Thursday, Jun 29, 2017, 5:00 AM CST – China

Commentary

China needs a coordinated strategy to avoid falling into the middle-income trap

The country must align its policies with the needs of companies and contemporary business trends

 For much of the past year, China has been combating an economic slowdown, leading many economists to warn that China may fall into the so-called “middle-income trap,” characterized by a sharp deceleration in growth after a previously impoverished country has lifted itself mostly out of poverty, barring its advancement to the economic status shared by developed countries. The reason behind this is middle-income economies often find it difficult to compete with low-income economies in terms of labor costs, while they also struggle to enter the high-tech fields that have long been dominated by high-income countries.

According to estimates by the World Bank, among the 101 economies designated “middle-income” in 1960, only 13 became high-income ones by 2008 – a success rate of 13 percent. In the age of globalization, it has become even more difficult for a middle-income country to develop into a high-income one, as the developed world controls the international financial system and monopolizes the power to set industrial standards and make rules for international trade. The challenge for China, given its size and population, is particularly acute.

To break the various technological and institutional barriers, the Chinese government has launched a number of initiatives in the past couple of years. By launching the One Belt, One Road initiative and establishing the Asian Infrastructure Investment Bank, China aims to strengthen its position in the rule-making processes of the world’s financial order. However, these State-led initiatives alone will not be adequate to achieve the much desired upgrade in industrial status. To successfully restructure China’s economy, the Chinese government needs to adopt policies that directly and precisely address some key issues.

Firstly, a major focus should be upgrading China’s manufacturing industry from a labor-intensive one into an innovation-intensive one, because of rising labor costs. Recently, the Chinese government has launched the “Made in China 2025” and “Internet Plus” strategies. However, with the competitive advantage established by “lean manufacturing” in development countries, particularly Germany and Japan, China should focus on the emerging trend toward smart manufacturing technology in order to unclog its technological bottleneck and successfully advance its economy.

 Secondly, the government should further reform its financial system to provide better and more efficient financial services to Chinese companies, especially those in the private sector. One of the financial reform’s focuses should be to promote the ratio of direct finance in China’s economy. Currently, 80 percent of all funds obtained by Chinese enterprises comes through indirect finance, meaning borrowers borrow funds through indirect channels, such as a bank. The proportion of direct finance, which is cheaper and more efficient, is only 20 percent. Comparatively, bank loans only account for about 20 percent of financing in the US, whereas direct financing accounts for 70 percent. China needs to expedite its current financial reform to liberalize its policies regarding interest and currency exchange rates, open the financial market to private investors and build a robust financial system. That way, China can increase its say in the global financial market and Chinese companies can have adequate access to financial resources.

Thirdly, the government needs to continue to adjust its policies to take advantage of new business models. In the past several years, the global business environment has experienced some important changes, with businesses increasingly anchored in innovative online platforms and integrative ecosystems, which will become the new battleground between different enterprises. A few online platform companies have already emerged in China, such as Alibaba and Tencent. At the same time, the Chinese government has facilitated the merging of State-owned enterprises in high-speed rail infrastructure in an effort to establish a business ecosystem in that industry. Several other mergers are reportedly underway.

China should further pinpoint its policies to encourage Chinese companies to take advantage of these new business models in order to achieve the country’s desired leap forward and transform into a high-income economy. 

The author is a researcher with Zhigang Think Tank, a private think tank specializing in public policy.

 

It has become even more difficult for a middle-income country to develop into a high-income one, as the developed world controls the international financial system

 

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