Middle Income Trap Myth and Analysis

The Economist reviewed the papers that analyzed possible middle income traps.

In 2004 Foreign Affairs magazine published “Globalisation’s Missing Middle” by Geoffrey Garrett, then at the University of California, Los Angeles. This essay is cited much less often than the other two, but in a roundabout way it has been equally influential. It argued that middle-ranked countries were in a bind, unable to compete either with the cutting-edge technology of rich nations or the cut-throat prices of poor ones. “Middle-income countries”, it said, “have not done nearly as well under globalised markets as either richer or poorer countries.”

There are at least four possible sources of growth in GDP per person.
1. moving workers from overmanned fields to more productive factories (structural transformation).
2. adding more capital such as machinery per worker (capital-deepening).
3. augmenting capital or labor by making it more sophisticated, perhaps by adopting techniques that a firm, industry or country has not previously embraced (technological diffusion).
4. advances in technology that introduce something new to the world at large (technological innovation).

Economists find it helpful to keep these sources of growth separate in their minds. The mistake is to think they remain separate between countries. In reality, in most countries several of these forces are at work simultaneously, at different paces and in varying proportions. Countries do not wait until the last surplus farm worker has left the fields to begin capital-deepening. Nor do they wait until the returns to brute capital accumulation have been exhausted before they start to increase the sophistication of their production techniques. So development does not proceed in discrete stages that require a nationwide leap from one stage to the next. It is more like a long-distance race, with a leading pack and many stragglers, in which the result is an average of everyone’s finishing times. The more stragglers in the race, the more room for improvement.

Statistical analysis shows that middle-income countries do suffer slowdowns. Analysis of poor countries show slowdowns are at least as prevalent as among middle-income ones.

Countries in the middle do slow more often than rich countries, but that is partly because rich economies rarely grow fast enough (3.5% per person over seven years) to be eligible for a slowdown as the paper defines it. Nor is such a slowdown sufficient to trap an economy. Hong Kong, Singapore, South Korea and Taiwan have all endured at least one, and none of them is trapped in middle income. Growth in China’s GDP per person has also slowed, to about 7.6% over the past seven years, against more than 10% over the previous seven. That qualifies as a sharp slowdown by the authors’ definition. But China is not trapped; it is still growing faster than most countries, rich or poor.

Often the definition for middle-income is too broad to be useful. By some definitions, a country with a GDP of just $590 per person (at 1990 prices) counted as middle income in 1960. That includes countries like China in the middle of its Great Famine. At the other extreme, a country with a GDP per person of $13,300 in 2008 also counted as middle income. This upper threshold for 2008 is more than 2,000% higher than the lower one for 1960. No wonder so many countries remained stuck in between them.

China’s GDP per person increased tenfold between 1960 and 2008, despite the famine and the Cultural Revolution. But because it started that period above $590 and ended it below $13,300, it remained confined to the middle square of the China 2030 grid.

One of the World Bank staff involved in the China 2030 report has subsequently co-written a paper investigating the middle-income trap more closely. It found no “evidence for [unusual] stagnation at any particular middle-income level”. More recently, research by Xuehui Han of the Asian Development Bank and Shang-Jin Wei of Columbia, and separately by Lant Pritchett and Larry Summers of Harvard, has also cast doubt on the trap. Another Harvard economist, Robert Barro, the doyen of empirical growth studies, thinks that “this idea is a myth.” The transition from middle to upper income is certainly “challenging”, he writes. But it is no more challenging than the transition from low to middle.