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Breaking Through the Middle-Income Trap: Seeking New Paths to Growth

Over the past 50 years or so, developing Asia has undergone a dramatic shift from a region that consisted mainly of low-income economies toward one that is dominated by middle-income economies. Indonesia is no exception. According to The World Bank, in the late 90’s, Indonesia had successfully transitioned from low-income to middle income level. It was an important milestone as it was a formal indicator that Indonesia had managed to improve its standard of living.

We have come a long way, but it’s a long journey still. As in 2017, Indonesia Gross National Income (GNI) per capita was US$3.540. Using World Bank threshold for middle-income classification (995-12,055 USD), indicates that Indonesia hasn’t surpassed middle-income level yet. Even barely surpassing lower middle-income level (3,895 USD). With average growth of GNI per capita around 4% it is dubious that Indonesia economy will move on to the next phase any time soon. Indonesia Minister of Finance, Sri Mulyani, stated that in order to transition from middle-income to high income-level within next century, Indonesia should has at least more than 5% growth. The risk of being trapped in the Middle-Income is something to look out for.

Source: World Bank (2018)

Pruchnik and Zowczak (2017) developed interpretations of Middle-Income Trap into five categories: nonempirical or descriptive interpretations, fixed income thresholds, relative income thresholds, time thresholds, and indices. The first category defined the trap as a situation when a country is no longer able to maintain the pace of strong convergence by continuing to use basic growth engines, most notably low wages. Such country is unable to compete with advanced countries that are not price but quality-competitive nor low-income countries that have even lower wages, hence it is trapped in the middle.

Second interpretation, as the name suggests, is based on a constant income range. One of heavily cited study setting the range was developed by Eichengreen, Park and Shin (2013). They identified two peaks between which the likelihood of growth slowdowns is most probable: between 10,000 and 11,000 USD per capita (PPP, constant 2005 prices) and between 15,000 and 16,000 USD per capita (PPP, constant).

The third­ uses a catch-up benchmark for relative income levels. Study conducted by Im and Rosenblatt (2013) used United States as the benchmark. They developed two alternative set of matrices to categorize country and its probability of moving to higher level of income classification. Those sets are concluded as follows.

Source: Pruchnik and Zowczak (2017)

The forth interpretation is based on the number of years it takes a country to move from one income category to another. Such an approach was suggested by Felipe, Abdon and Kumar (2012). They identified the threshold as 28 years in the lower-middle-income group (range between 2,000 and 7,500 USD per capita, PPP, constant prices 1990; average pace of growth 4.8% annually) or 14 years in the upper-middle-income group (between 7,500 and 11,500 USD per capita, PPP, constant prices 1990; average pace of growth 3.5% annually). A country exceeding these threshold numbers of years would be classified as a country that is stuck in the Middle-Income Trap. The last interpretation of Middle-Income Trap uses index, such as Catch-Up Index (Woo et al., 2012) and ESCAPE index (PwC, 2014), in order to evaluate whether a country had fallen into the trap.

According to Estrada et al. (2017) there is a view that the Middle-Income Trap is a problem of growth slowing down. This correspond to Eichengreen, Park, and Shin (2011) and that the growth slowdown is associated with productivity growth slowdown. Moreover, study, Eichengreen, Park, and Shin (2013) suggested that high quality of human capital is necessary to avoid growth slowdown which requires an advanced education as it helps transition toward the production of more technologically sophisticated goods and services.

With current advancement of technology, most notably the existence of Industrial Revolution 4.0, the topic of Middle-Income Trap become worthwhile to notice. As suggested by Solow Growth Model, advancement of technology enable a country to achieve long run growth. This implied that Middle-Income Trap can be escaped and avoided by implementing the technology of 4.0. However, without the development of human capital the advancement of technology may be rendered useless or at least not be able to achieve its full potential.

References:

Eichengreen, Barry, Donghyun Park, and Kwanho Shin. 2011. “When Fast Growing Economies Slow Down: International Evidence and Implications for China.” NBER Working Paper No. 16919.

————. 2013. Growth Slowdowns Redux: New Evidence on the Middle-income Trap. NBER Working Paper No. 18673, NBER.

Estrada et al. 2019. Asia’s Middle-Income Challenge: An Overview. ADB Economics Working Paper Series No. 525. Philippines: Asian Development Bank. Available: https://www.adb.org/publications/asia-middle-income-challenge-overview.

Felipe J., Abdon A., Kumar U. 2012. Tracking the Middle-income Trap: What is It, Who is in It, and Why? ADB Economics Working Paper Series No. 306 and No. 307. Asian Development Bank.

Im F., Rosenblatt D. 2013. Middle-income Traps: A Conceptual and Empirical Survey. World Bank Policy Research Working Paper No. 6594. The World Bank.

Pruchnik, K. and J. Zowczak. 2017. Middle-Income Trap: Review of the Conceptual Framework. ADBI Working Paper 760. Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/middle-income-trap-mit-review-conceptual-framework.

Hawksworth J. 2014. Escaping the Middle-income Trap – What’s Holding Back the Fragile Five? PwC blogs. Retreived from: https://pwc.blogs.com/ceoinsights/2014/08/escaping-the-middle-income-trap-whats-holding-back-the-fragile-five.html.

The World Bank. 2018. Classifying countries by income. Retreived from: http://datatopics.worldbank.org/world-development-indicators/stories/the-classification-of-countries-by-income.html.

Woo W., Lu M., Sachs J., Chen Z. 2012. A New Economic Growth Engine for China: Escaping the Middle-income Trap by Not Doing More of the Same. Imperial College Press.