Growth through Distributional Compression: Early Gains, Later Constraints, and China's Growth Model Transition

Since the reform and opening-up period, China's growth has been characterized by high investment, weak consumption, insufficient innovation, and a marked slowdown in recent years. This paper argues that these features reflect a strategy of growth through distributional compression: by suppressing wages and the labor income share, industrial policies increased the profit share and aggregate savings, thereby supporting investment, capital deepening, and rapid catch-up growth in the early stage of development. As the economy approaches the technological frontier, however, the main engine of growth shifts from capital accumulation to innovation. At that stage, low wages weaken firms' incentives to innovate by reducing the returns to labor-saving technologies and by depressing household consumption and market size, which makes it harder to recover the fixed costs of innovation. Growth through distributional compression is not unique to China, but a broader development pattern observed in many late-industrializing economies. To explain its stage-dependent effects, this paper develops a two-stage framework linking income distribution, capital accumulation, demand structure, and technological progress. Cross-country evidence and China's development experience reveal structural relationships among the labor income share, consumption, investment, and long-run productivity performance that are consistent with the theory. The findings suggest that the low-wage growth model can accelerate growth in the imitation-and-catch-up phase, but becomes a constraint in the innovation-driven phase through the channel of low wages, weak consumption, limited market size, and weak innovation. The paper concludes that this model is no longer suited to China's current stage of development. Future policy should shift from a supply-centered approach toward one centered more on household income growth and demand expansion, so as to support innovation, structural upgrading, and sustainable growth.