BEWARE the middle-income trap


CHINA’S LEADERS ARE usually shy of telling things as they are, but the prime minister, Wen Jiabao, put it bluntly when he described China’s economy in 2007 as “unstable, unbalanced, unco-ordinated and unsustainable”. Some foreigners may extol China’s handling of the global financial crisis, but Mr Wen has stuck to his guns. The phrase even crops up in China’s recently adopted five-year economic plan, standing out as an indirect admission of the failings of his own administration and as a marker for the next.
For all its problems, China in the coming 10-15 years is still likely to reach several symbolic milestones. The IMF predicts that in 2016 it will become the world’s largest economy on a purchasing-power-parity basis. The Economist Intelligence Unit, a sister organisation of this newspaper, reckons that on the basis of market exchange rates China will attain that glory in 2020. By the end of this decade, according to Daiwa Securities, GDP per person in Shanghai, China’s richest city, could be almost the same as the average for America in 2009.
And for all the bubbliness of China’s property market and the reckless spending of local governments, the country will probably avoid a crippling debt crisis. China has foreign-exchange reserves of more than $3 trillion and ran a modest budget deficit of 2.5% of GDP last year. Its worries are longer-term. The economy will certainly begin to slow in the next few years after three decades of nearly 10% average annual growth. Exports will be constrained by depressed Western markets, and investments in fixed assets will produce diminishing returns. But the slowdown will be less pronounced if the government succeeds in boosting consumption as a new growth engine.
Arthur Kroeber of GK Dragonomics, a consultancy, says the country still enjoys a considerable tailwind from urbanisation and a huge potential for productivity gains as it adopts new technology. He says a scattering of white-elephant projects (including the odd ghost-town of uninhabited new housing and office developments) does not concern him: “There’s no question that there are excesses, but the basic thing they are doing is sensible.” Louis Kuijs of the World Bank agrees. He sees the trend growth rate easing over the coming decade, but not dramatically. New infrastructure is generally being put to good use. Even though investment as a proportion of GDP is high, China’s accumulated investment in fixed assets is still low. Real wages have been rising strongly, which should help boost consumption. Standard Chartered, a bank, says that although China’s public debt is considerably higher than the 17% of GDP officially cited, it remains manageable. Even after allowing for bad loans to local-government investment companies, it runs at 80% of GDP, the bank estimates, about the same as Britain’s last year and well below Greece’s.
Chinese leaders are perennial worriers about inflation, not least because of its role in fuelling the discontent that led to the Tiananmen Square protests of 1989. But even though it rose to 5.5% in May, considerably above the government’s 4% target for the year, it shows little sign as yet of returning to previous highs of about 20% in 1988 and more than 25% in 1994. It also has a useful political side-effect, easing some of China’s tension with America over the value of its currency. America’s Treasury says that because of the higher inflation rate in China, the yuan is in effect appreciating against the dollar by more than 10% a year. Chinese leaders have been debating whether to push interest rates higher, but Mr Kuijs says Chinese policymakers have become more tolerant of medium rates of inflation.
Yukon Huang of the Carnegie Endowment for International Peace, a think-tank in Washington, DC, says doomsayers are wrong to be so concerned about the fall in the ratio of household consumption to GDP. True, it has dropped from around 50% two decades ago to 35% today, among the lowest levels in the world, whereas investment is among the world’s highest; but such a decline, he says, is not unusual for an industrialising country. The efficiency of stimulus spending may be questionable, “but how efficient do you expect stimulus money to be?” He thinks growth could remain at 7-8% for a long time.
The bears’ grumbles
But many analysts are far less sanguine. Some worry that China could be approaching a Japanese-style crisis: a boom in exports and investment along with bubbly property markets, followed by many years of stagnation. In China’s case the added sting would be that it has not yet got rich. Officials and experts debate endlessly whether the country is slowly heading towards a “middle-income trap”. China was already a lower-middle-income country last year, with a GDP per person of around $4,400. The fear is that it might suffer the same stagnation and turbulence as Latin American economies in the 1980s and 1990s.