High-income status an achievable dream

Central to the innovation-focused perspective is the notion that economic growth requires technology transfers and an environment in which new companies can form, grow and exit (thereby reallocating factors of production to more successful firms).Quality of management obviously plays a key role, but institutions and human capital also matter; corruption, credit constraints and lack of access to high-quality education all make economic transformation more difficult.

But fostering innovation is not a silver bullet. While providing returns to innovators can help spur more innovation, it can also allow businesspeople to capture too large a share of the transformation process. For example, whereas Bill Gates has probably been good for economic transformation, the Mexican telecoms billionaire Carlos Slim has not. Encouraging one kind of innovator could easily give rise to the other.

What does all this mean for China? As the country attempts to create the conditions for greater genuine innovation, it must also address myriad short-term challenges. It is caught in a deflationary spiral, with falling prices and increased anxiety over the economy's prospects reinforcing each other. And excessive lending to the corporate sector, particularly in manufacturing, has led to massive excess capacity and a growing mountain of bad debt, suppressing growth.

Compounding the challenge, China's economy is more globally relevant and interconnected than ever before, which means that any action it takes can have far-reaching effects. With tried and tested policies unlikely to work in this new context, the government is having to improvise. And, as anxious markets clearly recognize, that approach carries the potential for policy mistakes.

Nonetheless, there is good reason to believe that China can succeed because its economic history indicates an impressive capacity for transformation. Of course, China's economy has come a long way since Deng Xiaoping initiated reform and opening-up in 1978. But even in more recent years, the skill content in China's output has improved radically, and resources have been successfully transferred from agriculture to the services sector, rather than to the manufacturing sector, where large State-owned firms still dominate many industries.

If the recent research debunking the middle-income trap is correct, China has a very good chance of succeeding in becoming a high-income economy with similar vigor. The underlying structural changes that have occurred in China in recent years reinforce this optimism. China will need to continue reforms and overcome vested interests, particularly in the State-owned sector, but its chances of success remain high.

The author is director of the Institute of Global Affairs at the London School of Economics and Political Science.

Project Syndicate