Chinese firms to engage in product and process innovation not only through their own research and development but also by participating in global research and development networks. Essentially, the World Bank recommends that China seek to move away from being an imitator to an innovator in its own right.
Introduce market-based incentives, regulations, public investments, industrial policy, and institutional development that encourages China to transition to a greener economy and fosters more efficient resource use.
Reducing inequality by expanding opportunities and promoting social security for all by facilitating equal access to jobs, finance, quality social services, and portable social security.
Strengthen the fiscal system by mobilizing additional revenues and ensuring local governments have adequate financing to meet heavy and rising expenditure responsibilities. This reform could also reduce the need for local governments to raise tax revenues via property development and speculation.
Sixth, seek mutually beneficial relations with the world by becoming a pro-active stakeholder in the global economy, actively using multilateral institutions and frameworks, and shaping the global governance agenda.
According to the World Bank, these six priority reform areas lay out objectives for the short, medium, and long term, and Chinese policy makers need to sequence the reforms within and across these areas appropriately to ensure smooth implementation and to reach desired outcomes.
At the heart of the World Bank’s paper is the middle-income trap – the notion that developing economies tend to stop developing without institutional change once their per capita income reaches $10,000-12,000 a year. The China Bystander blog has a fantastic post explaining the middle-income trap phenomenon and relating it back to China:
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“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.” As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).
China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it [see below chart].
What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control…
The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained…
Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.
That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.
With China also facing a demographic timebomb courtesy of its rapidly ageing population from its one child policy, many observors believe that China will ‘grow old before it grows rich’, impeding its ability to achieve high-income status.
What do you think: can China avoid the middle-income trap? Or will it join the long list of nations stuck in the middle?
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
