Growing Beyond the Low-Cost Advantage. Yiping Huang

From a very poor and agriculture-based economy 30 years ago, the PRC has reached upper middle-income status with a large industrial base, and is now often called the “workshop of the world.”

Figure 1.1 Average annual GDP growth, selected economies, 1980–2011

      GDP = gross domestic product, PRC = People’s Republic of China.

      Source: World Bank, World Development Indicators Online (accessed 19 July 2012).

Table 1.1 PRC: Per capita income and human development indicators, 1980–2011

      ^a 1981 data. ^b 1984 data. ^c 1999 data. ^d 2006 data. ^e 2008 data. ^f 2010 data.

      GDP = gross domestic product, GNI = gross national income, PPP = purchasing power parity, PRC = People’s Republic of China.

      Note: Gross enrollment ratio is the ratio of total enrollment, regardless of age, to the population of the age group that officially corresponds to the level of education shown.

      Source: World Bank, World Development Indicators Online (accessed July 2012).

      Rapid growth and structural transformation have significantly reduced poverty, improved human wellbeing, and created a decent standard of living. When the reforms began, 84% of the population lived below the internationally accepted poverty line of $1.25 per person per day (Table 1.1). By 2008, that proportion had fallen to 13%—an incredible achievement. Longevity increased from 67 years in 1980 to 73 years in 2010, and child mortality under the age of 5 years declined from 65 to 18 deaths per 1,000 during the same period. These impressive achievements have been emulated by very few developing economies, and, in recent years, have become the envy of both emerging and advanced countries.

Rapid economic expansion has also led to a sharp rise in the country’s importance globally. The PRC is now the world’s largest exporter, the largest holder of foreign reserves, and the second largest economy after the United States (US). What happens in the PRC matters greatly to the rest of the world. The Millennium Development Goal (MDG) of reducing global poverty by half will be achieved by 2015 largely because of the PRC. The world economy recovered quickly from the 2008 global financial crisis because the PRC, India, and other emerging economies managed to sustain demand and growth (Figure 1.2). The current century can indeed become an “Asian century” only if the PRC—along with India—continues to make rapid economic progress (ADB 2011a). The PRC’s influence on global economic policy and governance is also growing rapidly and will continue to do so.

Figure 1.2 Contribution of the PRC to global growth, 2007–2011

      PRC = People’s Republic of China.

      Sources: ADB staff estimates using data from IMF, World Economic Outlook April 2012; and ADB, Asian Development Outlook 2012.

      The PRC’s impressive achievement, however, should not make one lose sight of the major challenges it faces.

      • First, despite significant gains, PRC’s technological and productivity gaps with advanced economies remain large. With a per capita gross national income (GNI) of $4,930 in 2011, it still has a long way to go before becoming a high-income country.

      • Second, the country’s rapid growth in recent decades has benefited greatly from its low-cost advantage, especially in labor. However, with declining rural surplus labor and rising wages, growth will have to be increasingly driven by productivity improvement through innovation and industrial upgrading—the PRC needs to move from a low-cost to a high-value economy which is much more challenging.

      • Third, rapid growth has exposed several structural problems in the economy, in particular, imbalances in the sources of growth and rising income inequality. While to some extent these are often associated with rapid structural transformation, incomplete reform is a major contributing factor. If not addressed, these problems could hinder the PRC’s efforts in moving toward a high-value economy.

      • Fourth, rapid growth has also created enormous pressures on resources, such as energy and water, and the environment.

      Because of these challenges, a question observers and commentators often ask is: How long can the country’s strong growth continue? With the current weak global economy and slowdown in the PRC growth, this question has only gained in relevance.

      International experiences show that, in many countries, growth slowed significantly after they attained middle-income status. They find they were caught in what is increasingly known as the “middle-income trap.” On one hand, they could no longer compete with low-income countries because of rising wages. On the other, they were unable to compete with high-income countries because they have not shifted into higher-value production through innovation and industrial upgrading. Many Latin American countries and several Southeast Asian economies are often considered caught in the middle-income trap—they became middle-income countries some 40–50 years ago and are likely to languish there for many years to come. While the PRC graduated from low- to middle-income status only in 1998, policy makers are increasingly concerned with the danger of getting caught in the trap.

      This report argues that, to avoid the middle-income trap, the PRC needs to tackle its emerging challenges effectively. Doing so requires a development strategy containing the following key agenda:

      • Stepping up innovation and industrial upgrading;

      • Deepening structural reforms, in particular reforms of enterprises, factor markets, and the fiscal system;

      • Expanding services and scaling up urbanization;

      • Maintaining macroeconomic and financial stability;

      • Reducing income inequality to make growth more inclusive;

      • Promoting green growth to conserve resources and protect the environment; and

      • Strengthening international and regional economic cooperation.

      Effective implementation of this strategy would enable the PRC to continue to grow at a robust pace and grow beyond its low-cost advantage. It would make the PRC technologically more advanced, structurally more balanced, socially more inclusive, and environmentally more sustainable—thereby greatly increasing the likelihood of advancing into high-income status before 2030. The report notes that, encouragingly, the PRC’s 12th Five-Year Plan has introduced many policy measures that support these agenda.

      The rest of the report is organized as follows. Section 2 discusses the key drivers of the PRC’s rapid growth over the past 30 years; Section 3 explains how a country enters the middle-income trap and discusses policy lessons learned from both countries caught in the trap and those that successfully avoided it; Section 4 examines the emerging challenges the PRC faces, which, if not addressed effectively, pose significant risks to its long-term growth; Section 5 discusses policy options to consider in sustaining growth and avoiding the middle-income trap; and finally, Section 6 examines the outlook of the PRC economy up to 2030.