Functional Income Distribution, Demand Driven Growth and the Middle Income Trap: The Case of China

It is critical for China to develop its domestic market demand and to engage in technological innovations to escape the Middle Income Trap. However, evidence suggests that China has been experiencing rising functional income inequality, manifested in the declining labor share in national income until very recently. The paper argues that functional inequality contributes to worsening income inequality. This in turn reduces average consumption propensity and dampens the consumption share of GDP. Further, the 'market effect' of income inequality could be more pronounced than the 'price effect', disincentivizing further innovations. Therefore, to gain growth momentum and graduate from the MIT, China must address functional income inequality through policy measures.