HISTORICAL evidence suggests the use of industrial, trade and technology policies was pivotal for successful transformations from middle-income economies to high-income economies. Notable successful examples include the computer and Internet industry in the US, the aerospace and aircraft industry in Europe, and the paper and pulp and metalworking industries in Finland.

The difficulty is that there is no recipe or standard formula for cherry-picking the next winning industries. However, there are some general rules of thumb suggested by a World Bank study, co-authored by Justin Lin and Celestin Monga.

A country should identify its comparative advantages based on existing and evolving endowments and then follow them in each subsequent stage of development.

South Korea is a particularly good example of such a strategy. Early in South Korea's growth period, domestic manufacturers there concentrated mostly on labor-intensive imported-parts assembling - which was in line with their comparative advantage at the time.

Countries and regions should target mature industries that are not too far advanced, compared with their own levels of per-capita income. On average, a catching-up country or region should target mature industries about 100 percent higher than their own level of per-capita income, measured in purchasing power parity terms.

Indeed, South Korea adopted industrial policies back in the 1960s and 70s by targeting industries in Japan instead of the US because its per capita incomes were about 35 percent of Japan's and only about 10 percent of that in the US. Based on this guideline, China should target mature industries in countries that are about twice its size in terms of per-capita GDP, measured in purchasing power parity terms.

Industrial upgrading

Specific industrial policy can then be formulated once the targets are identified. The government should provide information, coordination and external compensation during the process of industrial upgrading and diversification. The goal is to assist targeted industries to quickly become competitive, domestically and globally. It happens that seven priority industries were highlighted in China's 12th Five-Year Plan (2011-15). By comparison, China did not target any specific industry for development in the 11th Five-Year Plan.

We cannot ascertain if policymakers drew up this list after a stringent evaluation of China's latent and evolving comparative advantages.

To the best of our knowledge, there is currently a lack of accessible data on China's productivity and unit labor costs, which are often deduced based on employment figures and wage data and give only a close approximation in the strictest definition of productivity.

In South Korea, the Korea Productivity Center provides quarterly data on unit labor costs across different industries.

High frequency data on labor productivity are also readily available for countries like US and Japan. This is an area that China must work on as soon as possible. It will be of immense value for long term strategic planning.

Still, we are able to make some inferences. Broadly speaking, the seven industries are all high-tech industries requiring innovation and knowledge input, or human capital.

The World Economic Forum produces an annual report showing different countries' innovation rankings. China is 20 places behind South Korea for quality of scientific institutions and 23 places behind for availability of scientists and engineers.

On both counts, its rankings have slipped by many places in the latest report. This implicitly means other countries are catching up because competitiveness is a relative concept.

Concrete steps

The lesson is that more concrete steps must be taken to improve the quality of scientific institutions and universities. Meanwhile, the private sector should be encouraged, by direct subsidies if possible, to spend more on research and development.

That, in turn, suggests China has to shift from a nation with large human resources to a nation with strong human resources over the longer run.

However in one category of the rankings, China has beaten South Korea by more than 15 places for the past three years - and that's in "government procurement of advanced technology products."

If China has the financial resources to buy technological know-how from other countries, the right strategy would be to procure those that can enhance or sustain the evolving and comparative advantage of any particular industry. Smart investments could well improve labor productivity with the right capital augmentation.

If policymakers had not picked the targeted industries with a certain degree of strategic precision, "prioritizing" the development of these industries would neither increase the probability of success nor guarantee good returns for investors.

Expectations should be realistic.

Concerns that China will fall into the middle-income trap are not unfounded. Absence of a clear roadmap and associated strategies to nurture targeted industries does not offer comfort.

Meanwhile, the cheap labor model is running out of steam. Since a few years ago, wages in China have increased rapidly due to a decline in the supply of young and skilled workers and a stipulation by law that minimum wages have to increase no less than 13 percent per year. At the same time, labor productivity growth has declined at the margin.

The immediate effect is an increment in unit labor costs, meaning more wages need to be paid to generate a dollar of GDP. China's unit labor costs have increased from an average of a negative 0.5 percent over 2003-05 to 0.3 percent over 2006-08, and most recently 4.3 percent over 2009-11. It will likely trend higher.

Nevertheless, this alone does not signal the end of the Chinese miracle. At the very least, empirical data hitherto affirmed that China had maintained a high market share in the US and EU in the past few years in spite of the yuan's appreciation alongside higher domestic labor costs. Well-developed supply chains and economies of scale should buy China some time. But there is no room for complacency.

Bottom line

According to the World Bank report on China 2030, only 13 of 101 middle-income economies in 1960 made it to high-income status by 2008. Of these, five are in Asia: Hong Kong, Japan, South Korea, Singapore and Taiwan. China's per-capita GDP at US$4,383 in 2010 was still far away from the upper threshold of US$12,000 that draws the line between middle income and high income. The bottom line: As long as economic growth is sustainable, the "label" of whatever trap does not matter.

Industrial policies in China are under-researched. Gauging the probability of China's future success requires a deeper understanding of the comparative advantages of various industries with respect to specific industrial policies tailor-made particularly for the chosen ones.

Constant speculation by the market over the deployment of the next fiscal stimulus does not tell us anything about the future development path of China. The days of heavy reliance on fiscal and monetary policy to propel short-term growth had better be over.