Investments  

What is happening to the Chinese economy?

The traditional way to deal with higher inflation is to put interest rates up, but doing this causes the price of the country’s exports to rise, which could hinder the export-led growth that caused the economic growth in the first place.

In order to prevent this, many economies keep their currencies weaker and rates lower than is justified by the economic data. 

This leads to banks lending more and consumers borrowing more, with a significant portion of this debt going into house purchases. 

Politicians often justify this by saying the economy growing through domestic demand is a positive as it diversifies away from exports.

The challenge comes if the excessive liquidity in the system creates a housing bubble, which typically bursts when a global economic downturn happens.

The downturn also reduces demand for many exported goods and so makes the debt harder to service, causing a housing market collapse. 

When exports recover, the level of household debt remains very high, which makes it not the right time to put rates up. 

Evergrande had debt that originated in products sold to retail investors in the country.

The middle-income trap is not strictly an emerging markets phenomenon; Ireland probably experienced the same trajectory in the years approaching the financial crisis, while Italy has also struggled. 

Escaping the trap

Gerard Lyons is chief economic strategist at Netwealth, and also an independent non-executive director of Bank of China (UK), a state-owned bank. He says: “People first began talking about the middle-income trap impacting China a decade ago. China has introduced policies such as the belt and road initiative and the dual circulation policy, which aim to address the imbalances.

"But it is very hard to escape the middle-income trap. And in China, the issue is that while consumption as a total percentage of GDP has risen, it has only risen by a small amount. The government there talked a good story about moving out of the middle-income trap, but the amount of consumption has risen by only a small amount.” 

The notional solution that enables escape from the middle-income trap is for the country’s exports to be of services and more sophisticated goods, and so less reliant on being the cheapest source of production. 

In such a scenario, the goods being exported are less price sensitive, so policymakers can raise rates if need be, helping to address imbalances.

Lyons says that while the large cities around Hong Kong have probably escaped the middle-income trap by becoming technology hubs, the remainder of the country is still stuck in the trap.