The Human Capital Roots of the Middle Income Trap: The Case of China

China, like other middle income countries, is facing the challenges of the next stage of development as its leaders seek to guide the nation into becoming a high income country. At this same point of development, however, other countries have faltered, raising the possibility of stagnation or collapse. The stagnation of growth after reaching a level of income high enough to be call “middle income” is a phenomenon which some observers call the Middle Income Trap. In this paper we explore one of the major challenges that nations, including China, must face in the transition from middle to high income: the management of inequality. In particular, we explore the possible roots of future inequality that is associated with a nation’s underinvestment in the human capital of broad segments of its population. To meet this goal we first look at several benchmarks of successful transitions from middle to high income (e.g., the case of South Korea) and not-so-successful transitions (Mexico). We then exam more systematically the characteristics of countries that have successfully transitioned (or graduated) from middle to high income (Graduates) and those that are attempting to do so now (Aspirees). With this background, we describe the challenges that China faces in the light of rising wage rates and highly unequal income distribution today. We also document the high levels of human capital inequality in China today, a harbinger of high future inequality. In discussing the sources of the human capital inequality, in addition to the structural and institutional barriers that are discouraging many students (and their parents) from staying in school to achieve the levels of learning that we believe are necessary for preparing individuals for employment in the coming decades, we also identify severe nutritional and health problems. We believe that these nutrition and health problems, unless addressed, are creating serious China’s human capital deficiencies in poor areas of rural China and locking in decades of hard-to-address inequality. The paper ends with a call for leaders in China (and countries at the same level of income of China) to launch immediately a war on poor education, health and nutrition as one step in helping such nations avoid the Middle Income Trap in the future.