The middle income trap from a China and ASEAN perspective

There are many ways to discuss the essence of economic development associated with industrialization, technology catch-up, and innovation. The key question is why some societies move up rapidly to high income while others stagnate or slowdown along the way. Explanation may focus on industrial human resource, entrepreneurship and enterprise competitiveness, science and technology, participation in global value chains, labor productivity and total factor productivity (TFP), or the quality of national leadership. These overlap and may share similar fundamental causes. A middle income trap is certainly not a new phenomenon, but it has attracted much policy attention during the last decade. Discovery of this trap should also compel us to think deeply about the fundamental drivers of economic development. The debate on middle income traps should not be merely statistical or descriptive, such as counting the number of years an economy stays in the lower or upper middle income range, or an extensive narrative on the experience of one particular country. The analysis must be structural and comparative, enabling us to identify different causes, classify countries and phases, and suggest possible solutions for each individual case.

From this viewpoint, the book by Professor Tho and Dr. Karikomi is a new addition to our knowledge of the middle income trap. The book reviews data and offers theoretical arguments, then examines Northeast and Southeast Asian economies, distinguishing high performers and not-so-high performers in the Asian catch-up context. It clearly recognizes that all trapped societies are not the same. It argues that the trap phenomenon is caused by different reasons depending on the development stage of each economy – that is, whether it is trapped at lower middle income or upper middle income. Admittedly, this is an oversimplification and the real world is far more complex than that. But as a scientific method for producing meaningful policy analysis and advice, this approach is highly insightful.

According to the authors, there are two typical situations where a nation may encounter a middle income trap. Economic development toward high income passes through two stages. The first stage is characterized by the existence of surplus labor, vigorous capital investment, and improving systems and institutions for allocative efficiency – which the authors call “growth based on factor accumulation” and the present reviewer is tempted to call, more simply, “quantitative growth.” As the capital-to-labor ratio rises, labor productivity is automatically enhanced even if the average skill and knowledge of workers remain the same. Rising TFP, technology learning, and active R&D and innovation are desirable, but not absolutely necessary in this stage. However, the problem may already arise in this quantitative stage for various institutional reasons, such as excessive bureaucracy, weak governance, and unfriendly business climate that discourage investment and cause brain and asset drain. Furthermore, policy ambiguity, overregulation, and preservation of outdated state-owned enterprises collectively prevent efficient allocation of available humans, capital, land, and information within the economy. These problems are generated by incompetent governments with little knowledge of what private business is all about. If a nation has these undesirable qualities, it is likely trapped in a lower middle income trap.

If these institutional barriers are mostly absent, private dynamism can take the nation to the “turning point” in the sense of Arthur Lewis, where a reasonably high per capita income is attained, physical assets and infrastructure are sufficiently built up, labor surplus is exhausted, wage starts to rise via market pressure, and the economy approaches a “steady state” where growth slows down unless the production frontier is pushed up by technical change. At this point, “growth based on technical progress,” or “qualitative growth” for short, is required to continue the climb to a higher level. Rising TFP, technology learning, and active R&D and innovation, which were optional in the first stage, become absolutely necessary. If a nation is unable to engineer this shift and stays on the same production function, it will slow down and face an upper middle income trap. Investment promotion, deregulation, and anti-corruption campaign alone are no longer effective. Soaring wage without productivity enhancement will cause “premature de-industrialization,” in which the manufacturing sector begins to shrink, low-tech services expand, and FDI firms pack up and leave the country.

The dichotomy of middle income traps proposed by the authors is consistent with the ideas of Krugman¹ and Hayami² who argued that (Asian) industrialization in its early stage was predominantly factor-accumulation type, even though Krugman was cynical and sensational about this fact while Hayami was more empirical and positive. It also agrees with Ohno³ who states that growth driven by “given advantages” (which includes FDI, large public investment, trade opening, etc.) will eventually end unless a nation can stimulate skills, technology, knowledge, and innovation. Whether there are two distinct trap stages, as the authors claim, or the two traps are usually merged as one, as Ohno presumes, is moot. For policy analysis and teaching, the two-stage story should be helpful. However, actual policy making on the ground cannot always separate institutional weaknesses and the lack of support for technology and innovation. They are two aspects, among many, of the same policy capacity problem that many governments face.

In the empirical area, the book not only supplies sufficient data for international comparison in opening chapters but also offers detailed studies of selected Asian economies. Japan, Korea, China, Thailand, Malaysia, Indonesia, Philippines, and Vietnam are chosen for scrutiny. The balance between generality and uniqueness is thus preserved. Nevertheless, as the authors go into country-specific facts and assessments, readers may have more questions and disagreements than the first part of the book where the general theoretical framework is laid out.

Regarding Vietnam, for instance, the book cites slow reform of state-owned enterprises, macroeconomic instability arising from weak fiscal and monetary discipline, and the lack of progress in political and administrative reforms as the three main reasons for recent growth slowdown. Distortion of factor markets – capital, land, and labor – and inadequate governance and transparency in the public sector continue to spread inefficiency, it is argued. To avoid a middle income trap, one of the authors advises a new growth strategy which aims at a broader industrial base (including a healthy development of supporting industries), a closer linkage between FDI and domestic activities, a shift to high-skill production, and a higher growth target (9–10%) than presently considered. This diagnosis and prescription of the Vietnamese economy can be partially contested. Some of the cited problems seem to have been reversed more recently. More importantly, we need to go deeper than these “what-to-do’s” to explore the mind-set and systems that produce policy delay and resistance at the root of Vietnamese society. The high mark accorded to the economic policy of the current government relative to past administrations may also be controversial.

But these quibbles do not in any significant way reduce the value of the book. The main message is that middle income traps are diverse, and we cannot offer a one-size-fits-all answer to it. Pragmatic policy makers and researchers must classify causes, phases and solutions of the trap across time and places. The book stresses the difference between traps experienced during quantitative growth and traps caused by inability to shift to high domestic value. Certainly, this is not the only way to separate and group traps, but it gives us a good start. We can come up with other differentiating principles as long as we keep an eye on both general theory and country-specific uniqueness.

Notes

¹ Krugman, “The myth of Asia’s miracle.”

² Hayami, Kaihatsu keizaigaku.

³ Ohno, Learning to Industrialize.