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Innovation, education now needed in China's development

23 April, 2013

Kamel Mellahi, Professor of Strategic Management at Warwick Business School, has warned China has to boost innovation if it is to stop the slowdown in its economy and prevent it falling into the 'middle income trap'.

Prof Mellahi, an expert on emerging markets, believes China is at a crossroads as it looks to stoke domestic consumption to keep its economy on an upward curve.

But he said for that to happen and for China to reverse a decline in its growth, which saw it slip to 7.7 per cent in the first quarter it has to encourage more innovation.

"China must escape the 'middle income trap'," Prof Mellahi said.

"Countries that have tried to make the transition from a low income to a high income economy often got caught in the 'middle income' trap. Very few countries managed to escape the trap. This is because it is much easier to move up from a low income to a middle-income economy than it is to make the leap from a middle income to a truly high income developed nation.

"If one looks at why western developed economies and some East Asian countries like South Korea and Singapore evaded the middle income trap and became high income economies, one finds, among other things, two key drivers powering their economy into this position.

"One is the level of education, particularly focused on engineering, and the second is innovation capabilities. Although China's education looks solid and there is also evidence that China has made great progress in developing its innovation capability they need to enhance them further."

Prof Mellahi believes another problem China has to overcome to drive domestic spending power is to improve its social welfare. China's savings rate is at 52 per cent, compared to just 10 per cent in the US, and Prof Mellahi believes a better welfare programme would solve this trend to save instead of spend.

"In my mind the big difference between China and western countries is the social safety net," Prof Mellahi said.

"People are more willing to spend when they feel secure about pensions, education and healthcare. In the short term Chinese people will want to see tangible evidence that the safety net is there before they start spending.

"It is going to be two different segments driving the Chinese economy forward. The biggest segment is going to be the 'mass' segment, those in the lower income bracket. Their income is set to increase and they are expected to spend a big chunk of their money on white goods, and by so doing they will drive the lower end of the economy.

"There are many Chinese living in the rural area. It is estimated they represent £500bn of untapped opportunity. We also know from research that this segment has a high marginal propensity to spend, if they get money they are going to spend more, especially if they feel there is a social net for them.

"The core middle class are going to increase in the future and have more disposable income. They are likely to increase their consumption of high-end quality goods. This trend will drive the upper end of the Chinese economy as China moves up the value chain.

"As China goes up the value chain, it needs to sustain the lower end of the economy and the rural areas will absorb that. All these different segments need to be stimulated differently."

Prof Mellahi believes China needs to act quickly to boost its domestic consumption to insulate itself from jolts in the global economy.

"By relying on exports China is susceptible to external shocks that could have a negative impact on its development," he said.

"In contrast, local consumer-led growth is controlled more by the government and provides a more sustainable and manageable growth."