Middle-income Trap – Which countries are in it and why ?

There is a working paper from the Levy Institute which provides a clear definition of the middle income trap and a systematic analysis.

ABSTRACT -This paper provides a working definition of what the middle-income trap is. We start by defining four income groups of GDP per capita in 1990 PPP dollars: low-income below $2,000; lower-middle-income between $2,000 and $7,250; upper-middle-income between $7,250 and $11,750; and high-income above $11,750. We then classify 124 countries for which we have consistent data for 1950–2010. In 2010, there were 40 low-income countries in the world, 38 lower-middle-income, 14 upper-middle-income, and 32 high-income countries. Then we calculate the threshold number of years for a country to be in the middle-income trap: a country that becomes lower-middle-income (i.e., that reaches $2,000 per capita income) has to attain an average growth rate of per capita income of at least 4.7 percent per annum to avoid falling into the lower-middle-income trap (i.e., to reach $7,250, the upper-middle-income threshold); and a country that becomes upper-middle-income (i.e., that reaches $7,250 per capita income) has to attain an average growth rate of per capita income of at least 3.5 percent per annum to avoid falling into the upper-middle-income trap (i.e., to reach $11,750, the high-income level threshold). Avoiding the middle-income trap is, therefore, a question of how to 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. Finally, the paper proposes and analyzes one possible reason why some countries get stuck in the middle-income trap: the role played by the changing structure of the economy (from low-productivity activities into high-productivity activities), the types of products exported (not all products have the same consequences for growth and development), and the diversification of the economy. We compare the exports of countries in the middle-income trap with those of countries that graduated from it, across eight dimensions that capture different aspects of a country’s capabilities to undergo structural transformation, and test whether they are different. Results indicate that, in general, they are different. We also compare Korea, Malaysia, and the Philippines according to the number of products that each exports with revealed comparative advantage. We find that while Korea was able to gain comparative advantage in a significant number of sophisticated products and was well connected, Malaysia and the Philippines were able to gain comparative advantage in electronics only.

35 out of the 52 middle-income countries in 2010 (over two thirds
of the total) were in the middle-income trap—30 in the lower-middle-income trap (9 of them can potentially graduate soon) and 5 in the upper-middle-income trap (2 of them can potentially leave it soon). 8 out of the remaining 17 countries (i.e., not in the trap) are at risk of falling into the trap (3 into the lower-middle-income and 5 into the upper-middle-income).

By region, 35 countries are in the trap today—13 are in Latin America (11 in the lower middle-income trap and 2 in the upper-middle-income trap), 11 are in the Middle East and North Africa (9 in the lower-middle-income trap and 2 in the upper-middle-income trap), 6 are in Sub-Saharan Africa (all of them in the lower-middle-income trap), 3 in Asia—the Philippines and Sri Lanka are in the lower-middle-income trap, although the latter should get out of it soon, and Malaysia is in the upper-middle-income trap, although it should also get out of it soon. Indonesia and Pakistan will most likely fall into the lower-middle-income trap soon, and 2 are in Europe (both in the lower-middle-income trap). The middle-income trap occurs mostly at the
low level of the middle-income range (30 out of the 35 countries are in the lower-middleincome trap) and mostly affects countries in Latin America and the Middle East and North Africa (30 out of the 35 countries). On top of this, we have to add the 31 Sub-Saharan countries that have been in the low-income group since 1950.

Asia is different from the other developing regions. Of the 29 economies for which
complete data was available, 5 are already high-income (Hong Kong, China; Japan; Korea; Singapore; and Taipei, China). There are also 5 Asian economies that have been low-income since 1950. We have not classified the 8 Asian ex-Soviet Republics.

China has avoided the lower-middle-income trap and, although there is no guarantee, in all likelihood it will also avoid the upper-middle-income trap (it has been an upper-middle-income country only for 2 years). Therefore, claims that it may be approaching the trap are unwarranted. Even at a modest (relative to its 8.9 percent annual growth from 2000 to 2010) income per capita growth of 5 percent, China should be able to avoid the upper-middle-income trap. India became recently a lower-middle-income country and it will also probably avoid the lower-middleincome trap (although, again, there is no guarantee).

What do countries have to do to avoid the middle-income trap? Today’s development problem is how to accumulate productive capabilities and how to express them as (i) more products and (ii) in products that require more, and more complex, capabilities. Therefore, the aspect that sets countries apart from each other is their productive structure and the specific characteristics of the products that they export. These, in turn, depend on the capabilities that firms possess. Development in this paradigm is a process of generating new activities and letting others disappear. The primary driver of growth is the gradual build-up in firms’ capabilities, which raises the economy-wide real wage. Capital accumulation is a complementary effect: the higher real wage makes it profitable for each firm to shift to more capital-intensive techniques. As the firm makes that shift, the rise in its capital labor ratio further raises the marginal revenue product of labor at the firm level; and so underpins the rising real wage.

Our analysis indicates that the countries that have attained upper-middle-income (i.e., that jumped from lower-middle-income) status or high-income (i.e., that jumped from upper middle-income) had, in general, more diversified, sophisticated, and non-standard export baskets at the time they were about to make the jump than the countries stuck in the middle income trap today.

What makes growth difficult? We believe that most developing countries face a
“chicken and egg” problem: (i) a country cannot make new products because it lacks the necessary capabilities; (ii) a country does not want to accumulate the required capabilities because the products that need them are not being made (because of other missing capabilities). We conclude that it will be very difficult for countries in the middle-income trap to become high-income countries without developing a comparative advantage in these well-connected types of products. These are the ones that place a country on an automatic upward trajectory. Most often, these products require capabilities that the country does not possess, and this is what policy efforts should be directed to.

There are not many countries in the upper middle income trap. Malaysia and Uruguay are likely going to get out very soon. Saudi Arabia, Venezuela and Syria seem likely to stay in it for a while.

China’s PPP calculation by the World Bank is likely wrong (70% too low) and China is likely already out of the upper middle income range.

The analysis of products produced and lack of complex products for those in the middle income trap. We all know that China is making most every product. It is ridiculous to think that inability to produce complex products will be or is a problem for China.

There are other definitions of high income country. Some have a standard of $26,000 per capita (about 50% of the US per capita GDP level). Sometimes on a nominal basis and sometimes on a PPP basis. China will need to manage its shift to domestic consumer consumption and achieve other structural economic adjustments to reach that level.

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