China Meets the Middle-Income Trap: The Large Potholes in the Road to Catching-Up

Abstract

We follow Woo (2011) in using the Catch-Up Index (CUI) to define the middle-income trap and identify the countries caught in it. The CUI shows that China became a middle-income country in 2007-2008. We see five major types of middle-income trap that China is vulnerable to (a) fiscal stress from the nonperforming loans generated by the interaction between the lending practices of the state banks and the innate desire by state enterprise managers to over-invest and to embezzle; (b) the frequent use of macro-stabilization tools that hurt long-term productivity growth; (c) flaws in socio-political governance that exacerbate social tensions; (d) ineffective management of environmental challenges that threaten sustainable development; and (e) inept handling of international economic tensions that could unleash trade conflict. We recommend new governance principles and management methods to prevent China from falling into these five types of middle-income trap.

Keywords: middle-income trap, overly-large state sector, urbanization under principle of future home ownership, environmental stress, trade war

JEL Classification: D31, E21, E26, E44, E51, E65, F41, G21, O53, P24, P31, P36, Q50