Yikai Wang (University of Zurich)

“Will China Escape the Middle-income Trap? A Politico-economic Theory of Growth and State Capitalism”

abstract

Is China’s rapid growth sustainable if the labor and capital market distortions persist? Will democratization occur given that Chinese middle-class are supportive of the regime? To answer the above questions, this paper proposes a politico-economic theory, as follows. In oligarchy, a political elite extracts surplus from the state sector and taxes the private sector, but it also needs political support from sufficiently many citizens to maintain its power. “Divide-and-rule” strategy is implemented to guarantee such support: state workers receive high wages and become supporters of the elite, while wages of private workers are reduced due to the policy distortion. In the short-run, the low wages in the private sector lead to rapid growth of the private firms and total output. However, long-run growth is harmed by capital market distortions favoring the state firms. The theory suggests that the economy develops along a three-stage transition: “rapid growth”, “state capitalism”, and two cases in the third stage: “middle-income trap” or “sustained growth”, depending on whether democratization occurs endogenously. The theory is consistent with salient aspects of China’s recent development and gives predictions on China’s future development path.

Download the paper here:

https://dl.dropboxusercontent.com/s/f2t7z1p85kiyrcj/ChinaPE_paper.pdf