Morningstar Magazine - February/March 2018 - 39

EXHIBIT 2

21 low-to-middle transitions since 1960, 12
have occurred since 1990. China itself became
a middle-income country in 2011.

Back to Earth Post-boom growth
tends to revert to the global average of
around 2%.

forecast of 4% GDP per capita growth, on
average, over the next seven years, would be
on the high side of history.

Why has there been an uptick in low-to-middle
transitions just as middle-to-high graduation rates
40
have fallen? Globalization might explain
both phenomena.

Distribution of Post-Boom GDP
Per Capita Growth % (Seven-Year Avg.) Frequency

China's Odds Aren't Great

1 TO 2

40%

20

But communications technology, flowing
trade, and mobile capital seem to have pressured
10
growth among middle-income countries
by
0 subjecting them to increased competition
from countries with cheaper labor. In effect,
globalization can trap middle-income countries
between low-income countries with a competitive
advantage in labor-intensive industries
and high-income countries with a competitive
advantage in knowledge-intensive industries.
For China, the risk is that growth falters amid
stiffer competition from poorer countries that seek
to follow in its footsteps, such as Bangladesh,
India, and Vietnam.
Growth Deceleration

The historical experience of countries that have
fallen into the middle-income trap may offer
clues about the road ahead for China, including a
sense of how sharply growth slows once a country
achieves middle-income status, the causes of
slowing growth, and any attributes that influence
the size of the slowdown.

30

4 TO 5

5 TO 6

6 TO 7

20
3 TO 4

0 TO 1

-1 TO 0

-2 TO -1

-3 TO -2

Since 1990, there have been enormous improve20
ments in information technology alongside 5.0
dramatic reductions to trade and investment
10
barriers. That's enabled firms to pair richcountry technology with poor-country wages to
0
an
40 unprecedented extent. Thanks to capital
and technology inflows from high-income
countries, low-income countries have found it
30
easier to vault to middle-income status.

2 TO 3

30

10
0

Source: Eichengreen, Park, and Shin (2014), Morningstar.

Fortunately, the past several years have yielded
a bumper crop of academic research on the
middle-income trap.1 Perhaps the most widely
cited work comes from economists Barry
Eichengreen, Donghyun Park, and Kwanho Shin,
who surveyed the period from 1957 to 2010
to identify the key characteristics and causes of
slowing growth among middle-income
countries.2
Nearly all the episodes studied by Eichengreen
et al. (2012) were defined by a significant
deceleration in growth ( EXHIB IT 2 ). The typical
country saw average GDP per capita growth fall by
more than half over successive seven-year periods,
or by about 3.6 percentage points. Median
GDP per capita growth in the seven-year slowdown
period was 2.1%, essentially in line with
the long-term global average (1.9% since 1960).
Very few countries fared meaningfully better
or worse than the median. Only 9% posted GDP per
capita growth outside the 0% to 4% range. Only 3%
enjoyed the 5%-plus growth that consensus
anticipates for China. Even our supposedly bearish

To gauge the risk that China falls into the
middle-income trap and sees its once-explosive
growth slip all the way to the global norm of
0.3
0.6
roughly 2%, we begin by screening for a handful
of key risk factors identified by Eichengreen,
5.5
Park, and Shin from a long
5.0 list of economic,
demographic, and political variables. As we
discuss below, China's "risk scorecard" is mixed.
4.9

Risk Factor: High GDP Growth
China Risk Assessment: High

0.2
5.2

4.8
2.3

Eichengreen, Park, and Shin find faster-growing
countries are more susceptible to large slowdowns.
They hypothesize this may be a long-term side
effect of government efforts to prop up growth in
the short term, writing that "the more aggressive
the measures undertaken to boost growth, the
less likely exceptional growth can be maintained."3
China, which despite slowing growth has clocked
the highest average GDP per capita growth
rate of any country over the past 10 years, appears
high risk by this measure. The repeated stimulus
required to keep growth aloft would certainly
qualify as "aggressive measures." Similarly,
the side effects of stimulus-excess capacity and
bad debt-seem likely to reduce growth in the
long term.
Risk Factor: High Investment Share of GDP
China Risk Assessment: High
Beijing's efforts to generate high GDP growth have

required the country to sustain an unusually
high investment share of GDP: 44% in 2016 versus
a middle-income norm of roughly 20% to 30%. High
investment rates, Eichengreen, Park, and Shin
argue, "increase the likelihood of slowdown
as they may translate into low future returns on

1 See, for example, Eichengreen, B., Park, D., and Shin, K. 2012. "When Fast-Growing Economies Slow Down: International Evidence and Implications for China." Asian Economic Papers, MIT Press, Vol.
11(1), pp. 42-87, February; Eichengreen, B., Park, D., and Shin, K. 2014. "Growth Slowdowns Redux: New Evidence on the Middle-Income Trap." Japan and the World Economy, Vol. 32, pp. 65-84;
Aiyar, S., Duval, R., Puy, D., Wu, Y., and Zhang, L. 2013. "Growth Slowdowns and the Middle-Income Trap," International Monetary Fund Working Paper; and Agenor, P.R. 2017. "Caught in the Middle?
The Economics of Middle-Income Traps." Journal of Economic Surveys, Vol. 31, Issue 3, pp. 771-791, July. The first article in our series focused on the economic implications of demographic change,
including detailed analysis of fertility, aging, and urbanization. See "China's Next 10 Years," Morningstar magazine, June/July 2017, pp. 60-63.
2 Eichengreen et al. 2012.
3 Ibid.

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