Structural Change, Industrial Upgrading, and Middle-Income Trap

Motivated by several stylized facts about middle-income trap, we develop a simple multi-sector general equilibrium model of structural change and industrial upgrading. The model features the distinction between production service and consumption service and the input-output linkages between different sectors. We show that the role of production service is asymmetric at different levels of development. Whereas an underdeveloped sector of production service is not a binding obstacle for development (sometimes even beneficial) at an early stage of development, it becomes a key bottleneck when the economy reaches a middle-income status. To escape the middle-income trap, government intervention is needed to prevent premature de-industrialization and facilitate beneficial industrial upgrading. Moreover, it also requires a timely reduction of entry barrier to the production service and improvement in its productivity. These theoretical findings are shown to be consistent with the stylized facts and also useful to China. The analysis provides a justification for the government’s strategic use of industrial policies to avoid middle-income trap.