Upskilling China: Implications for Middle‐Income Economies

ABSTRACT Acquiring human capital and climbing the ladder of manufacturing sophistication are development policy goals shared by most middle‐income countries. What happens when China, a large economy with active industrial policy, begins to expand into sectoral niches formerly occupied by its middle‐income trade partners? We build a multi‐country, multi‐sector general equilibrium model of global trade and perform counterfactual experiments aimed at assessing the effects of China's human capital investments and industrial policies on trade, production and factor returns elsewhere in the developing world. The model features skilled and unskilled labour as primary inputs, as well as domestic and international trade in intermediate goods. Simulation results suggest that China's growth strategy may cause middle‐income economies to lose global export shares in their more skill‐intensive sectors and to be pushed toward blue‐collar and resource‐based exports. The effects are especially pronounced in Southeast Asia since that region is most closely linked to China's economy. Skill premia will fall, reducing incentives to invest in human capital. In the absence of policy responses, these trends might dim long‐run development prospects.