Trapped! China and the Middle Income Trap

Cover image by Yang Ruimin

Image credit: SCMP

The meteoric rise of China’s economy in recent decades has undoubtedly been one of the most significant economic developments the modern world has experienced. Since it launched its plan to reform and open up its economy, China has averaged an annual GDP growth rate of 8% from 1980 to 2015, catapulting it from a largely agrarian economy to a technological powerhouse which now stands at the cusp of becoming a high-income country.

However, the situation is not as rosy as it seems. Though China is currently classified as an upper-middle income country, there has been increasing evidence pointing towards it being at risk of falling into the middle income trap. Take China’s recent economic stagnation, for example - its GDP growth rates have fallen to 5%, with export growth severely declining, achieving only 0.6% in 2023. In this year’s annual plenary meetings, China cut its annual economic growth target to a range of 4.5%-5%, its lowest expansion goal since 1991. 

With China’s recent economic slowdown increasingly mimicking that of countries in the middle-income trap, there has been more debate as to whether China would meet the same fate. However, if China plays its cards right, there are grounds for cautious optimism that China might be able to smoothly transition to a high-income economy without falling into the trap.

The Middle Income Trap

To debate China’s ability to escape the middle income trap, though, it is first necessary to define what it is. 

Although there has been discussion amongst scholars about the existence of the middle income trap, it is widely agreed to be “a condition in which countries achieve rapid economic growth and escape from stagnant development at extremely low levels of income, but then stagnate at lower or upper middle-income status”. The trap is a common obstacle faced by developing countries like Malaysia, Mexico, and Brazil, among others. In fact, according to the China 2030 Report, only 13 out of 101 middle-income countries made the transition to high-income status between 1960 and 2008, including South Korea, Singapore and Spain. This proves the difficulty in obtaining the structural transformation and industrial upgrading required. 

The fundamental reason behind why countries fall into this trap is their failure to change their economic growth model in a timely manner, usually from a labour-intensive workforce to an innovative economy with a high technological growth rate. Many low-income countries extensively rely on labour-intensive industries, like low-wage manufacturing work, to propel their economies out of the low-income range. However, citizens’ increasing wealth makes workers less likely to accept such low wages, driving foreign enterprises to move operations to lower-cost locations. Ideally, this is when innovation and capital-led industries would begin to supplant labour-intensive ones, but this is often not the case. Thus, for most middle-income countries, the crux of the matter is that they cannot develop the capabilities for such innovation before their labour costs start to rise.

Why might China fall prey to the middle income trap?

For officials in Beijing, it is critical to consider the features of China’s economy that make it vulnerable to the trap. As a developing nation on the cusp of pivoting into a high-income economy, falling prey to the trap would severely derail most of China’s future economic plans by causing its pace of economic growth to stagnate. It also risks losing global influence and weakening its geopolitical prowess, making it difficult for China to compete with other major world powers.

Much literature has been published speculating on the likelihood of China falling into the middle income trap. Scholars have averred multiple reasons for this, one of which is China’s rapidly ageing population. This not only reduces the supply of labour, but also increases the burden of providing pensions on the labour force. It causes retirement security to have been shifted to employers and workers, forcing workers to reduce their take-home salary while making a mandatory contribution to the pension insurance system.  

However, the most prominent reason remains the fact that China has outgrown the predominantly export-and-investment-led growth model and is in desperate need of a recalibration. From an economic perspective, the 3 main drivers of any economy are export, investment, and consumption, also known as the three “horse carriages” that have promoted the exponential growth of China’s economy in recent decades. 

Since China’s economic reform in 1978, an export-oriented economy has been its focus. Taking advantage of its large working population at the time, China capitalised on low-wage manufacturing jobs on the lower end of supply chains, importing raw materials and undergoing further processing before exporting the finished goods. It was with this economic model that China earned the name of the “world’s factory” and became the world’s largest exporter of goods. But with the country’s working age population on the decline since 2012 and China’s GDP per capita rising rapidly, China quickly began to outgrow the export-oriented economy. In fact, as early as 2013, some economists had declared that China had begun to enter the “Lewis Turning Point” — where worker wages begin to rise faster than the rate of inflation because the surplus labour pool has been exhausted.

China’s investment-driven growth model has also outgrown itself. With over 40% of its GDP invested annually, China’s overreliance on investment for sustaining growth is a widely known fact. Although initial investments were hugely beneficial, the productivity benefits of additional investment eventually declined and increasingly contributed to a rising debt burden on local governments. 

That leaves consumption as the remaining sustainable driver of growth. Having long followed a mode of growth built on suppressed consumption and high investment,  the “rebalancing” of the economy that is now required of China would be no small feat. Boosting consumption on its own would require measures to increase the purchasing power of citizens and reduce lifetime uncertainties that bog down consumption rates.

China has rolled out a series of stimulus programmes targeting the electronics sector. Image credit: SCMP

Yet, hope still remains for the Chinese government in this aspect. Data from Deutsche Bank reveals that Chinese consumer sentiment is making a slow, albeit uneven,  recovery, with urban residents expressing more confidence about their income expectations and a stronger willingness to spend. Driven by Beijing’s supportive economic policies, there has been a slight uptick in market sentiment. If this trend continues, there is cause for hope that consumption can continue to drive further economic growth, preventing China from being stuck in a rut.

There is still hope yet

Why China can evade the middle income trap, with reference to South Korea

South Korea is one of the East Asian Tiger economies that have successfully made the leap from middle to high-income economy, and its experience provides grounds for optimism about China’s prospects for overcoming the middle income trap. Of course, obvious differences between the two remain, such as the fact that China had been a centrally-planned economy prior to its economic reform. However, many factors point towards the fact that China can follow in South Korea’s footsteps economically and avoid falling into the trap.

South Korea’s rapid economic growth and development from a war-torn, poor nation to a high-income economy closely mirrors China’s experience. Similarly to China, many researchers have also cited Korea’s export-oriented industrialisation as a key factor influencing its development. Both governments also utilised and fully supported meticulously prearranged economic plans, in the form of China’s “five year plans”, still utilised to this day, and South Korea’s five-year plans implemented from 1962 to 1996.

Firstly, South Korea leveraged innovation and technology while cultivating a strong culture of Research and Development (R&D). Since its sixth and seventh Five Year Plan, South Korea has aimed to shift to technologically intensive, high value-added industries, with the government nurturing promising private-sector companies in these fields. This resulted in the birth of technological conglomerates, or “chaebols”, like Samsung and Hyundai that pride themselves on being highly innovative and globally competitive. In short, Korea was sufficiently invested in science and technology development by the time input factors such as labour and capital no longer provided a comparative advantage.

In a similar vein, China’s “Made in China 2025” plan reveals its intention to pivot to high-value added industries. The plan, which seeks to allow Chinese manufacturing to produce high-quality, hi-tech and high-value products through scientific and technological advancements, has been widely agreed upon as a success. Reports suggest that Chinese firms appear well-positioned to make significant advances in several high-tech sectors, having made significant strides in closing the gap with foreign firms and advancing toward the technological frontier. China is also on track towards technological leadership, with other parts of the world increasingly reliant on Chinese technology. For example, China is one of the world’s largest producers and refiners of rare earth metals, which are critical components for almost all high-tech applications such as smartphone motors.

In particular, China has renewed its focus on AI and the semiconductor industry as part of its most recent Five-Year Plan. Facing technological sanctions from the US and other parts of the Western world, China has set out to improve self-reliance by pushing for supply-chain localisation and onshoring. For example, in the face of Nvidia’s restricted sale of chips to China, China’s semiconductor industry has managed to produce its own AI chips, albeit with poorer performance. In addition, China has begun to produce their own Large Language Models (LLMs), most notably in the form of DeepSeek, which gained global prominence in early 2025 due to its performance that rivalled US models.

South Korea’s advancements in technology-heavy industries have no doubt been pivotal in its transition to a high-income economy. Thus, with China’s plans to break into these sectors already bearing fruit, it seems promising that China can escape the middle-income trap if things continue to progress well. 

Secondly, South Korea’s high participation rate in Global Value Chains (GVCs) is also an integral factor influencing its leap to a high-income economy. GVCs are networks where different stages of value creation of a product are located across different countries according to their comparative advantages. South Korea, in particular, has been involved in global supply chains since the 1960s as a core strategy for its economic growth and is one of the most active countries in terms of GVC participation amongst 40 countries. Korea’s comparative advantage in terms of value added has also been increasing in high-tech sectors such as electronics, showing how such high-margin production helps it to escape the middle-income trap. 

China, too, participates in GVCs across multiple industries. By incorporating multiple stages of production and having a healthy mix of foreign and domestic enterprises, this incentivises foreign companies to stay as they are drawn in by the complete local production chain. In addition, firms are motivated to increase local value-added to offset higher operating costs through adding design, development and research capabilities, which all point to China’s increased dominance in high value-added industries.

If China wishes to successfully evade the middle income trap, it is imperative that it follows in South Korea’s footsteps by renewing its focus on high value-added technological sectors as well as by boosting its involvement in global value chains. Other methods remain, such as shifting from investment-led growth to innovation-driven productivity, or increasing domestic consumption, all of which also remain potential solutions China can consider. 

Conclusion

In summary, it seems that China has a high chance of overcoming the middle income trap. However, it remains important to note that the wider world’s current perception of China as a competitor, instead of a partner, is significantly different from the collaborative and open environment South Korea was in in the 1960s.

For example, geopolitical conflicts remain a point of tension for China. With much of the Western world monitoring China’s rapidly expanding economic and political footprint with growing concern, sanctions and trade barriers imposed by the West, especially around critical new technology, will continue to hinder China’s growth in the technological sector. As such, China will have its work cut out for itself in terms of increasing its self-reliance and eliminating technological bottlenecks in order to achieve the same level of technological upskilling as South Korea had. 

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