China at the Crossroads

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China at the Crossroads

China’s attempt to transform its economy from one based on cheap exports to one that is driven by middle-class consumer spending has hit a predictable roadblock. History shows that poor nations rarely climb out of poverty. In fact, in the past seventy years, only South Korea has made this transition, while several recently industrialized economies like those of Thailand, Indonesia, and Argentina have stalled short of the goal.

Instead, most emerging economies on the path to prosperity fall into the “middle income trap.” This economic concept highlights the reality that countries that try to achieve greater wealth invariably get stuck as the advantage that helped them dissipates along the way.

In China’s case, the low-cost manufacturing advantage that powered its export-driven economy inevitably eroded as wages started to increase. Rising wages are a sign of prosperity, but that prosperity makes the country unable to compete with nations with workers who are willing to work for lower wages. Since it didn’t take a lot of income growth for China’s workers to reach this level, they are still relatively poor by U.S. standards, and the economy can’t compete in markets for higher-value-added goods. This puts them squarely in the middle-income range of $10,000 to $12,000 per capita GDP, as defined by the World Bank.

As a result, at the end of 2014, the average disposable income per person in China was $3,360, compared to $41,180 in the United States.1 Therefore, while research by Credit Suisse reveals that private wealth throughout the world grew, on average, by 17 percent from the end of 2011 to the middle of 2014, growth in private wealth in China lagged behind, at just 10 percent.

Compounding this challenge is the fact that China is led by a Communist government that is trying to take advantage of market-based mechanisms. As we’ll discuss shortly, this approach simply can’t succeed without modification because it keeps China’s economy dominated by state-owned enterprises that stifle competition and innovation in at least twenty industries. And rather than pursuing market reforms, China’s leaders continue to intervene to prop up businesses and banks that would otherwise fail.

According to testimony by Derek Scissors, a resident scholar at the American Enterprise Institute delivered to the House Committee on Foreign Affairs, Subcommittee on Asia and the Pacific, “In 1978, China began to grant limited private property rights and to permit limited competition...

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