Poverty and Middle-Income Traps in the Philippines. Definition, Analysis and Possible Solutions

Introduction

Historical data show that the economic development of countries has been, more or less, a long sequence of transitioning from a low-income economy to a high-income one (Felipe, Abdon & Kumar, 2012). The earlier stages of the economy show an enormous reliance on subsistence agriculture which provides the largest share in both output and employment (Felipe, et. al., 2012). After some time, and as a result of capital accumulation of agriculture, and the transfer of the non-productive labor to industry and services, productivity starts increasing, growth could be readily expected, and development seem underway (Felipe, et. al., 2012). This sequence of economic growth is the ideal path for countries to take in order to drive their economies to high development. However, this is not the case for all countries.

Numerous studies yield that since the 1950s, rapid economic growth has allowed a significant number of countries to achieve middle-income status. However, very few have made the additional leap needed to become high-income economies (Agenor, 2016; Griffith, 2011). Instead of making such additional leap, many countries seem to have been stuck in a middle-income trap for a long period of time and do not seem to proceed (Agenor, 2016; Felipe, et. al., 2012). A middle income trap is a state which is characterized by a sharp deceleration in growth, following a period of sustained increases in per capita income (Agenor, 2016).

A poverty trap, on the other hand, is a situation “whereby an individual, a group of households, a country, or a geographic region occupies a stable equilibrium at a low level of wealth (capital stock) and output (per capita output)” (Griffith, 2011; Felipe, et. al., 2012). Agents caught in the poverty trap could not break out of its clutches because the economy has a tendency to return to the low-level steady state. Because of this, agents caught in the poverty trap find themselves in a vicious cycle of being trapped, attempting to escape, and being hurled deeper back into the trap again.

The Philippines has always been challenged by the recurring issues of poverty and inequality. In 2008, the country was challenged yet again by these two dilemmas as it was affected by the global financial crisis, accompanied by the increasing food, fuel, and commodity prices (Asian Development Bank [ADB], 2009). To add to this, the proportion of households in the Philippines living below the official poverty line has declined very slowly and unevenly in the past four decades (ADB, 2009). Further, in relation to its neighbour countries in the South East Asian region (such as the People‟s Republic of China, Vietnam, Indonesia, and Thailand), the country manifested a much slower poverty reduction rate (ADB, 2009). The Philippines‟ economic growth has been characterized by boom and bust cycles and episodic moderate income expansion offered limited impact on poverty reduction. This is not to discount the fact that other factors also contribute to the rampant poverty in the country. High rate of inequality among income brackets, regions, and sectors; high population growth rates; perennial occurrences of disasters; and the longstanding armed turmoil in some of its regions (ADB, 2009) are all attributes to the persistent poverty and growing inequality in the country.

This paper would look into the phenomenon of poverty and middle income traps, by looking into its empirical evidences using economic and descriptive indices. It would also focus on the experience of the Philippines to provide a deeper understanding of how the traps work as a curse for the poor. Lastly, possibilities for escaping the traps would be discussed and analyzed.

The Poverty Trap

A poverty trap is a self-reinforcing mechanism that causes poverty to persist, characterized by a “locked-in” equilibrium associated with stagnation (zero growth) o very low growth in income over time (Agenor, 2016). Poverty traps are often seen in countries with lacking or limited availability of key production input or public good, insufficient supply of private capital due to low savings ad low income, coordination failures, inadequate public infrastructure, insufficiently developed credit and capital markets, poor access to public health and education services, weak and inefficient institutions, etc, in an environment where income per capita is initially low (Agenor, 2016).

The Middle Income Trap

The concept of the middle income trap is entirely different from that of the poverty trap. The poverty trap discusses a phenomenon characterized by a tendency to return to the low-level steady state, while the middle income trap is a transition from a low-level income to a high-level income, which, for a variety of factors, was stuck in such state.

Before attempting to analyze the peculiarities of the middle income trap, I want to lay down Felipe, et. al.‟s (2012) contextualization as to the income groups and income transition of countries around the world. According to their study, four income groups of GDP per capita in 1990 PPP dollars is worthy to be defined. There exists a low-income group with GDP per capita below $2,000; the lower-middle-income between $2,000 and $7,250; the upper-middle-income between $7,250 and $11,750; and the high income above $11,750 (Felipe, et.al., 2012). They have also classified the 124 countries of the world which had consistent data sets for 1950-2010 and stated that there were 40 low income countries; 52 middle income countries; and 32 high income countries (Felipe, et.al., 2012). Of the 52 middle income countries, 38 belong to the lower cluster, while 14 are in the upper middle income division.

Felipe, et. al. (2012) also calculated the threshold number of years for a country to be considered „stuck‟ in the middle income. The cut-off is the median number of years that these countries spent in the lower-middle-income and upper-middle-income groups prior to their graduation to the next income group. From their study, they arrived at the two thresholds of 28 and 14 years respectively, implying that a country that becomes a lower-middle-income one has to attain an average growth rate of per capita income of at least 4.7% per annum; and a country that becomes a middle-income one has to attain an average growth rate of at least 3.5% to avoid falling into the middle income trap (Felipe, et. al., 2012).

Spence (2011) argues that countries stuck in the middle income are those characterized by having industries that initially drove the growth in the early period “start to become globally uncompetitive due to raising wages. These labor-intensive sectors move to lower-wage countries and are replaced by a new set of industries that are more capital-, human capital-, and knowledge-intensive in the way they create value” (Spence, 2011 cited in Felipe, et. al., 2012). In addition, Gill and Kharas (2007) argue that the idea that middle-income countries have to do something different in order to prosper is consistent with the finding that middle-income countries have grown less rapidly than either the low-income or high-income ones (Gill & Kharas, 2007 cited in Felipe, et. al., 2012). They further posit that “middle-income countries are squeezed between the low-wage poor country competitors that dominate in mature industries and the rich-country innovators that dominate in industries undergoing rapid technological change” (Gill & Kharas, 2007 cited in Felipe, et. al., 2012).

From Felipe et. al.‟s (2012) study, they came up with a list of the 52 middle income countries who are at risk of falling into the middle income trap. 35 countries out of these 52 belong to the middle income trap, with 30 belonging to the lower-middle-income classification while 5 are in the upper middle income trap for the year 2010. These countries are listed in Tables 1 and 2, respectively.

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Figure 1. Countries in the Lower Middle Income Trap in 2010

Source: Felipe, Abdon, & Kumar, 2012.

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Table 2. Countries in the Upper Middle Income Trap in 2010

Source: Felipe, Abdon, & Kumar, 2012.

In their study, Felipe, et. al. (2012) also shed some light as to why countries could not graduate from the lower-middle-income status into the upper-middle-income status, and from the latter into a high income one. There is, of course an array of factors that hinder the countries‟ leap to a more „advanced‟ stage, and many of them are interdependent (Felipe, et. al., 2012). The lack of a big push (investment) needed to start industrialization is one factor. Felipe et. al. (2012) also made mention that retaining low productivity activities rather than high activity ones may impede growth.

Studies show that middle-income countries such as Malaysia and Thailand manifested the inability to induce a shift in their industrial and export structures and these reflect their failure in developing their innate capacities to meet the needs of the fast-evolving international product markets which value innovation and product differentiation (Agenor, 2016). As a result, Malaysia and Thailand may end up being caught between low-wage poor countries which have mature industries and innovative rich countries who dominate technology-intensive industries. Low income economies tend to have a comparative advantage in labor intensive industries while high income economies have a comparative advantage when it comes to capital-intensive and technology-intensive industries (Agenor, 2016).

Further, Agenor (2016) identified the possible causes of the existence of middle income traps. The list includes diminishing marginal returns to capital, exhaustion of cheap labor and imitation gains, insufficient quality of human capital, inadequate contract enforcement and intellectual property protection, distorted incentives and misallocation of talent, lack of access to advanced infrastructure, and lack of access to finance, ad changing income inequality over time (Agenor, 2016). These causes are consistent with the finding that middle income traps are fundamentally a case of productivity slowdown, varying only in terms of the explanation they present as to why such slowdowns occur (Agenor, 2016).

The Case of the Philippines

From 2003 to 2015, the Philippines had an average of 5.5% annual growth in its Gross Domestic Product (GDP) (Albert & Vizmanos, 2018). However, this rate of growth is not inclusive as it did not translate into substantial poverty reduction. The World Bank (2018) made a similar finding and characterized the development in the country as a lackluster poverty reduction. The World Bank (2018) posits that “Despite the generally good economic performance, poverty remains high and the pace of poverty reduction has been slow compared with the other East Asian countries” (World Bank, 2018 cited in Albert & Vizmanos, 2018).

In addition, aggregate poverty incidence roughly stood still at about a fourth of the population from 2003 to 2012, dropping only in 2015 to over a fifth (21.6%) of the population. Economic growth during the period of 2003 to 2012 averaged at 5.2% per annum, but it was not also broad-based across major sectors (Albert & Vizmanos, 2018).

Looking at the major sectors of the country, from 2003 to 2012, all had shown positive growth in output (Albert & Vizmanos, 2018). It is noteworthy, however, that the agricultural sector was outpaced in its average annual growth of 2.5% by the industry (4.8%) and the services sector (6.0%). This trend is shown in Figure 1.

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Figure 1. Growth in Gross Domestic Product (GDP) by Philippines‟ Major Sectors from 2003 to 2015

Source: Philippine Statistics Authority cited in Albert & Vizmanos, 2018.

The agricultural sector is where most of the Philippines‟ poor households depend on their livelihood. It is alarming to note that in recent decades, this fundamental sector has been shrinking both in terms of total output as well as in total employment (Albert, Dumagan, & Martinez Jr, 2015 cited in Albert & Vizmanos, 2018).

Looking at poverty incidences among households, there had been a significant increase from 24.4% in 2003 to 26.9% in 2006 and the number of Filipino families who are classified as poor increased from 4.0 million in 2003 to 4.7 million in 2006 (ADB, 2009). Self-poverty has also been a focus of poverty studies in the country and for most of 2008, the numbers are at 50%-52% (ADB, 2009). The Gini coefficient of the Philippines improved from 0.4872 in 2000 to 0.4580 in 2006, however, this measure of inequality remains high compared to the country’s Asian neighbors. Further, the country’s Gini coefficient did not show significant change in the last two decades. The limited impact of various indicators of economic growth in the Philippines could be attributed to this high measure of inequality (ADB, 2009).

Going back to the Felipe et. al. (2012) study, they have forecasted that the Philippines, together with Albania, Botswana, and Ecuador, will likely be trapped in the lower-middle-income trap for another two to three decades if its income per capita continues to grow by less than 1% per year (Felipe, et. al., 2012). Further, the country is at risk of being stuck in a poverty trap unless the economy is able to shift to a higher growth trajectory. ADB (2009) projects the poverty incidence in the Philippines to be at the range of 21.1% to 28.7% by 2020. These numbers are not far from the 21.6% poverty incidence rate in 2015 as calculated by Albert & Vizmanos (2018).

Possible Solutions

With these data, perhaps the most important question to answer is how would the Philippines get out of the poverty and middle income traps?

Agenor (2016) argues that the middle income trap is best understood not as a transitional state, but rather as an equilibrium state which tends to be self-perpetuating. He posits that understanding the causes as to why growth slows down is only one side of the coin. What is more important is to come up with policies when the slowdown has occurred. Moving away from the steady state of middle income traps and poverty traps necessitate a major change in the form of implementing policies bold enough to shift the economy from its initial low-growth equilibrium that would hurl it into the path to high-growth equilibrium (Agenor, 2016). Further, as middle income traps and poverty traps are caused by a multiplicity of interdependent factors, a “critical mass of well-targeted reforms” may be pursued to set the economy onto the motion of high-growth (Agenor, 2016).

Some of these well-targeted reforms include, but are not limited to raising the quality of education, providing subsidies to innovative works, enforcing contracts and protecting property rights, promoting advancements in infrastructure, and improving access to finance. These recommendations are parallel to those that Felipe, et. al. (2012) suggested. In their study, Felipe and his team said that avoiding the middle income trap necessitates implementing policies and programs that would enable a country to economically grow fast enough so as to cross the lower-middle-income segment in at most 28 years and the upper-middle-income segment in at most 14 years. To attain this end, countries stuck in the middle income trap must develop a comparative advantage in order to reach an automatic upward trajectory (Felipe, et. al., 2012). These countries could look into making new products based on their capabilities.

Conclusion

The poverty and middle income trap continue to be hindrances for effective and successful economic growth in the Philippines. Statistics reveal that although there are instances of economic growth in the country, these do not necessarily alleviate the poor from their destitution. It is forecasted that the country would remain to be stuck on the middle income trap for another 2 to 3 decades and that the poorest Individuals and households will continue to bear the burden of being trapped in the vicious cycle of poverty unless proper economic planning and policy making are implemented. Governments must create more feasible and concrete policies targeted at improving the life conditions of the poor, giving them more access and opportunities, and strengthening their capabilities to aid them in escaping the traps. With these, the Philippines may be well on its way of breaking the curse and continue on the path that would drive its economy to a high income one through inclusivity and participation of the whole population.

References:

Agenor, P.R. (2016). Caught in the Middle? The Economics of Middle-Income Traps.

Foundation Pour Les Etudes Et Recherches Sur Le Developpement International.

Albert, J.R.G. & Vizmanos, J.F. (2018). Vulnerability to Poverty in the Philippines: An examination of trends from 2003 to 2015. Philippine Institute for Development Studies. Discussion Paper Series No 2018-10.

Asian Development Bank (2009). Poverty in the Philippines: Causes, constraints, and opportunities. 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila.

Felipe, J.; Abdon, A.; & Kumar, U. (2012). Tracking the middle income trap: What is it, who is in it, and why? Working Paper No 715 Levy Economics. Institute of Bard College, Annandale-on-Hudson, NY.

Griffith, B. (2011). Poverty Traps and the MDGs [Section 3]. In Nallari, R.; Yusuf, S.; Griffith, B., & Bhattacharya, R. (Eds.). Frontiers in Development Policy. The World Bank, Washington DC 20433.

Griffith, B. (2011). Middle Income Trap [Section 4]. In Nallari, R.; Yusuf, S.; Griffith, B., & Bhattacharya, R. (Eds.). Frontiers in Development Policy. The World Bank, Washington DC 20433.

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