by Jim Rickards, Daily Reckoning:

The story of China’s explosive growth from 1978 to 2008 is well-known.

China’s GDP surged from less than $150 billion in 1978 to over $3 trillion by 2008. China’s average annual growth rate exceeded 10% from 1978 to 2005. During this period, over 600 million people escaped poverty to obtain at least a stable if low-income standard of living.

Between 2000 and 2008, China became the factory to the world providing everything from simple assembly to textiles to world-class automobiles and laptop computers.

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In the 1960s and 1970s, development economists believed that moving an economy from low-income to middle income was a huge challenge, but once middle-income status was reached the path to high-income was just a matter of time.

This was called the “takeoff ” theory based on the view that it was hard to get a plane off the ground, but once airborne it could soar to almost any feasible altitude in time.

It turns out that theory was completely wrong.

In fact, it’s relatively easy to move an economy from low-income to middle-income. All that is required is cheap and plentiful labor, urban infrastructure, basic education, and foreign capital. With those ingredients, an economy can turn itself into a manufacturing powerhouse.

The catch is that this manufacturing is mostly assembly-based. Investors may know that China is the source for about 90% of all iPhones. They may not know that Chinese value-added to the iPhone is only 6% of the sale price.

The other 94% of value added comes from the U.S. (invention and patents), Japan (gorilla glass), South Korea (semiconductors), and 26 other countries that supply critical parts.

China assembles the phones, but they did not invent them, and they did not create the high-tech inputs.

A low-income country is considered to have about $5,000 annual income per capita. The middle-income countries begin at about $10,000. The high-income countries begin around $20,000 annual per capita income but have no ceiling.

China is often touted as the “second largest economy in the world,” which it is on an aggregate basis. But when calculated on a per capita basis, it drops from number 2 to number 77 in global rankings, between Equatorial Guinea and Botswana. On a per capita basis, U.S. income is six times greater than China.

So much for China taking over the world.

Therefore, the challenge for China is how to break out of the middle-income trap and reach high-income status. This is extremely difficult to do. The only countries that have made the leap are Japan, South Korea, Hong Kong, Taiwan and Singapore.

The list of countries stuck in the middle-income trap along with China is a long one — Malaysia, India, Turkey, Thailand, Brazil, Mexico, Argentina, Russia, Chile and others.

China Is Trapped

By Jim Rickards

The way out of the middle-income trap is to develop your own high-technology intellectual property that you can then apply yourself and license to others. The middle-income countries basically pay others licensing fees for the technology they need to grow.

It’s only when you develop your own technology that you can move to higher value-added in your manufacturing and earn fees from others. The key to forecasting Chinese growth in the years ahead is therefore technology.

Can China develop its own technology ahead of advanced economy competitors and create the high-value-added industries that come with it? The outlook here is not good for China. They have shown little or no capacity to invent or produce in areas such as advanced semiconductors, high-capacity aircraft, medical diagnostics, nuclear reactors, 3D printing, AI, water purification, and virtual reality.

The projects that China does have on display that are advanced (such as their bullet trains that run quietly at 310 kph) are done with technology licensed from Germany or France or with stolen technology. China has produced major technological advances, but it has done so in non-sustainable ways including excessive debt and theft of intellectual property.

China has done little innovation on its own. The stolen technology channel is being shut down by bans on advanced semiconductor exports to China, and sanctions on the use of 5G systems from Huawei. Even China’s ability to import high-tech semiconductor manufacturing equipment as a path to developing their own semiconductors has been cut off through export bans from the U.S. and Netherlands.

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