China needs to deepen its economic reforms and encourage innovations to avoid the middle-income trap and finally reach a high income status, said a report released by the Asian Development Bank (ADB) and Peking University's National School of Development (NSD) on Oct. 27.

The report, which took a year and half to compile, said that with per capita gross domestic product reaching US$4,930 in 2011, China has become a middle-income country, but remains at risk of an economic slowdown without proper action.

After several decades of fast economic expansion, China still lags far behind developed countries regarding technology and productivity, the report said. In 2009, China's labor productivity was 10 percent of US levels. "While it is considered the world's factory, the PRC is largely an assembler with few internationally known brands," the report said. The Chinese economy also suffers from great imbalances in the sources of development. On the demand side, it relies heavily on net export and investment, with the weak private consumption. On the supply side, services remain underdeveloped, with a proportion of GDP lower than those of middle-income and high-income countries.

Many people believe that China is approaching a "Lewis turning point", where a decline in rural labor pool leads to rising wages, the report said. Meanwhile, the country has seen people's income gaps widening. China's Gini coefficient, a major benchmark to measure the income disparity, increased from 0.3 in early 1980s to 0.434, among the highest in Asia, in 2008.

Furthermore, China's fast growth imposes considerable pressure on the country's natural resources and environment and increases its dependence on energy imports such as oil, the report said, adding that the "energy supply and security could also constrain the country's future growth." In addition, the external economic environment will pose further challenges. Slow global economic recovery and the ongoing eurozone debt crisis will affect demand for Chinese-made products. China's trade balance with its partners will continue to be challenged.

Under such circumstances, the ADB and NSD urge China to step up innovation and industrial upgrading. While retaining macroeconomic and financial stability, the country should move toward a "knowledge-based society" by encouraging enterprise innovation and further structural reform, "in particular reforms of enterprises, labor and land markets, the financial sector, and the fiscal system." Likewise, China should expand its service sector, scale up urbanization, and reduce income inequality so that ordinary people benefit more from economic growth. Finally, it should also pursue green growth to protect the natural environment. At the same time, strengthening international economic cooperation is necessary.

"Implementing this strategy would greatly increase the likelihood of sustained growth and reaching high-income status before 2030. Scenario analysis shows the PRC has the potential to grow eight percent annually from 2010 to 2020 and 6 percent from 2020 to 2030—if it addresses its challenges effectively. Under this scenario, real GDP per capita in 2010 constant prices would reach $16,500 in 2030," the report said.

Justin Yifu Lin, senior vice president of the World Bank and honorary dean of NSD, said: "There are two most important things for China to do in order to avoid the middle-income trap. One is to achieve industrial upgrading and technological innovation faster than developed countries. The other is to improve market mechanisms and reform the double-track system (in which the market economy coexists with the planned economy)."

Jia Kang, director of the Research Institute for Fiscal Science, Ministry of Finance, said that Chinese economy is facing two obvious threats: the gradual loss of the competitive edge of cheap labor and the underdevelopment of hi-tech value-added industry. He added that the upcoming 18th National Congress would be a historical turning point and is expected to add new momentum to China's reform schemes.

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