What sort of internal and external risks will China face in the new period? These risks arise from only two areas, namely, changes in the internal and external objective environments and incorrect coping strategies. On the whole, since entering the new period, the internal and external risks that China has faced still center on the “two traps” that have been discussed for many years before and after the 18th Party Congress, namely, the internal “middle-income trap” and the external “Thucydides trap.”

The risks of these two “traps” are two-fold. On the one hand, many objective circumstances may cause the country to fall into these two “traps.” On the other hand, on the subjective level, no effective policies have been found to avoid these two traps. The decision-making error in this latter aspect is the “fatal mistake” that has been discussed in the past few years. This article will discuss the “middle-income trap”; the “Thucydides trap” will be discussed in another article.

Before and after the 18th Party Congress, people argued about the “middle-income trap” for many years. They are not arguing anymore. There are two reasons the argument stopped. First, in recent years some people have grown overly optimistic. They believe that China has escaped the middle-income trap and is already at the lower end of developed economies. Given that the trap has been avoided, there is no need to discuss it. Second, the argument cannot be had. China has no shortage of pessimists, but pessimism can easily be seen as political incorrectness. However, with the sudden changes in the current internal and external environment, people are beginning to feel that the country is not far from either the “middle-income trap” or the “Thucydides trap.” Without strong policies, it will be difficult to avoid falling into these traps.

So, where is the core of the “middle-income trap” crisis? The crisis has many roots, but its main manifestation is the crisis of non-development. Since reform and opening up, “development is the top priority” (发展是硬道理) has always been the primary consideration for important decisions. As a developing country, Chinese society faces endless problems. This is not surprising, as this is the case with any society. However, China’s success lies in continuous development. All problems find solutions in the process of development. However, once there is a problem with development itself, resulting in a situation of non-development, all the other problems will rise to the surface. Not only will they remain unresolved, but they will even worsen and eventually become crises.

Like other problems, the “middle-income trap” must be avoided through sustainable development. After the 18th Party Congress, China’s economic development entered a new normal, that is, from the high double-digit growth of the past to less than 7%, which is medium-speed growth. This transition was inevitable because no economy can sustain high growth permanently. Be it the environment, energy, or human resources, all would struggle to sustain such continuous high growth. More importantly, in the high growth stage, people do not pay enough attention to an important question, that is, what kind of high growth is needed? If high growth leads to a high degree of social differentiation, environmental degradation, and resource exhaustion, such high growth is not only unsustainable, but also “bad” high growth. Therefore, the 17th Party Congress posed the question “What kind of development should we achieve?” and the focus of national policy began to shift to social distribution. In recent years, the state has put forward the policy goal of transitioning from a quantity economy to a quality economy.

However, even with moderate growth, if China can maintain a growth rate of 6% to 7% for the next 10 to 15 years, then it can still escape the middle-income trap and enter the ranks of developed economies. The 19th Party Congress planned a vision for national development from 2017 to 2050, which called for the achievement of a moderately prosperous society in all respects by 2020, the basic achievement of socialist modernization by 2035, and the achievement of a great modern socialist country that is prosperous, strong, democratic, culturally advanced, harmonious, and beautiful by 2050.

We can expect that, by 2035, mainland China will be upgraded to a developed economy, at least at the level of the last (Taiwan) of today’s “Four Little Dragons” economies (South Korea, Singapore, Hong Kong, and Taiwan), which is about U.S. $25,000 per capita. Today, the national per capita income in mainland China today is more than U.S. $9,000. Although there is still a long way to go to reach the level of Taiwan, if the “package” of economic development policies since the 18th Party Congress can continue to be effectively implemented, this goal will not be difficult to achieve.

Reasons to worry about the “middle income trap”

So why are people now worried about the coming of the “middle-income trap”? Here, there are the factors of internal bureaucratic inaction and changes in the external international environment.

The bureaucracy is what implements policy. Why is it inactive? There are reasons related to both decision-making and to execution. In terms of decision-making, in recent years it has become very important to emphasize the top-level design of policies. Because reforms have reached this stage—the stage of “comprehensive deepening”—sporadic reforms led by departments and local governments are difficult to sustain. However, the “top-level” nature of decision-making often leads some policies to lack scientificity and implementability. For example, if free trade zone policies are too broad and the costs of trial and error are not fully considered, this results in the inability to fully delegate many powers. The reason is simple. If these powers were all delegated, the entire national economy would be affected. Because no one can guarantee the success of a free trade zone, it is not unreasonable that some departments are wary of delegating power.

Another example is targeted poverty alleviation, which is extremely important because it is related to social fairness and stability. However, in many areas, the policy designs are too idealistic, approaching a “Utopia,” understanding targeted poverty alleviation as the complete eradication of poverty. But the fact is that even the richest society still has a considerable number of poor people, and no society in the world is entirely without any poor people. In order to achieve a society without poor people, many places have mobilized their greatest efforts for poverty alleviation. Yet mobilization-style poverty alleviation soon caused “fatigue” among poverty alleviation personnel, leading to a transition to formulaic poverty alleviation during the implementation process. Now, some places are beginning to worry that once the government stops its “blood transfusion,” there will be a large-scale “return of poverty.”

Moreover, in terms of decision-making, at some levels of government, these years have also seen a tendency for pursuing policy quantity while ignoring policy quality. One reason for this is that some people understand “comprehensively deepening reforms” in terms of numbers and pursue the quantity of decisions, thinking that the more policies there are, the more comprehensive reforms will be. In fact, “comprehensively deepening reforms” does not imply that all the areas specified for reform are of equal importance and urgency. Policies must pay attention to “breakthrough points.” Or as we used to say, “Once the headrope of a fishing net is pulled out, all its meshes open” (纲举目张, a metaphor for making widespread changes by acting on a single key point). No one can comprehensively promote reform without assigning priorities.

In addition, the quality of policies often does not depend on their logic in theory; it relies more on their logic in practice. A policy can have strong theoretical logic without necessarily having practical logic. A policy that does not conform to practical logic is often unimplementable. There are too many policies and the policies are not implemented, which has led policies to lose credibility. This brings about the so-called “Tacitus trap,” where people do not believe in the policies formulated by the government.

In terms of difficulties in policy implementation, there are also many reasons, but one of them is that scientific power supervision mechanisms do not yet measure up. Be it to fight corruption or to overcome the resistance of vested interests to reform, highly centralized power supervision mechanisms are needed. To this end, based on prior local practice, the 19th Party Congress established supervisory authority, indicating that an internal three-power system is in place, namely decision-making, execution, and supervision. This system is of milestone significance to China’s long-term security. However, the boundary between the three powers, the internal operating mechanisms, and the relationships between the three powers must all undergo a long period of exploration. Currently, once supervisory authority becomes excessive, or it can supervise anything, the executive power then becomes “idle.”

In practice, if reforms are to be made or a policy to be implemented, there is inevitably a risk of making mistakes. Once mistakes are made, they must be supervised. To a large extent, if the sole responsibility of supervision agencies is to find the “mistakes” of policy implementers, then they are certain to be able to find “mistakes.” This is just like in a multi-party system with “mutual vetoes,” where an opposition party will always be able to find high-sounding reasons to oppose the ruling party. At present, in many areas of China, you could say that there are more people who complain than people who work, and complaining costs nothing. Under these circumstances, many bureaucrats rationally choose not to act. Although “inaction” comes with its own risks, the risk of “inaction” is still lower than the risk of making a “mistake.” Although the central government has also issued documents to tolerate “trial and error” in reforms, none of these documents have legal significance and will not easily change the actual behavior of the executors.

In addition, the risk of the “middle-income trap” has greatly increased due to the international environment and geopolitics, especially the recent U.S.-China trade war and other factors (how external factors affect China’s “middle-income trap” need discussing separately).

How to avoid falling into the “middle-income trap”

Internally speaking, in the present situation, how can we avoid the “fatal mistake” of falling into the “middle-income trap” through policy changes? At the very least, we can consider the following aspects.

First, we must correctly understand “top-level design.” “Top-level design” cannot be simply understood as “upper-level design,” or as the designs of a few people from behind closed doors. Effective policies must be a combination of both bottom-up and top-down. At the same time, achieving scientific top-level design would be difficult without extensive research and investigation.

Second, decision-making needs to transition from quantity to quality. Although reforms need to overcome piecemeal implementation and make comprehensive progress, it is vital to find effective breakthrough points among the numerous policies. Comprehensive advancement with and without breakthrough points produces different results.

Third, the central government should focus on the general direction, while the executive departments should concentrate on the details. Currently, many policies concentrate too much on the macro-level, are too theoretical, or are even too ideological, and lack executable details. Policies without details are not only difficult to implement, but will also be bent out of shape in the implementation process. Moreover, policy details require the participation of professionals. In terms of the relationship between the central and local governments, many policies require more local participation.

Fourth, in many fields, the state needs local policies. China’s size determines the importance of its localities. Since the reform and opening up, it is difficult to understand the huge social and economic changes in China without considering local initiative. Although in some areas, such as finance and the rule of law, the role of the central government is becoming increasingly important, meaning there is a need for centralization of power, many policy areas still require local governments to play a primary role, such as local economic and social services. In these areas, the local government is the main actor, and the central government is the supervisor.

Fifth, policy review and evaluation are required. In recent years, a great deal of effort has been made to adjust the economic structure, but the results have been less than ideal. For example, everyone is aware that the focus should be on the development of the real economy and that we need to curb the excessive financial and Internet economies, but after so many years, the focus on finance and the Internet to the detriment of the real economy remains unchanged, and most financial strength has not flowed into the real economy. Why is this?

Sixth, policy implementation needs to allow all actors to take action. This requires selective centralization and selective delegation of power. Power that should be centralized should be centralized, and power that should be delegated should be delegated. As stipulated by the Third Plenum after the 18th Party Congress, the relationship between the market and the government, and the relationship between the state and society, need to be transformed into practical and operational policies. In terms of actors, the situation in recent years has been one where the central government has taken action, but local governments, state-owned enterprises, private enterprises, and foreign-invested companies have struggled to take action, or have even not taken action. Since reform and opening up, these have been the main actors for policy implementation. If these actors fail to take action, policies will be nothing more than pieces of paper.

Seventh, the most important thing is to establish a “government based on the rule of law” (法治政府) as stipulated by the Fourth Plenum after the 18th Party Congress. Whether it is the legitimacy or efficiency of government, both depend on government being based on the rule of law. In terms of the economy, government based on the rule of law is a regulatory government. The government needs not only to regulate the behavior of enterprises, but also to regulate its own behavior. Although building a regulatory government has long been a goal of reform, the government is still currently a control-type government (控制型政府). This is also the main reason why over the last few years it has remained difficult to decentralize despite the government itself advocating the “decentralization of approval power.” Under a regulatory-type government, the operating principles for enterprises should be “free entry, market first, government steps back, and effective supervision.” But under a control-type government, the government still stands at the door, keeping enterprises out. The same is true for society. If the government does not give society room to develop, society will never mature.

Simply put, the government is a (rule of law) framework and should not concern itself with so many details. The details are the concern of the market and society. Without the market and society, there would be no dynamic mechanisms for sustainable development.

The external risks of China’s new period refer to the “Thucydides trap.” This concerns how to avoid conflicts and even wars between China and the United States. Simply put, the “Thucydides trap” refers to the relationship between emerging powers and established powers. Whether due to an emerging power challenging an established power or to an established power that fears an emerging power, it is possible that this situation can eventually lead to conflicts and wars between the two.

According to the statistics of a research team at Harvard University, the world has experienced 16 transfers of power between emerging and established powers since 1500. This has resulted in 12 wars, while only four transfers can be described as peaceful transfers. Over the past few years, whether China and the United States will fall into the “Thucydides trap” has become a hot topic of discussion for China and the United States, and even the world. Chinese President Xi Jinping himself has publicly stated a number of times that China must avoid this trap.

How to avoid conflicts and wars between major powers has been the greatest concern of the Chinese leadership since opening up. How did reform and opening up become possible? The most important external condition was international peace. A peaceful international environment provided the conditions for China’s internal reform and opening up, and China must itself also contribute to international peace. This has basically become the highest principle in interactions between China and the outside world since reform and opening up. From Deng Xiaoping to the present day, the principles of China’s foreign policy have changed superficially, but their essential nature has remained internally consistent. In the Deng Xiaoping era, it was “hide your capacities and bide your time” (韬光养晦、有所作为), in the era of Jiang Zemin and Hu Jintao, it was “peaceful rise,” and since the 18th Party Congress, Xi Jinping proposed a “new type of major-country relationship” (新型大国关系). The essence of these policy goals is to properly handle external relations, especially relations between major powers.

However, with the recent start of the trade war between the two major economies of China and the United States, people suddenly feel that the “Thucydides Trap” is approaching. In fact, there are already some people in the West who believe that China and the United States have already fallen into this trap, at least economically. The question is, why is it that the “Thucydides trap” has still emerged even though China has made so many efforts in this area? Many people point to reasons from China, believing that China has changed Deng Xiaoping’s strategy of “hide your capacities.” Perhaps, at the subjective level, policy is a reason, but the main factor is the change in objective factors. This can be understood from the evolution of the relations between China and the world.

Simply put, the relationship between China and the U.S./Western-dominated world system has gone through three main stages. In the 1980s, when China was just embarking on reform and opening up, due to the shortage of capital, China implemented a “please come in” policy and opened its own door to welcome foreign capital to China. In the 1990s, China implemented a policy of “alignment” (接轨) in order to join the World Trade Organization. “Alignment” meant changing China’s own institutional system to conform to international rules.

It is not difficult to understand that, in these two stages, China would not objectively have serious conflicts with the outside world. Not only that, whether for “opening up” or “alignment,” China was welcomed by the outside world. But now we are at the third stage, “going global.” “Going global” had already begun in the early 2000s, but the scale was small at first, and it was unlikely to have a substantial impact on the outside world. After the 18th Party Congress, China began to “go global” in a fairly systematic manner, and it became a national policy. This was particularly manifested in the “Belt and Road” initiative, the Asian Infrastructure Investment Bank, and the New Development Bank. The combination of excess capital, excess production capacity, and mature infrastructure construction technology constituted a massive driving force for “going global.”

In the process, from the perspective of the West, China’s attitude towards the outside world has undergone a dramatic change. The West believes that the relationship between China and the world system has shifted from “learning,” “aligning,” and “maintaining” to “revisionism”. Internally, both officially and among the people, China’s diplomatic discourse has taken on an increasingly nationalistic color. China has begun to act like a “teacher” for the West. It has taught the West a lesson and begun to export its own “models,” whether economic development models or political system models.

For the West, this turning point occurred in 2008, when a large-scale financial crisis occurred in the West. After this, most Western economies slumped and faced the difficulties of long-term structural adjustments. The “mutual veto” party system also made it difficult for Western countries to adopt effective national policies to lead their economies out of the crisis.

Trade war as a manifestation

Obviously, this contrast between China and the West is the result of both subjective cognitive components and more importantly changes in the objective environment. From this perspective, the trade war is not hard to understand. People could even say that the trade war is just a manifestation of the Sino-U.S. relationship at this stage. If it did not manifest as a trade war, it would have manifested in other forms.

The nature of the Sino-U.S. relationship is manifested through the trade war. This indicates that the nature of the trade war is not merely economic, but the overall relationship between the two countries. What is the overall relationship between the two countries? Stated simply, as the world hegemon, the goal of the United States is to maintain its position as world hegemon. To maintain its hegemonic status, the United States must obstruct the challenge constituted by China, whether this challenge is real or imagined.

Here, we need to make a judgment. Will there be a military conflict or even a war between China and the United States? Because China and the United States are both nuclear powers, the possibility of a hot war is extremely small. Local conflicts are possible, such as over problems in the South China Sea and Taiwan, but a full-scale war between the two countries is hard to imagine. Moreover, from the point of view of the United States, “conquering” China militarily is not only impossible, but also unnecessary. However, it is possible for relations between the two countries to develop from a local conflict to a military-political cold war. This is also the expectation of the hardline Cold War faction in the United States. The Cold War faction hopes that, whether through trade wars or other local conflicts, to lead Sino-U.S. relations to a military cold war. Once a military cold war occurs, the United States will deal with China just as it dealt with the Soviet Union in the past.

Will the trade war turn into a military cold war? This depends on the next stage of interaction between China and the United States. From China’s perspective, what it needs to consider is how to prevent the trade war from turning into a military cold war while engaging in a trade war with the United States. Achieving this goal will require serious consideration of why Trump initiated this trade war.

What is Trump afraid of from China? For Trump, China’s core strength lies in its gradually growing “consumer society.” What does China’s becoming a “consumer society” mean for the United States? This means that China has a “big market,” which means economic power. It is China’s massive “consumer market,” rather than other factors, that can really cause China to change the whole world structure. In recent years, China has more rapidly become a regional and even world economic center that can compete with the United States. The main reason for this is China’s consumption level.

Therefore, it is not difficult to understand that the core of this trade war is a “technological cold war,” which targets “Made in China 2025.” In the end, through this “technological cold war,” the United States wants to stop China from improving its technological level, or at least to delay China’s modernization process. You could also say that what the United States needs to do is to push China into the “middle-income trap” or to push China back to the stage of “poor socialism.” As long as China remains in a state of “internal poverty,” China will have no external influence. From the U.S. perspective, China’s falling into the “middle-income trap” is the most effective way to prevent the two countries from falling into the “Thucydides trap.”

Obviously, if China falls into the “middle-income trap” in the way that the United States hopes, and thus avoids the “Thucydides trap,” this would not be in China’s interests. Instead, it would be the minimization of China’s national interests. How can China avoid the occurrence of this situation? In a word, it is still necessary to resolve the contradiction between China and the United States through further reform and opening up, while simultaneously avoiding falling into the “middle-income trap” and “Thucydides trap.”

China should be clear about its own level of technological development

First, China needs to be clear about its own resources. For example, how far has its technology developed? If industry version 1.0 is defined as mechanization, version 2.0 is automation, version 3.0 is informatization, and version 4.0 is intelligentization, where exactly does China stand? Where are the gaps between China and the highest international level? How large are they?

Realistically, most enterprises in China are located between mechanization and automation. Informatization and intelligentization are also in the process of development, but how much at these two levels is actually China’s own innovation? How much is the application of foreign technology? In which core technologies is China highly dependent on or even constrained by other countries, including the United States? In the event of a decoupling from U.S. technology, what kind of problems would the lack of these core technologies cause in China’s economic development and national security? Does China have ways to deal with these problems within a short period of time?

This series of questions is very important when it comes to how to deal with the Sino-U.S. trade war. Although China’s economic construction in the past 40 years of reform and opening up has certainly made great achievements, in terms of technology, this was basically still the application of Western technology. Currently, there is still no “Made in China” in the true sense. After World War II, the economic take-off of countries such as Germany and Japan was indeed based on “Made in Germany” and “Made in Japan,” but this is not the case with China. In China, it was only “Processed in China” and “Assembled in China.” Only after we are clear about our own resources can we rationally evaluate the relationship between China and the United States.

How should we deal with the trade war?

To a certain extent, a trade war was inevitable, but it has to be a very limited trade war. China can fight a trade war in some areas where it can find alternative imports, such as agricultural products or automobiles, but it cannot fight a trade war in many technical fields because China itself does not have the technology. It is easier to find alternative imports for agricultural products. In terms of automobiles, countries such as Japan and Germany have the technology, and China can turn to imports from these countries.

The rapid development of U.S. shale oil technology signifies the strengthening of U.S. energy export capacity. China can increase energy purchases and investment in the United States. Because the United States is unwilling to export high-tech products to China, and other commodities are insufficient to balance out the trade deficit between China and the United States, currently only bulk energy transactions can balance the deficit. The trade deficit is precisely what concerns Trump most in Sino-U.S. relations.

In the trade war, we must pay attention to the role of multilateralism. After the United States officially initiated the trade war, China immediately brought a dispute against the United States for its taxation measures in the World Trade Organization (WTO). This is a constructive direction. Recently, Xi Jinping has also emphasized multilateralism many times, and China will become more open. Next, China will accelerate the opening up of the automobile and finance sectors. In addition, China may need to consider the external opening up of the Internet industry to allow more technology and capital to enter the Chinese market.

The Chinese Internet is only the application of U.S. technology, and it does not have much original technology. If China accelerates the opening of the Internet market, even if in the initial stage the West occupies a little more in the Chinese Internet market, at least China will still have its own share and will develop its own original technology through real competition. If things continue to develop according to the current trend, the original technology in China’s Internet market will all be in the hands of the United States, and Internet development in China will be even more difficult in five or ten years. Protecting the Internet for so many years has not led to the emergence of original technology. In fact, the automobile industry’s development likewise illustrates this point. Protection is required in the beginning, but after a period of growth, it needs to be open and competitive, or else there will be no progress.

More importantly, we must accelerate the construction of open platforms in China. For example, the “Guangdong-Hong Kong-Macao Greater Bay Area” and “Hainan Free Trade Zone” should be key targets for construction. We absolutely need strong and in-depth reform policies concerning these internal platforms that are coordinated by the central government. The establishment of free trade zones with other countries and regions takes time and is not under China’s control. However, these internal free trade platforms are completely under China’s own control. We really must make these internal open platforms attractive to high-quality international capital.

We must also accelerate internal reforms, especially in the area of intellectual property rights. The purpose of intellectual property rights protection is not only to deal with the pressure from the West, but more importantly to provide an effective mechanism for technological innovation for Chinese enterprises themselves. Without the protection of intellectual property rights, enterprises will not have motivation to innovate. At the same time, since China obtains technology from the international market, we must educate enterprises to accept international rules. The experience and lessons of the ZTE incident should be carefully summarized.

Generally speaking, although the Chinese market is extremely important to the United States, once a cold war begins, security considerations will dominate the United States’ relationship with China, and the United States will have to abandon the Chinese market for the sake of security. The United States can develop other markets, but if China is excluded from the world economic system dominated by the United States, or there is an economic and trade decoupling between China and the United States, this will be the beginning of the “Thucydides trap.”