China: Surpassing the “Middle Income Trap” by Shaojie Zhou and Angang Hu

CHAPTER 1
 What Is the “Middle Income Trap”?
 1.1  ProPosition of the “Middle incoMe traP”
 In 2007, Indermit Gill and Homi Kharas (2007), two World Bank econo
mists, published a report titled An East Asian Renaissance: Ideas for 
Economic Growth, which suggested that East Asia would soon develop 
into a middle-income region and proposed the concept of the “middle 
income trap”. It should be noted that the report did not provide an in- 
depth interpretation of the concept, nor did it offer a clear income range 
for the “middle income trap”. In 2011, Homi Kharas and Harinder Kohli 
(2011) further elaborated on the concept, specifying that when a country 
escapes the poverty trap in the low-income development stage and enters 
into the middle-income development phase, the country may face growth 
stagnation and inability to further move up the ladder into the high- 
income range.
 Why does the “middle income trap” phenomenon exist? They empha-
sized the need for different growth strategies after reaching the 
middle- income status through comparing the long-term performance of 
Latin American economies and East Asian economies. In the latter case,

 countries successfully shifted their growth strategies after achieving the 
middle- income status and adopted new growth strategies to sustain eco-
nomic growth. However, economies from Latin America failed to achieve 
the shift.
 Generally, one fundamental reason for low-income economies to break 
away from the poverty trap lies in the ability to create jobs for the abun-
dant and cheap labor which promotes labor transfer from the low- 
productivity agricultural sector to the high-productivity sector. The 
structural change of labor force allocation is the key factor in sufficiently 
mobilizing economic potentials. However, when a country enters into the 
middle-income status from the low-income development stage, it loses the 
comparative advantages of cheaper labor cost and becomes less competi-
tive in manufacturing exports against low-income and low-wage countries 
due to rising labor costs. If the country does not achieve substantial prog-
ress in technological innovation, its ability to compete with developed 
economies in the arena of high-tech and innovation products would be 
hampered, resulting in the loss of export competitiveness. Thus, the coun-
try may fall into the predicament of declining economic growth or even 
experience economic regression, causing the country to be trapped in the 
middle-income status and lose the ability to stride toward the high- 
income status.
 After its proposal, the concept of the “middle income trap” which pro-
vided a new perspective for understanding the economic growth in devel-
oping countries, received immediate media and academia attention. In the 
wake of the 2008 global financial crisis, the investment-driven and export- 
led growth model of China faces great challenges due to the domestic 
structural adjustments and external demand shocks. Whether the Chinese 
economy could maintain its high-speed growth has raised substantial 
concerns.
 In 2010, China surpassed Japan in gross domestic product (GDP) for 
the first time to become the world’s second largest economy. The 2012 
World Development Report listed China as a middle-income country for 
the first time on the basis of 2010 per capita income in China. In this 
sense, 2010 marked an important juncture in the course of China’s eco-
nomic development. Subsequently, China began the implementation of its 
12th Five-Year Plan. As the world was reeling from the global financial 
crisis, China’s economic performance came into the spotlight. Being the 
world’s second largest economy, China’s economic growth undoubtedly 
affects global growth, especially for countries that have China as their 

China: Surpassing the “Middle Income Trap” by Shaojie Zhou and Angang Hu