Introduction

The middle income trap refers to the phenomenon of stagnation of countries in the middle
income category. These countries have raised their per capita income level from low to middle
income status, but have failed to progress further and reach the high income category.
With a per capita income of $5,445 in 2011 (World Bank 2012), China is in the middle income
category, and in its upper group. Chinas entry to the middle income group has raised the
question whether it will be able to avoid the middle income trap (MIT), which refers to
prolonged stay in the middle income category and failure to move ahead to the high income
category. Many researchers have pointed to inequality as a reason for MIT. In fact, there appears
to be an inequality trap which is associated with MIT. The inequality trap refers to a situation
when high income inequality itself makes reduction of inequality difficult. As a result,
inequality persists. The hallmark of the East Asian model of development has been the
combination of high growth with equitable distribution. China has deviated from this model and
has let inequality to reach a high level. In fact, Chinas inequality dynamics now resemble those
observed in MIT countries. This resemblance raises the question whether China too will get
caught in the inequality trap, leading to MIT. The purpose of this paper is to examine Middle
Income Trap and the probable reasons that keeps China in this trap.

China Enters into Middle Income Trap

According to the World Banks definition, the middle income category comprises of countries
with per capita GNI lying between $1,026 and $12,475 (of 2011). This is a very wide range,
with the upper bound being more than ten times higher than the lower bound. It comprises 88
countries and accounting for about half of the worlds population. The World Bank therefore
distinguishes two sub-groups, with a lower middle income group, comprising of countries
with per capita GNI between $1,026 and $4,035, and an upper middle income group
comprising of countries with per capita GNI between $4,036 and $12,475 (all figures are for
2011). With a per capita income of $5,445 in 2011 (World Bank 2012), China is in the middle
income category, and already in its upper group. Chinas middle income status has given rise
to considerable discussion, which is not surprising, given the weight of China in the world, in
terms of both population and size of the economy.

Inequality and growth

GDP at current prices - US$
3.5E+11
3E+11
2.5E+11
2E+11
1.5E+11
1E+11
5E+10

GDP at current prices - US$

Source: World Bank

GINI Index
0.45
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
1981

1984

1987

1990

1993

1996

GINI Index

1999

2005

2008

2010

Source: World Bank

There is strong positive correlation between GDP growth of China and GINI Index as observed
in above figures.
China is becoming more unequal as it gets richer, with about a third of the country's wealth now
concentrated in the hands of 1% of its citizens, according to new research. A report by the
Peking University Institute of Social Science Survey also found that the poorest quarter of
Chinese citizens owned only 1% of the country's wealth. The report, which was covered
extensively by China's state media, concludes that while the country is getting richer as a whole
the average net worth of a Chinese household rose 17% between 2010 and 2012 to $71,000
(42,000) inequality is a serious and growing problem.
A Gini coefficient of zero represents absolute equality, while one represents absolute
inequality.
I have identified two areas where inequality breeds
1.

Inequality in China is not the result of stagnant or declining incomes among poorer
groups, but of more rapid growth in incomes of richer groups.

Despite the strong income growth for poorer groups, income inequality still increased because
the incomes of richer groups grew even faster. Between 2002 and 2007, the richest two deciles
of the income distribution saw their income nearly double (figure 2). As a consequence, the
income gap between the richest and poorest deciles widened from 19:1 to 25:1, and national
inequality increased.

2. Inequality in China is strongly linked to urban-rural differences.

Chinas urban-rural income gap has widened since the early 1980s (figure 4). By 2002,
per capita incomes for urban households were, on average, more than three times higher
than those for rural households. Since that time, the urban-rural income ratio (measured
as the average income per capita of urban households divided by the average income
per capita of rural households) has remained well above 3.0. This urban-rural income
differential is very high by international standards (Knight and Song 1999, p. 138; see
also World Bank 2009b).

Lewis Turning Point

China supplies developed markets with cheap goods which, to some extent, make up for
stagnating wages. Cheap labour also keeps the Chinese economic model humming by providing
the foundation for growth.
When an economy first becomes industrialised it grows very fast by importing foreign
technology and employing capital and plentiful, cheap, unskilled labour from the farm. But after
a while the extra agricultural labour is put to work and wages start to rise. This makes firms less
profitable and they have to come up with their own technology to keep growing. This shift is
known as the Lewis Turning Point, named after Nobel-Prize winner Sir Arthur Lewis.
According to the IMF economists China is not there, yet. But the glut of labour peaked in 2010
and, as the population ages, its all down-hill from here. They estimated that if things stay as
they are, China will reach the Lewis Turning Point between 2020 and 2025.

% of workforce in agriculture

1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010

80
70
60
50
40
30
20
10
0

% of workforce in agriculture

Source: World Bank

Lewis turning point looks at the dual aspect of a developing economy. The first is represented
by its agricultural sector, which engages a major part of the labour force, and the second by the
modern market-oriented sector, which is primarily engaged in industrial production. The growth
of the economy is driven by the modern sector with the support of unlimited supplies of labour,

GNI per Capita in US dollars

Fertility rate
6
5
4
3
2
1
0

6,000
4,000
2,000

1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012

GNI per Capita in US dollars

1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012

8,000

Source: World Bank

Fertility rate

which is mainly drawn from the agricultural sector. This migrant labour force accepts low wages
corresponding to the living standards prevalent in farming. The modern sector (also called the
capitalist sector) is able to reap profits andhelped by low labour costsgenerate savings. The

growing savings finance the capital formation for expansion. However, a point is reached when
no more labour is forthcoming from the underdeveloped, or agricultural, sector and wages begin
to rise. This is known as the Lewis turning point.
China has continued to grow for the last three decades due to the cheap labour it gets from its
vast rural hinterland, which is still a traditional, or subsistence, economy. But due to various
administrative measures taken by the government, such as the one-child policy, their
demographic structure is changing and the amount of surplus labour is also decreasing.
China has also experienced labour strikes and shortages and wage increases in the past two
years, prompting many researchers to debate whether the Lewis turning point had been reached.
For any country that reaches the Lewis turning point, its industrialised sector slows down as
cheap labour is no longer available and consequently its growth too starts declining

GDP Growth rate - %

16
14
12
10
8
6
4
2

Growth rate - Percent

Source: World Bank