Pay rise doesn't necessarily hinder growth

Who benefits and how from this? Consumer products-driven industries, such as retail, white goods and automobiles, could be the net beneficiaries (or, at least, could mitigate the negative effects with rising sales). The losers, on the other hand, would be industries whose products are not directly targeted at consumers - for example, infrastructure investment entities, the capital goods sector and companies dealing in raw materials. Such industries and companies would see their cost bases rise without the counterbalancing effect of increased revenues.

The other consideration one has to make is that, neither all workers nor all consumers are the same. In particular, individuals who already are in the higher-income group show less propensity to spend more despite a pay rise. That is to say, such people will spend only a fraction of the extra money they earn from increased salaries. At the other end of the spectrum, individuals in the low-income group tend to spend a larger proportion of their additional earnings.

According to the laws of economics, as your income grows it becomes increasingly "difficult" to spend everything you earn (one can eat only three times a day, go on holiday a certain number of times a year and buy only so many luxury items, and so on). Therefore, the policy of increasing wages should be targeted mainly at the low-income group. If the policy is focused on this disadvantaged group, it will not only ensure that a very high percentage of the increased wages is spent on consumer goods, but also help narrow the rich-poor income gap.

However, there are always net losers in this approach and, as is often the case, political considerations can be more important than economic factors. So, tackling the wage issue must be only the first step toward avoiding the middle-income trap. In the longer term, China will have to put to use its great creative and innovative potential, which now faces layers of obstacles.

The process of removing those layers could start with a thorough reform of the education system, starting from primary schools and ending with higher education to build a new system that would encourage young students to express their genuine views, debate with their teachers and develop their own critical thinking. Only then will creativity and innovation start playing the most vital role in economic growth and allow China to shed the image of the "factory of the world".

The author is head of China Economic Policy Program at Nottingham University Business School, China and at the Global Policy Institute, London.