Beyond the Mysteries of the "Middle-Income Trap"

Erinç Yeldan

The concept of the “middle-income trap” had been brought into fashion by Barry Eichengreen and colleagues (see their recent NBER Working Paper). The concept is used to describe the challenges, for countries with GDP per capita of around $16,000 (at 2005 prices), in achieving productivity growth and key institutional transformations.

Many economists have taken note of the fact that, as economies converge to this middle-income level, “easily-accessible” sources of growth based on the transfer of virtually unlimited supplies of labor from rural agriculture to urban centers and towards capital-investment-led high profit sectors gradually lose their stimulating impact. Technologies grow mature and finally become worn out. After this threshold is reached, sources of growth must be derived from technological and institutional advances and productivity gains, which can only be achieved by investments in human capital, research and development (R&D), and institutional reforms. This, however, is no easy task, and countries often get “trapped” at this stage of development, hence the middle-income trap.

Yet, as such, the middle-income trap is an average concept defined by national boundaries. Recent work reveals, however, that divergences persist, and often times are reinforced, between regions embedded within national economies and even within municipalities. In many instances, poverty-stricken regions co-exist side by side with rich and highly productive regions. The persistent co-existence of such divergent structures leads us to ask whether poverty is in fact being reproduced by the workings of the market mechanism favoring high-income regions. This observation has its roots in a long tradition in development economics of duality and dependency theories.

My recent study with several colleagues (Yeldan, et.al. (2013)) recognizes, for instance, that Turkey reached middle-income status in 1955 and has remained there for an excessively long period. In the fifty years through 2005, Turkey only graduated to the high middle-income status. Yet Yeldan et.al. ask “which Turkey?” and report that Turkish overall gross domestic product is in fact divided into three sub-divisions by income brackets:

With a regional income of $376 billion, exceeding those of European economies such as Norway and Switzerland, the high-income Turkey led by Istanbul and Ankara gives the impression of relatively powerful dynamics for escaping the middle-income trap. This sub-division hosts Turkey’s administrative, political, commercial and financial power centers and yet its links with the rest of Turkey are weakening gradually.

Apart from the “high-income Turkey,” there are two more sub-divisions: the one which is exposed to the danger of being trapped in the middle-income bracket, and the one that does not even have the opportunity to graduate to middle-income status (the “Poor Turkey”). Being stuck in a poverty trap, the Poor Turkey includes 27 provinces, all of which suffer from low levels of education (the average period of education is less than five years; i.e., there is a high prevalence of drop outs from elementary school), a lack of investment in fixed capital and infrastructure, and social exclusion of its seasonal and low-skilled labor force.

Similar voices were also raised in a recent McKinsey Report on Mexico. Referring to Mexico as a “two-speed economy,” the report indicates that the country’s slow income growth in the past three decades—GDP per capita rose by just 0.6% per year on average and only 0.4% during 2013—is due to weak labor productivity, which fell from $18.30 per worker per hour (in purchasing power parity terms) in 1981 to $17.90 in 2012.

Accordingly, the report concludes:

Behind the productivity averages are two dramatically divergent trends: the productivity of large modern enterprises, many of which have become integrated into the global economy, has risen by 5.8 percent a year since 1999; in small traditional enterprises, productivity is falling by 6.5 percent a year. In between are mid-sized companies—a mix of traditional and modern establishments whose productivity growth has been close to flat at about 1.0 percent a year. Overall, the gains of modern companies have been all but offset by the decline in traditional ones, leaving economy-wide productivity growth at about 0.8 percent a year since 1990.

There is a modern Mexico, a high-speed, sophisticated economy with cutting-edge auto and aerospace factories, multinationals that compete in global markets, and universities that graduate more engineers than Germany. And there is traditional Mexico, a land of sub-scale, low-speed, technologically backward, unproductive enterprises, many of which operate outside the formal economy. It is precisely the deep division between the two economies that has kept Mexico’s growth at disappointingly low levels despite three decades of economic reforms. What makes this dichotomy important now is that the two Mexicos are pulling in opposite directions.

At the global scale, the United Nations defines the Least Developed Countries as those economies with less than $750 of per capita income. By this definition, LDCs include 1 billion of the people on our planet. This group includes 400 million people in sub-Saharan Africa and about 30% of the population of Latin America. Thus, “less development” became treated as synonymous with weak governments, weak markets, and weak institutions. An estimated 1 billion lack safe drinking water, 2.6 billion lack proper sanitization, and 1.5 billion do not have access to electricity. A 2010 report by the Institute of Development Studies found that 70% of the world’s poorest people live in middle-income countries, so tackling inequality is one of the most effective ways to accelerate progress towards eradicating poverty. The celebrated globalization of the international markets and the euphoria of “structural reform” over the last quarter of the 20th century has been accompanied by threats of a worldwide increase in environmental degradation, social exclusion, and economic inequality.

Personal and inter-regional inequality ought to be regarded as one of the key obstacles to sustained growth. Many development economists now recognize the fact that “business as usual” does not any work any more. This observation was in fact one of the key points of the Resolution Adopted by the UN General Assembly, over the United Nations Millennium Declaration (December 2000), stating that “the central challenge we face to day is to ensure that globalization becomes a positive force for all the world’s people. For while globalization offers great opportunities, at present its benefits are very unevenly shared, while its costs are unevenly distributed .… Developing countries and countries with economies in transition face special difficulties in responding to this central challenge. (Emphasis added.)

Furthermore, the recent spurt of growth under the so-called great moderation of the 2000s proved fragile under the speculative-led bubbles of the global economy. Together with the eruption of the global crisis in 2008 and the ensuing Great Recession, terms of employment suffered from continuous informalization as labor markets became more segmented and fragmented, and labor rights were severely restricted under conditions of flexibilization.

The International Labour Organization (ILO) estimates that the number of people in vulnerable employment reached 1.5 billion. (ILO defines vulnerable employment as “those small-scale producers who work for their own and unpaid family workers.”) This constitutes about half of global employment and has increased by 146 million from 1999 to the present. This type of informalized vulnerable labor includes 75.8% of employment in sub-Saharan Africa, 32.2% in Latin America, and 65.4% in the cheap-labor havens of East and South Asia. With additional pressures due to stratification by ethnic, religious, and other social statuses, this type of employment suffers deeply from informalization and open exploitation.

The ongoing global Great Recession is a testament that the ongoing Keynesian demand-driven growth patterns of the early 2010s are not sustainable over the long run. The IMF estimates reveal that the gap between the advanced economies and the global poor is likely to escalate over the rest of the 2010s. IMF estimates also suggest that the gap among the developing world is widening, that substantial global inequality remains, and that opportunities are not open to all. The 1.2 billion poorest people account for only 1% of the world consumption while the billion richest consume 72%.

Attaining reinvigorated development—breaking through the walls of the middle-income trap for middle-income developing countries and securing gains against the poverty trap in the poorest nations of the global economy—is an entirely new challenge that can not be tackled by a single set of policy recommendations. All of this calls for more policy space, and an open vision against the clichés or dogmas of “one-size-fits-all” recipes.

Sources

ILO, Global Employment Trends, 2011, Geneva

Yeldan, Erinç, Kamil Tascı, Ebru Voyvoda and Emin Ozsan (2013) “Escaping the Middle Income Trap: Which Turkey?” Turkish Enterprise and Business Confederation (TURKONFED), Istanbul.

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