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The middle income trap refers to the pattern in which certain economies grow rapidly enough to move into the global middle class, or even into the group of high-income countries, but at some point this catch-up growth seem to stall. The problem seems potentially widespread. For example, Japan and Korea both went through several decades of rapid growth, but then slowed to a more common pace. China’s exceptionally rapid growth seems to be slowing. The World Bank offers an overview of “The Middle Income Trap,” and possible policy solutions, in the World Development Report 2024.From the report:
Developing economies change in structure as they increase in size, which means that changes in the pace of growth stem from factors that are new to them. Although these imperatives can vary across countries, economic expansion, on average, begins to decelerate and often reaches a plateau in income per capita growth, typically at about 11 percent of US GDP per capita. Today, this figure would be about US$8,000, or around the level at which countries are firmly considered upper-middle- income. A systematic slowdown in growth then occurs. … However, the pace of progress in middle-income countries is slowing. Average annual income growth in these countries slipped by nearly one-third in the first two decades of this century—from 5 percent in the 2000s to 3.5 percent in the 2010s. A turnaround is not likely soon because middle-income countries are facing ever-stronger headwinds. They are contending with rising geopolitical tensions and protectionism that can slow the diffusion of knowledge to middle-income countries, difficulties in servicing debt obligations, and the additional economic and financial costs of climate change and climate action.
Here’s an illustrative figure. Classify the middle-income countries as they were in the late 1970s. The blue line shows how those countries have done relative to the US, when measured on per capita GDP. The overall catch-up is quite modest, and as the orange line shows, the catch-up that has occurred is mostly due to China. The graph also shows some prominent examples of middle-income countries from different regions. Yes, Poland and Chile have caught up a bit, but their per capita GDP still hovers at about 20-25% of US levels. South Korea is the shining example of a middle-income country that has kept growing, but even after decades of rapid growth, its per capita GDP is about half the US level–and it’s catch-up seems to have stalled over the last decade or so.
The report suggests that economic development involves multiple steps. The first step is for a country to increase its investments in physical capital and human capital. However, the report offers a striking fact on this point: Middle-income countries already, at present, have about 71% of the physical and human capital of the US on a per capita basis; however, output per worker is only about 21% of US levels. The capital investment in these countries is not translating into output.
A plausible reason for this gap is that the quality of physical and human capital investment in middle-income countries is not as high, or to put it another way, the technology is not as good. Thus, the report argues that after an increase in investment, additional steps is needed.
To achieve more sophisticated economies, middle-income countries need two successive transitions, not one. In the first, investment is complemented with infusion, so that countries (primarily lower-middle-income countries) focus on imitating and diffusing modern technologies. In the second, innovation is added to the investment and infusion mix, so that countries (primarily upper-middle-income countries) focus on building domestic capabilities to add value to global technologies, ultimately becoming innovators themselves. In general, middle-income countries need to recalibrate the mix of the three drivers of economic growth—investment, infusion, and innovation—as they move through middle-income status
Consider this sketch of the relationship. Notice that the original step of greater investment is needed, but it doesn’t do much for catch-up growth. That happens with the later steps of infusion and innovation.
These additional step of infusion and innovation are potentially quite hard, because changing the technology of an economy is not plug-and-play. The necessary changes don’t just happen inside companies, but also involve shifts in earlier economic, social and political understandings. Incumbents will push back against forces that require substantial change. As one example: “In many middle-income countries, power markets are still a monopoly: an SOE [state-owned enterprise] operating under a vertically integrated utility remains in charge of generation, transmission, distribution, and the retail supply.” Such incumbent firms are comfortably sheltered behind a barricade of powerful political and economic forces.From this perspective, the key to growth isn’t exactly the technology itself, but rather the incentives and flexibility within a given country and economy that determine how and how fast the technology will be adopted. For firms, this flexibility is about entry of new firms and the extent to which existing firms evolve and change, and about giving successful firms space to grow and inefficient firms the chance to shut down or be absorbed. For people, it’s about opportunity and mobility. The report notes: “Economically and socially mobile societies are better at developing skills and utilizing talent, but social mobility in middle-income countries is about 40 percent lower than that in advanced economies.”The report has much more to say: about how the finance industry can support these evolutions, or not; about how countries with an international diaspora of skilled emigrants might be able to draw on those connections; about striking a balance where success is encouraged without being allowed to become entrenched; and so on.The emphasis of this report on a dynamic and evolving society struck me as having relevance not just to middle-income countries, but also to high-income countries including the United States. For example, the report notes: ]
Three kinds of preservation forces perpetuate social immobility in middle-income countries, shutting out talent from economic creation. The first force is norms—biases that foreclose or limit opportunity for women and other members of marginalized groups. Next are networks—above all, family connections. And the last force is neighborhoods—regional and local disparities in access to education and jobs. Although all three factors can have positive impacts on talent creation—filling voids left by missing markets and services—they become forces of preservation when they block the disadvantaged from accessing opportunity.
Thinking about how to limit the constraints that norms, networks, and neighborhoods can put on the flourishing of individuals seems like a US issue, too.More By This Author:Russia’s Economy And Deathonomics
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