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Beware the Middle Income Trap – Says Who?

Borko Handjiski's picture

Fishing in the Hai River Economic development theorists and practitioners are increasingly using the term “middle-income trap” to describe the situation where developing economies’ convergence to the development frontier comes to a halt once their income per capita reaches a middle-income level. The term is ambiguous: is it a halt in convergence or slowdown in growth, and what exactly is the definition of middle-income? Nevertheless, the concept has been successfully used to create a scare that developing countries are more likely to run out of breath or even give up the race in the middle of the track than to continue catching up with the leading economies. Eichengreen et al. and several IMF economists are among those who provide empirical evidence that the “middle-income trap” is real and that developing countries do get stuck at some low-level equilibrium.

The finger has been repeatedly pointed at China and year after year the question is raised as to when China’s growth is going to slow. Examining the validity of the “middle-income trap” does not require sophisticated analysis. The trap implies that countries at the middle rungs of the development ladder will grow slower than the U.S. economy - the benchmark for the development frontier. Looking at average GDP per capita growth for 155 economies during the last half-century, convergence has been taking place in 3 out of 5 decades. It is only during the 80s and 90s that convergence slowed: U.S. average GDP per capita growth in the 80s (2.4%) and the 90s (2.2%) was higher than in 102 and 93 other economies, respectively, including most middle-income countries. Interestingly, even though the term was coined in 2007 by two World Bank economists, since the turn of the century, more developing countries than ever have been converging, i.e. they have been growing faster than the U.S. economy (see chart). Only 33 countries had lower GDP per capita growth during 2001-13 than the U.S., and only a handful of these were middle-income countries.
 


Recent history makes the “middle-income trap” even less of a scare. In the last two decades, 19 countries with a combined population of 330 million (in 1991) became high-income countries according to the World Bank’s income classification. Six of them, all from Eastern Europe except Chile, went from being lower-middle to upper-middle to high income within this period. Interestingly, GDP growth in all but Chile accelerated during their upper-middle income status, compared to when they were lower-middle income countries. And in Chile, as in more than a third of the newly listed high-income countries, growth was higher after reaching high income than before. There is also empirical counter evidence to the middle-income trap from two other World Bank economists: Im and Rosenblatt find little support for the idea in the data. More importantly, a dozen countries are close to reaching the high income threshold (Gross National Income per capita of $12,746 in 2014) within a decade or less. This group, with a combined population today of half a billion, includes Brazil, Turkey, and Mexico.

The proponents of the “middle income trap” often mention how Latin America and the Middle East have been unable to escape the middle-income trap for decades. It seems, however, that the fault is not in the fact that they are middle-income economies but elsewhere; that the two largest Latin economies are about to leave the middle income ranks confirm this. And even if annual growth slows in China to 6-7 percent, more than 1.3 billion people will join the high-income ranks before 2030.
 

Comments

Submitted by Homi on

Economists trying to use historical data on growth to identify whether or not there is a “middle income” trap miss the point. When my colleague Indermit Gill and I coined the term, we used it to indicate the changes in policy that are required for countries to continue growing once they reach middle income levels. These policies may be quite different from those that propel countries from low income to middle income levels. The analogy we make is with sand bunkers in golf. When professionals (or at least non-duffers) play on a course with many bunkers, they do their best to avoid them. They may register a score of par or better. Looking at their score, one should not conclude that bunkers do not exist. Policy traps abound for middle income countries in the same way as sand traps abound on some golf courses. Thankfully, in many countries, professionals are now at the helm of economic policymaking and as more lessons are learned the chances for avoiding getting stuck go up. If only the same could be said about my golf game.

Submitted by Borko on

There is absolutely no doubt that growth model has to change as countries move up the income ladder: sources of growth that are present at low-income (e.g. abundant low skilled labor force) can only contribute so much to raising income per capita. Sadly, however, the debate on the “middle-income trap” in media and economic literature seems to have moved away from the policy implications of the term to the conclusion that high income levels are an exclusive right for the pre-WWII rich countries and the few outliers that you had identified in the Growth Report, while all other countries are bound to be stuck at middle-income levels. What made me do this analysis was an article on China which raised the point that China’s economy is bound to slow just because it has reached middle-income - the same point being made for many years now. As you noted, convergence can be maintained beyond middle-income levels as long as professionals are at the helm of economic policy making. The latter point is true actually for countries at all income levels, otherwise most of Sub-Saharan Africa would not have been stuck at low income levels for decades. Global economic trends in the XXI century seem to imply that there are more professionals at the helm than in previous decades. This begs the question: what has changed? I would list technology, increased public demand for better public services, more democracy as possible answers… but this is a topic for another blog.

Submitted by Mehdi Bhoury on

Good Point!
I think it is all a matter of bad governance and absence of strategic planning. By the time the "middle-income trap" started to be used, latin american and middle-eastern countries were badly governed and were subject to economic turmoil and/or political instability.
When Chile for example made its transition to democracy and when turkish established a political stability, theses countries boosted their growth rates and started to look at the longer term issues. China is a specific case, but political stability and the intelligence of their centralized regime gave place to a well-planned long-term development strategies profiting from their large and cheap workforce.
I hope Tunisia is on its way to prove the inconsistency of the "middle-income trap"!!!

Submitted by Borko on

Dear Mehdi, I share the same view, governance and economic policy making are key factors that define whether a country moves up the ladder or not. I hope that not only Tunisia but other countries too break with the past and speed up their convergence. The last decade shows that convergence is happening in more places than ever.

Submitted by Steve Muzira on

Great blog Borko. The world is changing so fast that those who get trapped in the past are bound to be overtaken by events. Good governance and prudent economic policies are critical at the macro level. What do you think are the contributions of infrastructure provision (roads, railways, ports, energy, water & sanitation) and human capital formation (education and health) in accelerating the shift from low income to middle income status and beyond? Maybe a topic for another blog/s?!

Submitted by Borko on

Thank you Steve, global economy is changing rapidly in a way that it is creating more opportunities than ever for the developing world. So the potential is there and developing countries need -as Homi mentioned in his earlier comment- forward looking and capable professionals at the economic policy helm. Regulations/governance are important, but as I discuss in my earlier blog it's not the only thing that matters. Infrastructure is equally, or maybe even more important, and skills is another of the key pieces of the puzzle.

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