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Escaping the Middle-Income Trap in Emerging Markets

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Escaping the Middle-Income Trap in Emerging Markets The Growth Elixir: Escaping the Middle-Income Trap in Emerging Markets INStitUte FOR EmeRgiNG MARKet StUDIES (IEMS) MOSCOW SCHOOL OF MANAgemeNT SKOLKOVO IEMS Emerging Market Brief Vol. 13-08, November 2013 IEMS EMERGING MARKET BRIEF // NOVEMBER, 2013 Author: Dr. Christopher Hartwell, Senior Research Fellow Editor-in-Chief: Seung Ho “Sam” Park, Executive Director Contents Executive Summary 2 I. Introduction 4 II. What is Wrong with the Middle-Income Trap: Policy Failings are Not New 10 III. Institutional Development: The Missing Key 18 IV. Conclusions and Recommendations 28 IEMS EMERGING MARKET BRIEF // NOVEMBER, 2013 Executive Summary 2 EXECUTIVE SUMMARY IEMS EMERGING MARKET BRIEF // NOVEMBER, 2013 There are few places in the world where Global growth by any metric quality of life was not better in 2010 than in 1960, although certain regions has been the rule, have shown incredible success and others have stagnated. Growth paths not the exception have not been self-sustaining in many countries, with plateau effects after at- taining certain thresholds of per capita Beyond merely the size of government are income. This phenomenon has been observed the institutions that make up the government. in nearly every region of the world and at every In many of the emerging markets we examine, income level. political instability has served as a continu- Researchers from the World Bank have ous drag on growth, as in Argentina and sub- dubbed this problem of fading growth for mid- Saharan Africa. Thus, as part of a pro-growth dle income countries exclusively “the middle- package of reforms, countries should strive to income trap,” to distinguish it from the “pov- construct or solidify political environments erty trap” that afflicts poorer countries. With that are routine, predictable, and constrained by the bulk of emerging markets now approach- checks and balances. Policymakers, if they truly ing middle-income status, and given the reality wish to help their countries to grow, should be of slower growth for many countries (and the prepared to pursue prudent policies but also to policy recommendations that currently exist step aside if the polity demands it. for overcoming this problem), are there lessons Similarly, policies that encourage the to be learned from some of the highest-flying growth of market-oriented economic institu- performers of the past three decades? tions should be pursued. This list includes The key finding of the analysis of emerg- property rights, judicial independence, and la- ing market performance over the past 30 years bor market flexibility, as well as business en- is that the fundamentals still matter. Simply vironment reforms that can help these insti- put, macroeconomic stability is necessary at tutions to emerge and thrive. Many of these all levels of development, and governments crucial “good” economic institutions are still are advised to keep their eyes on maintaining lacking, with property rights being the most macroeconomic stability (especially in regards important. Other countries have also focused to inflation) at all times. Even growth that has on “bad” institutions that do not contribute to been achieved can be wiped out by just one ex- growth, such as tax administration, at the ex- perience of high levels of inflation, and thus, in clusion of other expenditures that could have order to avoid the middle-income trap, macro- aided growth. economic stability (including fiscal prudence) We believe that if a country’s government must be adhered to. This includes avoiding in- focuses on these simple prescriptions, the mid- flationary temptations (unlike Argentina, Tur- dle-income trap will one day be irrelevant to key, and other countries that have fallen into the study of economic growth. the trap), while keeping the overall size of gov- ernment low (as in Poland and Estonia). Similarly, we find that institutions are necessary, both political AND economic. In the first instance, the growth of government is generally a sign that a growth slowdown is imminent, often leading to crowding out of pri- vate investment and a diminution of the same entrepreneurial spirit that sparked growth in the first place. India is a prime example of this lesson. EXECUTIVE SUMMARY 3 IEMS EMERGING MARKET BRIEF // NOVEMBER, 2013 I. Introduction 4 I. INTRODUCTION IEMS EMERGING MARKET BRIEF // NOVEMBER, 2013 The fact that poverty, in all its similarity, per- been the real story in economic development sists in some regions of the world is a paradox over the past two decades; researchers from the given the experience of the world over the past World Bank have dubbed this problem of fad- 40 years. Over this timespan, global growth by ing growth for middle-income countries exclu- any metric has been the rule, not the exception, sively “the middle- income trap,” to distinguish with currency and debt crises only briefly inter- it from “the poverty trap” that afflicts poorer rupting an upward trajectory (Figure 1). There countries.1 are few places in the world where quality of life The middle-income trap (hereafter MIT) was not better in 2010 than in 1960 even if, as has been defined as the slowdown in growth Figure 2 shows, the growth has not been evenly once countries reach middle-income levels. In distributed, with certain regions showing in- the words of the World Bank, “after exceeding credible success and others stagnating. the poverty trap of US$1,000 GDP per capita, The key to this paradox may be that the many emerging market countries head rapidly global growth shown in Figure 1 masks the to the ‘take-off stage’ of US$3,000 per capita fact that growth paths have not been self-sus- GDP [b]ut as they near this figure… they expe- taining in many countries, with plateau effects rience long-term economic stagnation, divi- after attaining certain thresholds of per capita sions between rich and poor become serious, income. This phenomenon has been observed corruption is rampant, and they fall into the in nearly every region of the world and at every ‘trap.’”2 This convention has been picked up by income level (see Figures 3 and 4), with even others to utilize the boundaries of the trap: As countries that had reached a standard of living long as a country stays in the middle-income above subsistence finding difficulties in raising category, all the way from a GNI of $1,006 to it further. Indeed, this “start-stop” growth has $12,275, it is presumed to have reached middle- Figure 1. World GDP in constant 2000 US$, 1970-2011 6500 6000 5500 5000 4500 GDP in constant 2000 US$ 4000 3500 3000 1974 1972 1970 1976 1978 2010 1984 1994 1982 1992 1980 1990 1986 1988 1996 1998 2004 2002 2000 2006 2008 Source: World Bank World Development Indicators 1 Gill, I., & Kharas, H. (2007). An East Asian Renaissance. World Bank Report. 2 Ibid. I. INTRODUCTION 5 IEMS EMERGING MARKET BRIEF // NOVEMBER, 2013 income, and it is only when a country exceeds of Korea, Singapore, Spain, and Taiwan.”5 The this threshold and becomes “high-income” that vast experience outside of this select group was it is considered to have “escaped” the middle- of stagnation, with Latin America, for instance, income trap.3 seeing “income per capita relative to the United The MIT literature has made heavy refer- States [falling] almost continuously from 1960 ence to Latin America’s experience in the 1980s to 2005, especially after the debt crises of the as the bulk of empirical observations, but oth- early 1980s.”6 According to economists Inder- er recent work by researchers such as Barry mitt Gill and Homi Kharas (who coined the Eichengreen from the University of California- phrase “middle-income trap”), the only “part of Berkeley has focused on the specific problem of the world that has most notably defied this ten- growth slowdowns from (formerly) high-per- dency is East Asia.”7 forming countries such as China.4 Indeed, the The policy prescriptions offered in support MIT is perhaps more interesting because so few of breaking out of the “trap” have also varied ac- countries have escaped it: Of “101 middle-in- cording to the region and/or the institution do- come economies in 1960, only 13 became high- ing the examination, although much research income by 2008—Equatorial Guinea, Greece, has tended towards recommending “strategic, Hong Kong SAR (China), Ireland, Israel, Japan, proactive and coherent government policies Mauritius, Portugal, Puerto Rico, the Republic for the advancement of social and firm-level Figure 2. World GDP by Region, constant 2000 US$, 1970-2011 14000 12000 10000 Sub-Saharan Africa 8000 Middle East & Northern Africa Latin America & Caribbean 6000 Europe & Central Asia East Asia & Pacific 4000 2000 0 1973 1991 1970 1976 1979 1997 1994 1982 1985 1988 2003 2000 2006 2009 Source: World Bank World Development Indicators 3 Of course, these cutoffs are not static, as the frontier is always moving forward and prices are changing. These definitions are based on 2008 devel- opment levels, which will naturally become less relevant in the future. 4 See B. Eichengreen, D. Park, & K. Shin (2011). When Fast Growing Economies Slow Down: International Evidence and Implications for China. National Bureau of Economic Research. Retrieved from: http://www.nber.org/papers/w16919. 5 World Bank, (2012). China 2030: Building a Modern, Harmonious, and Creative High-Income Society. Washington, DC: World Bank Press. 6 Agénor,P., Canuto, O., and Jelenic, M. (2012). Avoiding Middle-Income Growth Traps. Economic Premise, No. 98. Retrieved November 27, 2012, from: http://siteresources.worldbank.org/EXTPREMNET/Resources/EP98.pdf?goback=.gde_1292267_member_188665291. 7 Gil, I., & Kharas, H. (2007). An East Asian Renaissance. World Bank Report, p. 53. Retrieved November 26, 2012, from: http://siteresources.worldbank.
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