tag:theconversation.com,2011:/us/topics/middle-income-trap-2789/articlesmiddle income trap – The Conversation2016-01-28T02:23:16Ztag:theconversation.com,2011:article/535672016-01-28T02:23:16Z2016-01-28T02:23:16ZChina’s greatest challenge will be escaping the middle income trap<p>China’s <a href="https://theconversation.com/chinas-6-9-gdp-growth-rate-is-not-the-hard-landing-feared-and-australia-can-benefit-53370">slower growth figures</a> have caused jitters in world financial markets. Nevertheless its growth remains at miracle levels. At this pace, China would appear to remain on track to become the richest and most powerful country in the world, bar none. </p>
<p>In a scenario where Chinese “miracle” growth continues around 5-6% for three decades and gradually slows to the average world growth rate, the average Chinese citizen would be as wealthy as the average American. </p>
<p>But ongoing Chinese growth miracle seems an unlikely outcome, when compared to the history of emerging economies. Instead, it is likely China will have to grapple with what is called the “middle income trap”. This is because China’s income level is currently at a level where many countries seem to stagnate.</p>
<h2>The middle income trap</h2>
<p>An example of this can be seen in the figure which charts per capita income for China, Turkey and Brazil as a percentage of the United States. It shows that, despite its remarkable growth, China’s income gap with the US has only reached the level that Brazil and Turkey had already achieved by the 1970s. </p>
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<img alt="" src="https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=436&fit=crop&dpr=1 600w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=436&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=436&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=548&fit=crop&dpr=1 754w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=548&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/109423/original/image-20160127-26778-1nykof.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=548&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="attribution"><span class="license">Author provided</span></span>
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<p>Moreover it can be seen that, since the 1970s, Brazil and Turkey made practically no further ground in closing the gap with the US. </p>
<p>According to a 2012 <a href="http://documents.worldbank.org/curated/en/2013/03/17494829/china-2030-building-modern-harmonious-creative-society">World Bank</a> report, this slow growth pattern is typical of middle income countries. Specifically, of 101 countries that were “middle income” in 1960, only 13 broke through the middle income band to become rich countries. </p>
<p>Thus, based on history there is a reasonable concern that China’s growth will slow to an extent that it stops catching up with the West. China would then begin to look like like Brazil or Turkey in the sense that per capita income remains well below Western levels and there is a constant threat of political and economic instability. </p>
<h2>Causes of the middle income trap</h2>
<p>Unfortunately we don’t know very much at all about why there appears to be a middle income trap.</p>
<p>The authors of the <a href="http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/EASTASIAPACIFICEXT/0,,contentMDK:21056110%7EpagePK:146736%7EpiPK:146830%7EtheSitePK:226301,00.html">World Bank study</a> who coined the term suggested it was due to rising wage costs that make exports less competitive. </p>
<p>It is true that wage increases can hurt some export sectors, but market forces prevent this happening for the economy as a whole. Thus wage growth cannot reduce an economy’s overall competitiveness. </p>
<p>Other explanations suggest the middle income trap results from too much investment in physical infrastructure at the expense of education and skills. Alternatively it could be a result of political failure.</p>
<p>But these are only descriptions of the symptoms – they don’t tell why so many countries have political failures or why so many countries over-invest in physical capital. </p>
<p>So while there are many descriptions of the middle income trap, there is no clear theory and hence there are no testable propositions. It remains an elusive statistical fact.</p>
<h2>Traps versus bad luck and bad policy</h2>
<p>The lack of a clear view about the causes of a middle income trap makes it difficult to know whether it is a pattern likely to continue in the future. In a recent <a href="https://www.researchgate.net/profile/Peter_Robertson3/publication/256050484_On_the_Existence_of_a_Middle_Income_Trap/links/55de944e08ae45e825d3a173.pdf">study</a>, therefore, we tried to get a better sense of the predictability of a middle income trap from a purely statistical viewpoint. </p>
<p>For example if, for any reason, a country was unable to change its growth rate, the growth rate would exhibit persistence over time. That is, if things got better by chance one year, there would be some market or political force that brings things back to trend. </p>
<p>Alternatively if some countries simply had a run of bad luck, or made some big policy mistakes, there may be little persistence in the data. The growth rate might display some randomness from one year to the next. </p>
<p>We therefore tested to see whether we could reject the hypothesis that the path of per capita income had followed a random trend for 47 middle income countries.</p>
<p>Thus in the previous figure one can see that there is apparently very little difference in the trend path of Brazil and Turkey – they have similar growth rates and growth variance. But, in fact, the statistical tests show that Turkey’s growth rate has persistence, but Brazil’s growth rate is random.</p>
<p>So despite the visual similarity, Brazil and Turkey have very different statistical properties.</p>
<p>We found that only seven countries show evidence of a persistent trend toward staying stuck in the middle like Turkey. </p>
<p>Of the rest of the countries, half had a trend that was random like Brazil. For most countries there was no evidence of a persistent trend toward the middle income band. </p>
<p>So only very few countries’ per capita income time paths are consistent with the pattern that we would expect to see if they were constrained to their current relative income level.</p>
<p>Although these results are descriptive, they could be taken as evidence against a structural reason for a middle income trap. That is, perhaps what appears to be a pattern of behaviour across many countries, is just the way things panned out. </p>
<p>So despite the bleak historical record, maybe good statesmanship, market friendly policies and bit of luck are all that is needed to sustain growth.</p>
<p>For China therefore, as a middle income country, the historical odds are against replicating the Japanese or South Korean economic miracle. Thankfully, however, the past need not be a good predictor of the future.</p><img src="https://counter.theconversation.com/content/53567/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Robertson receives funding from The Australian Research Council. </span></em></p><p class="fine-print"><em><span>Longfeng Ye does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The history of middle incomes countries shows China’s “miracle growth” probably won’t continue.Peter Robertson, Professor, The University of Western AustraliaLongfeng Ye, Assistant researcher, The University of Western AustraliaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/361332015-01-19T19:25:50Z2015-01-19T19:25:50ZExpanding the GST would hit the ‘middle’ and women the hardest<p>Many developed economies have experienced a significant increase in inequality in recent decades. Survey <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2291299">data for Australia</a> show that the share of the top 10% of the income distribution, and more markedly that of the top 1%, has grown dramatically. At the same time, tax reforms over the period have reduced tax rates on top incomes.</p>
<p>Over the short period from 2004-05 to 2008-09 alone the top bracket limit rose from A$70,000 to A$180,000 and the top marginal rate fell another two percentage points, concentrating billions of dollars of tax cuts in the upper percentiles. Those in the middle of the distribution gained little to nothing, an outcome achieved by combining tax cuts at the top with the Low Income Tax Offset. The LITO raised the zero rated threshold for those on very low incomes while simultaneously denying gains for the middle through its withdrawal rate of 4 cents in the dollar. </p>
<p>Against this background an expansion of the GST, which is well recognised to be highly regressive, is a reform that will further undermine the “middle”. A weakened “middle” will have negative effects on aggregate demand, jobs growth and productivity.</p>
<p>Proponents of an expanded GST typically claim that a consumption tax is more efficient than an income tax. For example, Liberal MP Dan Tehan <a href="http://www.dantehan.com.au/news/692/59/BROADEN-GST-BEFORE-ANYTHING-ELSE.html">argues</a> a shift from direct to indirect taxes like the GST will deliver higher standards of living. This view, which is supported in the Henry Review, reflects the belief that a tax on consumption is more efficient because it allows capital income to be tax exempt. The argument, however, contains a fundamental error in logic.</p>
<p>Modern public finance now recognises that the optimal tax rate on a given source of income, whether labour or capital, can only be determined on the basis of empirical evidence on distributional outcomes and behavioural effects. Even if capital were highly mobile, which is very much open to question in a number of important contexts, this does not imply an optimal rate of zero. This principle, derived from the <a href="http://www.iza.org/en/webcontent/publications/papers/viewAbstract?dp_id=6615">theory of “second-best”</a>, has been well established for over half a century.</p>
<h2>Outdated thinking</h2>
<p>The argument for a shift towards consumption taxation also reflects an outdated view of the household. </p>
<p>As explained in detail in the Henry Review, capital income is tax exempt under a cash flow expenditure tax (a consumption tax) and under a labour earnings tax (e.g. a payroll tax). The two are said to be equivalent. This is a fallacy that can be traced to the failure to observe that with the dramatic increase in female workforce participation over the last half century the majority of working-age adults live in couple households with two earners. </p>
<p>With information on earnings we can have an individual based tax that is not only progressive but applies a lower rate to the earnings of the partner with a lower income, typically the female on a lower wage. In contrast, we cannot observe individual consumptions (or saving) in two-person households. A consumption tax is inevitably limited to a flat rate tax on joint consumption and therefore cannot be superior to a well-designed labour income tax.</p>
<h2>Compensation problems</h2>
<p>The labour supply of partnered women as second earners is far more sensitive to taxes than male labour supply, as evidenced by the significantly higher estimates of their <a href="http://www.treasury.gov.au/PublicationsAndMedia/Publications/2007/Treasury-Working-Paper-2007-04">labour supply elasticities</a>. The higher they are taxed the more likely they are to drop out of the workforce. Efficiency therefore requires they face lower marginal tax rates. Due to the Howard family tax reforms many face effective MTRs that are much higher than the top rate on personal income. Expanding the GST will not only add to these already excessively high rates, but the provision of compensation targeted towards low income earners, as suggested by Tehan, will exacerbate the problem. Higher effective rates can only be avoided by introducing a more progressive rate scale on personal income, and this is clearly not the intention.</p>
<p>These issues are missed by KPMG in its analysis of the costs of alternative taxes in terms of consumer welfare loss per dollar of additional revenue. Liberal MP Angus Taylor <a href="http://www.afr.com/p/opinion/liberal_mp_how_to_sell_tax_reform_dUhXRPVK8avPuONAE45T2H">cites KPMG’s finding</a> that taxes on labour cost 24 cents for every dollar levied, in contrast to less than 10 cents for the GST. The result is based on a single-earner household with a single labour supply elasticity set at 0.2. While findings from KPMG’s modelling approach might have been relevant in the 1950s when most households were single-earner, they are entirely fictional for a 21st century economy.</p>
<p>The evidence on wage elasticities suggests female labour is the most mobile factor of production. Yet under current policy settings partnered mothers not only face the highest tax rates on earnings, many also face excessively high child care costs due to the failure of successive governments to invest in a learning focused public sector child care system. </p>
<p>Not surprisingly, well over 50% of married mothers of prime working age remain out of the work force or work part time not only during the child rearing years but throughout the entire life cycle due to loss of human capital. A conservative estimate of the overall loss would be in the order of 20% of GDP, a loss we cannot afford with an ageing population.</p>
<p>To reduce this loss we need to reverse the direction of tax policy in recent decades – that of shifting the burden from top incomes to wage earners in the middle of the distribution, and particularly towards partnered mothers as second earners. We also need to cut massive tax expenditures that primarily benefit high income earners and invest the revenue in child care. Expanding the GST is no solution.</p><img src="https://counter.theconversation.com/content/36133/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Patricia Apps has received funding from the ARC for her tax research.</span></em></p>Many developed economies have experienced a significant increase in inequality in recent decades. Survey data for Australia show that the share of the top 10% of the income distribution, and more markedly…Patricia Apps, Professor of Public Economics, Faculty of Law, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/62232012-04-22T20:35:11Z2012-04-22T20:35:11ZFor China, politics will be crucial to avoid the pitfalls of the middle-income trap<figure><img src="https://images.theconversation.com/files/9567/original/99nx374t-1334291707.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Growing income inequality in China will continue to hamper its transition from a middle-income to high-income country.</span> <span class="attribution"><span class="source">oliverlaumann</span></span></figcaption></figure><p>Can the economic rise of new middle-income countries such as China, Brazil, India and even Indonesia continue until they become high-income countries like Australia? Japan, Singapore, South Korea and Taiwan are living proof that such a transition is possible, but there is increasing debate whether political elites in the current group of middle-income countries have the willingness or capacity to undertake the economic and political reforms necessary for them to attain “high-income” status. </p>
<p>The notion of the “middle-income trap” has existed in a variety of forms since countries such as Brazil and Argentina in the 1970s and 1980s failed to continue the growth rates they had exhibited in the decades after the Second World War. More recently, analysts have attempted to decipher why East Asian economies such as South Korea successfully pushed into the “high-income” bracket when others that were similarly placed thirty years ago failed to exit the middle-income grouping. </p>
<p>The World Bank report, <a href="http://www.worldbank.org/content/dam/Worldbank/document/China-2030-complete.pdf">China 2030</a>, raises similar concerns regarding that country’s capacity to become a “modern, harmonious, and creative high-income society”, as opposed to one caught in a middle-income trap. The report argues for changes to existing economic growth strategies. The first item on the Bank’s reform agenda is that China completes its transformation into an open-market economy. The Bank also notes the need for China to address the growing income inequality among its citizens. Importantly, economic policy and social policy are not seen as mutually exclusive. </p>
<p>The development policies that have driven China’s extraordinary advances in per capita income since the 1980s have largely followed classical growth models, albeit within the context of a one-party state.</p>
<p>A “modern” economy has drawn in low-cost, unproductive surplus labour from a “traditional” rural economy, which has led to an increase in per-capita productivity. With state encouragement, this has set off a virtuous cycle of savings and investment and technology importation. When allied with export-focused policy settings and a low fixed exchange rate for the yuan, the resulting growth rates are often hailed as a vindication of mainstream development economics.</p>
<p>What the China 2030 report points out, and what analysts such as <a href="http://eme.sagepub.com/content/3/3/281.abstract">Homi Kharas and Harinder Kholi</a> also argue, is that there are brakes on growth which inevitably kick in unless a government is prepared to alter its approach toward development.</p>
<p>One of the most pressing issues in relation to China is the environmental impact of large-scale industrialisation. An equally insidious product of the last three decades of economic growth has been the increase in income inequality. </p>
<p>The key expression of a country’s income inequality is the Gini coefficient, where 0 equates with absolute income equality and 1 (or 100 in some descriptions) equates with absolute inequality (i.e. one person earns all of a country’s income). </p>
<p>Over the past decade China has refused to release its official Gini figures, but it is believed that the current measurement is around 0.47, or possibly even higher. This indicates that relatively high inequality – Australia’s Gini measurement, by comparison, is a modest 0.31 – has accompanied China’s transition from low to middle income.</p>
<p>Failure to address income inequality has the potential to restrict the expansion of a middle class and stall further general income growth. High inequality acts as a dampener on domestic demand for goods and services. A large middle class has the capacity to purchase a greater total value of products than a small “wealthy class”, who will consume a comparatively small amount of high value goods and services. Greater domestic demand also moderates any changes in export income and creates a need for local firms to diversify and innovate. </p>
<p>The rise of a middle class also has supply-side implications, most notably in driving local firms to shift from low-wage, low-skilled manufacturing to the production of goods and services that are higher-cost and require a greater level of worker skills. This in turn initiates a search for economies of scale that lead to a specialisation in certain high-value sectors. It also requires national investment in good quality education. In an increasingly globalised labour market, the need to attract high-skill workers with reasonable social conditions, and a legal system that protects property, has become vitally important. </p>
<p>All this suggests a level of income redistribution, usually via a tax-transfer system bolstered by a strong rule of law, which challenges the economic dominance of certain political elites. Similarly, the rise of an educated middle class is usually accompanied by demands for political rights. </p>
<p>Even Singapore, which is often cited as, effectively, a one-party state that has managed to expand its middle class without dislodging entrenched elites, is experiencing an increase in local calls for improved civil and political rights.</p>
<p>While there is no one economic pathway for a country to follow as it makes it way from low to high income per capita, it is clear that it is difficult to achieve - and sustain - this transition without a political class who are prepared to prioritise the needs of the country over their own. It is a message that resonates well beyond middle-income countries.</p><img src="https://counter.theconversation.com/content/6223/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Tom Davis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Can the economic rise of new middle-income countries such as China, Brazil, India and even Indonesia continue until they become high-income countries like Australia? Japan, Singapore, South Korea and Taiwan…Tom Davis, Lecturer, School of Social and Political Sciences, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.