THE MIDDLE-INCOME TRAP: WHY COUNTRIES CAN’T BECOME WEALTHY?

Written by Jathew Roman.

Nov. 15, 2019

 

 

The Middle-Income Trap (MIT) is the situation when undeveloped countries can't fulfill its transition to become a fully wealth country. This happens especially when those nations have already achieved a middle-income status but unfortunately, several factors prevent prosperity and affect the entire society. But how or why those countries can't accomplish higher incomes per capita? Which factors can contribute to MIT? 

 

This article is going to tackle the key causes of the Middle-Income Trap. Furthermore, possible solutions to mitigate the problem, as well as some strategies to avoid MIT will be explained too. But first, it is important to know that countries can be classified by their incomes per capita [1] and also, MIT tends to appear in upper-middle-income countries.

 

 

Key causes of MIT:

Demographics

Underestimating demographics is one of the causes of MIT. Policymakers must take into consideration the demographic transition of their countries because in the long term the population pyramid goes inverted like in some wealthier countries. In other words, there are fewer people able to work because of an aging society and fertility rates have a decreasing tendency. This phenomenon can be an opportunity to get rich before the population grows old. The majority of developing countries have lower age averages than the wealthier ones, which means that the labor force is greater and younger.

 

Internal migration

Undeveloped countries are mainly based on agricultural and manufacturing economy meaning that the population tends to live in the countryside. But when jobs are waiting in the city, people do not hesitate and migrate to urban areas looking for a better and stable life. This is known as internal migration or rural-urban movement. However, when this internal labor migration runs dry, companies are unable to hire people and they struggle to find cheaper workers. When this happens, firms have a higher risk to close and consequently unemployment increases and recession can peek out. 

Higher wages 

The labor force in underdeveloped nations is much cheaper. The industrialization of a country provided by policies can incentive companies to set up their factories because of a competitive and low-cost workforce. As industrialization brings prosperity to the country, prices tend to increase (inflation) and so wages do so (probably not at the same pace). This phenomenon provokes higher costs for companies causing them to leave and fired people. Another possible cause of income stagnation is that the government is biased by firms so they can maintain lower wages in exchange for staying. [2]

 

Innovation

The engine for prosperity in developing countries is its people willing to work. This leads to a constructing society where the population has income allowing them to spend it or save it. But when these developing countries reach a certain level of capacity of workers and the engine for prosperity is outdated, growth may lay on innovation. This situation is called a “steady state” and that is when countries stopped to “catching-up”. Take a look at South Korean GDP growth [3] where growth is appreciated but in lower levels over the years.

To keep growing, developing countries should focus on how to innovate because growth depends increasingly on innovation. They need to take into account how to make a transition from a manufacturing-based economy to an innovative based one. 

 

Productivity

Mixing an aging society with a lacking educated labor force and an outdated prosperity engine as mentioned in the last section, productivity may be affected negatively. Productivity yields decrease as underdeveloped countries stop “catching up” provoking a slow-down in the economy. This surely lies in a possible failure to invest in human capital (i.e. tertiary education) to be able to innovate more than to manufacture and misallocate talent. [4]

 

 

Possible solutions to get rid of MIT and strategies to prevent MIT:

Economic specialization and more innovation

Specialized industrial production can guarantee long-term development in the innovation of that specific area. For example, the US was a big manufacturer of cars last century. Nowadays, apart from being a manufacturer, American companies innovate in car design and production. This specialization can be largely attractive when a country owns natural resources or can produce cheaper. [5] Even though, substantial specialization may outcome to a vulnerable economy depending on that field as happens in the Bangladesh textile sector, that accounts the 91% of exports. [6] However, true innovation requires more advanced skills.

 

Human capital investment: Education Improvements

Investing wisely in human capital avows better and innovative workers that impulse growth. While a country is facing an industrialization process, the government should provide education and jobs for the youth to continue prosperity. For example, after the Korean War in 1950-1953, South Korea was devastated. Industrialization began and so education spending increased. This explains why South Korea could escape from MIT among other more factors.

 

 

Large-scale institutions at world-class levels

Another key to getting rid of the MIT is to guarantee good institutions to rely on. Inclusive political and economic institutions are crucial to driving economic growth seeing that firms and individuals have more opportunities to construct their ambitions, property rights and stability from the state. In particular, Philippine economic growth [7] is strongly sustained today as a result of improvements on institutions as well as the coordination and cooperation between them towards the “BUILD BUILD BUILD” program. [8] [9] [10]

Infrastructure and R&D investment 

Underinvestment in infrastructure and R&D can lead to decreasing potential growth. When there are investments for advanced infrastructure firms and individuals have easier access to develop their projects such as business creation or as simple as commuting. In short, they can innovate and develop ideas and consequently recover economic growth. Eventually, these investments bring out a positive effect on supplying high-skilled workers as innovation requires sophisticated labor. [11]

 

 

In general, Middle-income Trap is a serious issue that any country wouldn't wish to face due to its massive downsides that causes. The government requires to implement public policies aimed to improve access to infrastructure, invest in human capital, enhance labor market and guarantee inclusive institutions whilst MIT symptoms are becoming present. These policies foster technological learning, attract talented individuals and boost knowledge networks. Anyhow, preparedness is crucial for countries to confront upper-middle-income and to ensure to become a fully wealth country.

 

 

 

References:

[1]https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bankcountry-and-lending-groups

[2] https://firescholars.seu.edu/cgi/viewcontent.cgi?article=1027&context=honors

[3] https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?locations=KR

[4] https://www.oecd.org/sdd/productivity-stats/40526851.pdf

[5] http://www.economicsguide.me/?page_id=1543

[6]https://oec.world/en/profile/country/bgd/

[7]https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?end=2018&locations=PH&start=2000

[8] Por qué fracasan los países. Daron Acemoglu & Robinson. 21-62

[9] https://www.adb.org/news/features/making-build-build-build-work-philippines

[10] https://www.asiatimes.com/2019/09/article/dutertes-golden-age-comes-into-clearer-view/

[11] https://openknowledge.worldbank.org/bitstream/handle/10986/16954/NonAsciiFileName0.pdf?se

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