Beyond the middle-income trap: The role of institutions in China’s growth

AFTER decades of economic expansion, is China losing steam? Discussions around the causes and nature of the economic slowdown in China centre around issues such as the real estate crisis, debt overhang or deflationary spirals. Many of these narratives – such as Adam Posen’s recent article in Foreign Affairs on “The End of China’s Economic Miracle” – highlight the confluence of many factors that contribute to the slowdown. Our research has focused on one of these factors that is structural to the Chinese economy, which we believe is one of the main impediments to growth: the quality of institutions.

We first raised the question of how long China’s economy would continue to grow in a Harvard Business Review article back in 2009. To this question, our answer was, “Not much longer, we suspect, unless the country engages in deep structural reforms that improve its institutions”.

Unveiling patterns of growth

Without strong institutions, a country cannot grow past the middle-income level of development to become rich. In 2009, we illustrated the relationship between the quality of institutions and income per capita with a simple scatterplot. As a measure of institutional quality (on the vertical axis), we used the average of six governance indicators produced by the World Bank. These include: rule of law, voice and accountability, quality of regulation, political stability, control of corruption and government effectiveness. On the horizontal axis, we plotted income per capita adjusted for purchasing power parity.