Will China Fall into a Middle Income Trap Will China Fall into a Middle Income Trap? Growth, Inequality and Future Instability Introductory thoughts  Scott Rozelle Stanford University (FSE, APARC, SCID) Director, Rural Education Action Project (REAP)

We all know why such a large share of the things the world makes are manufactured in China today! It is because China’s wage rates were so low in the 1980s and 1990s … 0.50 China US Japan EU Korea Australia Mexico Brazil Sri Lan. Hourly Wage, 1990s 2

Korea 1970s / Early 1980s Hourly Wage, 1990s But, it was not always like this … in the 1970s, most things were made in South Korea … and Taiwan … and Mexico Korea 1970s / Early 1980s 0.50 0.75 China US Japan EU Korea Australia Mexico Brazil Sri Lan. Hourly Wage, 1990s 3

Korea 1970s /Early 1980s Korea Today Hourly Wage, 2005 But through the 1980s and 1990s, South Korea’s wages rose rapidly … Korea 1970s /Early 1980s Korea Today 13.56 0.50 0.75 China US Japan EU Korea Australia Mexico Brazil Sri Lan. Hourly Wage, 2005 Hourly Wage, 1990s 4

And a transformation took place in its economy (and work force): From a low-wage, labor-intensive economy … … to a high-productivity, service-base, innovative-based economy The 1970s/Early 1980s Late 1990s to Today

South Korea in the early 1980s How did South Korea make this transformation? South Korea in the early 1980s In no small part it was due to the fact that its labor force was highly educated … Even in the early 1980s, almost everyone (urban and rural) in South Korea graduated from high school (or attended school to reach a high school level of training) Percent of students that go to High School 1980s Today 6

But, not all countries made this transformation (from middle income to rich) as smoothly in the 1980s and 1990s as South Korea

Mexico Early 1970s Hourly Wage, 1990s That is not to say that there were not other candidates for “developing” successes in the 1970s/80s/early 90s … One was our neighbor, Mexico … although wages in the 1970s were low … manufacturing was growing … Mexico Early 1970s 4.00 0.50 0.75 China US Japan EU Korea Australia Mexico Brazil Sri Lan. Hourly Wage, 1990s 8

Mexico Mexico Early Mid-1990s 1970s 4.00 Hourly Wage, 1990s And just as in Korea, wages in Mexico began rising in the late 1980s and early 1990s … Mexico looked like it was on the path to becoming a developed country … Mexico Early 1970s Mexico Mid-1990s 4.00 0.50 0.75 China US Japan EU Korea Australia Mexico Brazil Sri Lan. Hourly Wage, 1990s 9

As would be expected, low-wage factories in Mexico shut down and moved elsewhere in the world

The hope was that employers would invest in higher productivity jobs that would be able to support the rising wage rates (this is what development is all about, after all …)

South Korea in the 1970s/1980s Mexico in the 1980s! BUT, Mexico’s education system had not succeeded in educating large share of the labor force for the new economy. South Korea in the 1970s/1980s Mexico in the 1980s! Percent of students that go to High School 1980s 1980s Today 12

Mexico in Crisis Travel Warning U.S. DEPARTMENT OF STATE Bureau of Consular Affairs, Mexico Foreign Direct Investment in Mexico Cartels & gangs Violence Unemployment

In fact, history is littered with a lot of wannabe OECD members: This motivates a more fundamental question: Is it inevitable that Developing Countries that are growing fast and achieve Middle Income status always will continue to grow and become rich, industrialized nations? In fact, history is littered with a lot of wannabe OECD members: Argentina … one of the four richest countries in the world in the early 20th century … collapse and stagnation after WWII Uruguay / Iraq / Venezuela (in the 1960s & 70s) MORE RECENTLY: How about Tunisia? Or … as we are seeing before our eyes: Mexico

List of Countries that Have Moved from Middle Income to High Income After WWII East Asian Countries / Regions Mediterra-nean Eastern Europe Others (oil countries*) S. Korea Portugal Croatia E. Guinea* Taiwan Spain Slovenia Trin & Tob* Greece Slovak Rep. Israel Hungary Ireland Czech New Zea. Estonia

List of Countries that Have Moved from Middle Income to High Income After WWII and the GINI Ratios (XX) East Asian Countries / Regions Mediterra-nean Eastern Europe Others (oil countries*) S. Korea (32) Portugal (38) Croatia (34) E. Guinea* Taiwan (32) Spain (35) Slovenia (31) Trin & Tob* Greece (34) Slovakia (26) Israel (39) Hungary (31) Ireland (34) Czech (26) New Zea. (36) Estonia (36)

List of Countries that Have Moved from Middle Income to High Income After WWII and the GINI Ratios (XX) East Asian Countries / Regions Mediterra-nean Eastern Europe Others (oil countries*) S. Korea (32) Portugal (38) Croatia (34) E. Guinea* Taiwan (32) Spain (35) Slovenia (31) Trin & Tob* Greece (34) Slovakia (26) Israel (39) Hungary (31) Ireland (34) Czech (26) New Zea. (36) Estonia (36) Average Graduates: 33

Aspiring / Struggling (?) Middle Income Countries Argentina Brazil Chile Costa Rica Malaysia Mexico Russia Thailand Tunisia Turkey Uruguay Venezuela

Aspiring / Struggling ( Aspiring / Struggling (?) Middle Income Countries and their levels of Inequality (gini ratios) Argentina (46) Brazil (54) Chile (52) Costa Rica (50) Malaysia (46) Mexico (52) Russia (42) Thailand (42) Tunisia (41) Turkey (43) Uruguay (42) Venezuela (44)

Aspiring / Struggling ( Aspiring / Struggling (?) Middle Income Countries and their levels of Inequality (gini ratios) Argentina (46) Brazil (54) Chile (52) Costa Rica (50) Malaysia (46) Mexico (52) Russia (42) Thailand (42) Tunisia (41) Turkey (43) Uruguay (42) Venezuela (44) China: HIGH

Aspiring / Struggling ( Aspiring / Struggling (?) Middle Income Countries and their levels of Inequality (gini ratios) Argentina (46) Brazil (54) Chile (52) Costa Rica (50) Malaysia (46) Mexico (52) Russia (42) Thailand (42) Tunisia (41) Turkey (43) Uruguay (42) Venezuela (44) Average Aspirees: 46

So how different are inequality levels in the successfully graduating countries and the countries currently aspiring to move from middle income to high income? Average Graduates: 33 Average Aspirees & Stugglers: 46 GAP between Graduates / Aspirees & Struggles 13 So how big of a difference is 13 points … Illustration 1: China current Gini is 49 … China’s Gini was 36 in the 1980s, a time when people thought China’s income was quite equitably distributed … Illustration 2: US is 41  Finland is 28

The stories of Korea and Mexico provide the backdrop for interpreting what is happening in China today and where China is heading While low wages and labor-intensive manufacturing fueled economic growth in China in the 1980s and 1990s … China today (like Korea and Mexico earlier) is entering a new era … 0.75 0.50 China US Japan EU Korea Australia Mexico Brazil Sri Lan. Hourly Wage, mid-1990s 23

Skilled / managerial wage Since 2000 > 2.00 per hours Skilled / managerial wage Unskilled wage 2010 They are rising now … and rising fast! In coming years … wages are projected to rise even faster … Unskilled wage rate increased by 19% in 2010

Implications By 2025 to 2030  $10/hour or so China continues to grow: RISING DEMAND Size of labor force falls: FALLING SUPPLY Rising wages in the future Changing industrial structure By 2025 to 2030  $10/hour or so

27

But, with higher wages, China will have to move itself up the productivity ladder Can it?

“Textile worker” in high wage countries “made to order” Gucci shoe factory To do his job, he needs to be competent in math, language, English and computers …

Will these young women … who are working in China’s textile plants now … be able to do the job in a modern high fashion textile plant? Unfortunately, most barely know how to read and write … 30

This is my auto mechanic … in Palo Alto …

Question: “Will these boys be able to do the jobs that need to be done in the future economy?” None of these students have ever touched a computer or surfed the web 32

So: China’s real challenge is coming … and there are fundamental questions: Can China transform itself like: Taiwan / South Korea / Spain / Slovenia Or  will China become a: Mexico / Argentina / Tunisia

Today’s Agenda Session 1: Inequality in China Today Session 2: Inequality Tomorrow and the Forces that Shape / Affect Tomorrow’s Economy Session 3: Countries that are Flailing (Mexico) / Fixing it (Brazil) / Free and Clear (South Korea) [Can we draw lessons for China?]