Why do some countries fall and some survive?
Middle- income (MI) trap has become a well-known phenomenon with a large number of countries falling into the trap and getting stagnated. The essay is an attempt to investigate whether falling into the Middle- income trap is inevitable or there is a way out through in-depth review of secondary research. The essay argues, supported by previous empirical and descriptive evidence, that countries (and regions within) are not systematically bound to fall into a MI trap, rather, certain determinants, such as institutions, economic structure, infrastructure and other factors make countries (and regions within) more susceptible to a MI trap. It discusses how the complex economic structure of a MI country (and region within) requires a shift to capital intensive, innovation- driven efficient economy to make a timely transition to HI economy. It also highlights the need for a certain level of infrastructure to capture the benefits of an export-based economy. Moreover, decentralization, inequality and demography play significant role in intensifying the MI trap period affecting growth. Therefore, the essay concludes, while some countries (and regions within) fall into a MI trap and stagnate, others do not, due to uneven condition of their determinants.
While in 1960, 101 countries were middle-income (MI) economies, by 2008, only 8 countries upgraded to the high-income (HI) group (World Bank, 2012). This striking finding brought attention of academicians, researchers and practitioners to the widely discussed phenomenon of the 21st century, the’ Middle Income Trap’.
The central argument of this essay is that countries (and regions within countries) do not fall systematically into a Middle income trap and stagnate, rather it depends on certain determinants like institutions, economic structure, infrastructure and, other factors that make countries more susceptible to MI trap.
First, in section 1 the essay explains the MI trap. Subsequently, in section 2, it discusses the main determinants, particularly focussing on institutions, economic structure, infrastructure, and other factors that make countries (and regions within) more prone to MI trap or vice versa in the light of descriptive and empirical evidence. Finally, the section 3 offers a conclusion.
MI trap is a “sharp deceleration in growth after following a period of sustained increase in growth” (Agénor, 2015, p.2). Although extensive literature on MI trap can be found, defining the ‘MI trap’ is rarely observed (Doner and Schneider, 2016). According to Felipe, Abdon, and Kumar (2012a, p. 26) a country is considered to be in a ‘MI trap’ when i) it remains in the income range of $2,000- $ 7,500 for over twenty- eight years or ii) in the income range of $7,500–$11,500 for more than fourteen years, or iii) in MI status for a total of forty-two years (per capita GNP). The range is same for regions within countries. However, the measure holds two limitations. First, it takes the median value of years for both lower MI and Upper MI transition which changes if taken mean instead; second, the sample consists of limited number of MI to HI transitioned countries (Agénor, 2015).
Hence, the answer to escaping the MI trap is to grow at a rate to cross the lower MI threshold by 28 years and cross the upper MI threshold by 14 years. Nonetheless, instead of a long stagnation the growth slowdown of MI countries may occur in stages (Kharas and Kohli. 2011). Eichengreen, Shin and Park (2013) identify that many thriving MI countries may face two or more growth strangle points during their MI lifetime, one at $10,000-$11,000 range and another at $15,000-$16,0000 (2005 PPP in dollars). However, range may vary depending on economic, institutional and other conditions that make countries more or less susceptible to growth slowdown and a possible MI trap.
Why do some countries fall and some survive?
Extensive institutional reform, especially through education, R&D and strengthening state, is the key to gaining leverage and compensate the increasing labour cost to escape MI trap. Eichengreen, Shin and Park (2013) well-describe the importance of human capital and innovation with empirical evidence. Once the under-employed labours are exploited, the MI countries soon lose their low-wage labour advantage and struggle to compete with the low-wage labours of low income (LI) countries causing growth slowdown (Gill and Kharas, 2007). Findings of Hanushek and Wößmann (2007) explain adequately similar struggle of Brazil due to its poor primary and secondary education. Education helps to build a high- skilled labour force, moreover, the increase of secondary and tertiary education is strongly related to economic growth (Eichengreen, Shin and Park, 2012). Furthermore, higher education also creates the base for innovation and helps achieve total factor productivity (OECD, 2007).
Another challenge faced by MI countries is lack of competitive innovation and advanced technology compared to high income (HI) countries. Hence, the MI countries get squeezed between the LI countries and HI countries losing comparative advantage in both scenarios and fall into the MI trap (Kharas and Kohli. 2011). Innovation ensures competitive advantage over rival countries and maintain a robust growth (Sengupta, 2014). Lewis’s growth model explains, two phases of technological development seen in MI countries (Todaro and Smith, 2012); imitating advanced technology and enabling economy in the initial stage and developing indigenous technology in the later stage (Glass, 2010, Agénor and Alpaslan, 2014). Countries can achieve this desired goal only through innovation. South Korea’s extensive spending on R&D, which was 4.29% of GDP in 2014, government subsidies and export prossessing zones explain Korea’s innovation-driven remarkable growth (OECD, 2014) and successful escape from MI trap (Kharas and Kohli. 2011). On the other hand, as identified by Doner and Schneider (2016), Brazil’s poor investment on R&D, which is merely one-third of HI countries, explains its average innovativeness compared to its rival countries, China and Malaysia. Although, China is making remarkable progress, whether China can escape the MI trap would depend on continuity of its innovativeness. Hence, education and innovation through R&D is essential for a timely transition from MI to HI.
Furthermore, strong property rights, both physical and intellectual, facilitate investment, innovation and growth (Claessens and Laeven, 2003, Schneider, 2005). The importance of property rights is recognized by the new institutional approach of development economics (North, 1990). Although communal property rights have significance in some societies, property rights typically mean private property rights to prohibit others from using an asset (Robbins, 2000 p. 18). Rodrik and Rosenzweig (2010) stress that strong property rights facilitate trade and proper utilization of assets. South Korea has moderately strong real property rights (i.e. Foreigner’s Land Acquisition Act (amended in 1999)) that incentivize foreign direct investment and efficient property allocation (Ministry of Legislation, 2003). Moreover, Korean Patent Act (1997) along with WTO’s Trade-Related Aspects of Intellectual property rights (TRIPS) agreement encourage innovation and technological development (Erstling, 2010), ranking South Korea globally 35th in International Property rights index (IPRI) (IPRI, 2017). On the contrary, Brazil employs a complex intellectual property rights process under Intellectual property law (1996) and copyright law (1998) which are time consuming and bureaucratic, ranking Brazil globally 64th (IPRI, 2017). The insecure land rights in Brazil create internal conflict and cause economic and environmental loss. Moreover, Brazil’s constitution contains ‘social function of property’ clause which conflict with Civil code and make a poorly functioning land rental market (Climate Policy Initiative, 2015).
Additionally, prevalent corruption weakens an economy from within and cause growth deceleration. although researchers may argue that different forms of corruption impinge growth differently (Meon and Weill, 2009), corruption in general hinders growth (Mauro, 1995). Corruption brings uncertainty, increases transaction cost, and misallocation of production factor (Murphy et al. 1991, Rose-Ackerman 1997) which in return hampers growth by reducing investment (Mauro, 1995, Mo, 2001). HI countries usually have less corruption. Whereas, according to the corruption perception index (Transparency International, 2016) Ireland, Taiwan and South Korea hold 19th, 31st and 52nd position respectively, Latin American countries who are trapped in MI for years rank quite high apart from Chile.
Once a MI country (and region within), the economic structure requires a transformation from resource-driven economy to productivity-driven economy in order to escape the MI trap (Kharas and Kohli. 2011, p.282). Countries (and regions within), with abundance of cheap labour, intense diversification and proliferating growth make transition to a MI country (or region), dominated by the second sector (i.e. manufacturing, construction) (Todaro and Smith, 2012, p. 115-116). Moreover, initially they enjoy the advantages of ‘being backward’, explained as “Gerschenkron principle”, adopting technologies and learning from early mover’s mistakes (1962). Since, the cost of labour increases at a higher rate than the cost of capital, the MI countries soon lose their low-wage labour advantage and find themselves competing with the LI country’s manufactured export goods and cheap labour (Flaaen, Ghani and Mishra, 2013). Latin American countries represent similar experience. To avoid growth deceleration, countries require to achieve better terms of trade, cost-competitiveness, shift from labour to capital intensive production and upward movement in the global value-chain which can only be facilitated by advanced innovation (Aiyar et al, 2013). When countries (and regions within) fail both to compete with LI economies in terms of cheap labour and HI economies in terms of advanced technology and innovation, they face intense stagnation and fall into the MI trap (Kharas and Kohli. 2011, p.282).
Brazil exemplifies the scenario perfectly, as after becoming a MI country in 1965, Brazil grew fast for several years, however it lost its low- wage labour advantage to China and Vietnam and although it made technological improvements, its products were not enough advanced compared to China and Malaysia. On the contrary, South Korea and Taiwan province of China, who make large-scale investment on R&D, with their extensive advanced innovation and sharp move from labour- intensive production to capital intensive production achieved specialization and moved up the global value-chain (OECD, 2014). Moreover, they fought the disadvantage of increasing labour wage by achieving economies of scale in niche specialized products, which boosted their economic growth and enabled successful transition to HI group (Gill and Kharas, 2007). Nevertheless, efficient income distribution to build a strong MI class is also important for transition and Brazil’s growing MI class gives hope to researcher for a possible transition (World Bank, 2012).
- Quote paper
- Tahsina Akbar (Author), 2017, Middle-Income Trap. Is there a way out?, Munich, GRIN Verlag, https://www.grin.com/document/412812