Middle Income Trap Theory Is Not Perfect

Obviously, I’m nowhere near of anywhere to consider myself a knowledgeable person on the topic of economics, and to have myself even consider of dabbling with the topic of world economy is just ludicrous.  Nonetheless, I’m just like any other human who has imperfections, and so let me indulgently dabble with what I want to write next.  I have seen people talk of middle income trap this and that, but the uneducated me think the middle income trap is overrated.

When people talk of middle income trap pertains to a country, they tend to assume that such a country has uncompetitive edge in export market and (has) yet to be able to raise the per capita income level which can break out of the middle income status.  This idea/theory does have some merits (but must include the inflationary rates in the formula).  If a country is losing in export competition around the world and yet the per capita is still hovering around the middle income status, it’s true that such a country can be in for a struggle of improving the country’s economic status and people’s happiness.  Nonetheless, this theory doesn’t work for a country such as China or similar country to China.  Why?

China has 1.3 billion people, and their economy is still the fastest growing economy in the world which hovers around 7% of GDP growth.  When people think in term of percentage for GDP growth, they tend to over-rate the growth percentage.  When China’s economy was way way smaller than Italy, China’s GDP growth was hovering in double digits of GDP percentage growth, but now China economy is the biggest in Asia and way way more bigger than Italy — the GDP growth of China slows down to 7%.  This fact alone can argue that with bigger economic base and foundation, even at 7% GDP growth China can still bring in more revenues as a whole country than Italy can ever achieve even if we see Italy grows at 7% in GDP.  In reality though, if I’m not wrong, in 2013, Italy has around 2.1 trillion dollar GDP economy in nominal term, but the GDP growth is at -1.9% (negative 1.9%).  To sum this idea up, at 7% of GDP growth, China is still growing like she was around 10% or higher, because her whole economy is so much more powerful and bigger.

As China is slowing down in term of nominal GDP percentage growth, the world is fixated with the percentage growth in GDP and wondering if China may stuck in the middle income trap.  Some people, out of ignorance, are definitely loving to use the slowing down of nominal GDP growth percentage for China to make their point that China is going to stuck in the middle income trap if she doesn’t transform herself into a domestic consumption led economy.  I don’t like to delude myself and agree with such nonsense.  Not because I dare to think I’m smart and taking the road that less people walk and say that China doesn’t need to transform herself into domestic consumption led economy, but the facts on the ground are that China is getting richer — meaning when the Chinese average citizens have more money they automatically spend the extra money they have even though they are going to save a lot still.

I think China knows this, and this is why we are seeing China encourages the world to support her in building new land and maritime silk roads.  Instead of implementing policies that would transform herself into domestic consumption led market, China wants to have her cake and eat it too.  In China case, I have a feeling that she may achieve this objective.  Why?  The facts on the ground tell me that China is now the largest trading partner for most countries around the world, and so it’s logical for China not to be stupid and thinking that by letting go the export market and just ramping up the import market will make China richer.  It’s just common sense that I sense China knows this, and so this is why we are seeing China promotes more trades around the world.  The argument that China must transform herself into domestic consumption led is nonsense.  China takes 35 years to build up herself as the largest export trading partner with the world, why would she want to give all that up and get herself into debts by going the hyper-importing route?  The truth is that China is going to import more anyway since she is richer and wealthier, but she is going to do this in a natural manner.  Natural manner?  When her citizens get richer and wealthier, her citizens are going to demand for more import goods naturally with or without the intervention of her government’s import preset models.  One example would be China now has the largest automobile market in the world.

I’m writing this article to argue why people should not think the middle income trap theory is always going to be correct.  To think so would be a delusion.  Who would want to be delusional?  In the end the facts on the ground will always going to be freely available for people to understand.  As long China has the export competitive edge, she is going to be fine even if her per capita income isn’t higher than the middle income status.  Only when China loses her export competitive edge, that is when she finds middle income trap is troublesome.  Nonetheless, China is too smart to fix something that isn’t broken.  The proposal of the new land and maritime silk roads is one of the logical methods of how China is going to build a stronger export foundation to ramp up her future export market.  China is seeing weakness in her export market as the world experiences a big recession.  Europe and America and many other countries around the world are poorer now, thus the export market for China is naturally weaker.  As China is seeing this, she proposes the silk roads and establishes AIIB (Asian Infrastructure Investment Bank) so she can ramp up her export market and maintain her manufacturing hubs and capabilities.  If China is going to achieve this, even if China is still a middle income country for the next ten years, I think China is going to be just fine and her economy is going to grow even bigger than ever before.

China is also a special case in term of her foreign exchange reserve.  China has a surplus of around 4 to 5 trillion dollar foreign exchange reserve, and so she can use this to preemptively stopping weaknesses in her economy.  One example would be funding the AIIB that she is in process of establishing.  Furthermore, China is still pegging her Yuan to the Dollar, and so she can just tweak her currency the way she wants.  By being able to tweak her currency the way she wants, China can effectively control how she wants to get herself out of the middle income trap at the pace that she decides.  How?  By being able to increase or decrease the strength of Yuan according to the Dollar peg, China can dictate how much more stuffs her citizen can afford from import.  Rising Yuan would make her export weakened, but she can afford more from import.  Weakening Yuan would boost her export but weaken her import.  Instead of raising the wages of her people’s per capita income, China can just tweak her dollar currency peg to have the same effects as countries that have already escaped the middle income trap.

As long the United States’ Dollar is still the reserve currency of the world, I don’t think China will unpeg her Yuan against the Dollar.  Only when China can establish her own currency as the reserve currency of the world, this is when China will unpeg the Yuan from the Dollar.  Of course, if this to happen, I think China will be more careful in tweaking her currency and will consider of implementing policies that encourage higher wages/incomes for her people.  Nonetheless, if China’s Yuan becomes a reserve currency, she will have a lot of tools to get herself out of middle income trap easily.  Why?  Because world reserve currency has a lot of power!  The power to affect trade and world policies are two examples of a country that has her currency as a reserve currency for the world.  With huge export capability and manufacturing power, a Yuan currency reserve for the world will make China unchallenged for decades to come.  Nonetheless, it’s not that easy for just any country to turn her own currency into a world reserve currency, and the United States is going to challenge such a country for sure if that is going to happen.  I think we are going to see China and United States compete in currency arena for some time to come, because I think China is challenging the United States’ world currency reserve status as we speak.

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