Corresponding author: Christopher A. Hartwell ( christopher.hartwell@case-research.eu ) © 2019 Non-profit partnership “Voprosy Ekonomiki”.
This is an open access article distributed under the terms of the Creative Commons Attribution License (CC BY-NC-ND 4.0), which permits to copy and distribute the article for non-commercial purposes, provided that the article is not altered or modified and the original author and source are credited.
Citation:
Hartwell C (2018) Old wine and new bottles: A critical appraisal of the middle-income trap in BRICS countries. Russian Journal of Economics 4(2): 133-154. https://doi.org/10.3897/j.ruje.4.27726
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The idea of a middle-income trap is now over a decade old and continues to be applied to growth paths which have not been self-sustaining. With the bulk of emerging markets now approaching middle-income status, and given the reality of slower growth for many countries (and the policy recommendations that currently exist for overcoming this problem), is the middle-income trap still a relevant framework? Using reference to the BRICS countries, the key finding of this analysis is that the middle-income trap conceptualization is of little value-added, as fundamentals still matter, especially in relation to macroeconomic stability. Similarly, we note that “quality” institutions are necessary, both political and economic, including (smaller) size of government and property rights. The “trap” as currently formulated is thus nothing new or particularly relevant, as it repackages some familiar structural issues while avoiding other crucial ones.
middle income trap, growth, BRICS, institutions, total factor productivity
Why some countries grow while others stagnate is perhaps the most important question in all of economics, grappled by luminaries such as Adam Smith and David Hume and still a relevant research topic today. Part of the allure of this question comes from the continuing challenge of countries to attain economic growth, as well as the fact that the path to growth appears to change: the faces of success are different around the world, from the glittering skyscrapers of Hong Kong to the larger-than-life appearance of New York and Moscow, the spread-out environs of Los Angeles, and the restrained wealth of Hamburg. However, the faces of economic failure are only too similar: shantytowns on the outskirts of Dhaka could be mistaken for favelas in Brazil but for the people inside, and small earthen compounds found in rural Afghanistan could just as easily be placed in rural East Africa.
The fact that poverty, in all its similarity, persists in some regions of the world continues to be a paradox given the experience of the world over the past 50 years. Over this timespan, global growth by any metric has been the rule, not the exception, with currency, debt, and even global financial crises only briefly interrupting an upward trajectory (Fig.
World GDP per capita, 1970–2016 (constant 2010 US$).
Source: World Bank. World Development Indicators.
World GDP per capita by region, 1970–2016.
Source: World Bank. World Development Indicators.
The key to this paradox may be that the global growth shown in Fig.
The middle-income trap (hereafter MIT) has been defined precisely as this slowdown in growth which occur once countries reach middle-income levels. In the words of the World Bank, “after exceeding the poverty trap of US$1,000 GDP per capita, many emerging market countries head rapidly to the ‘take-off stage’ of US$3,000 per capita GDP [b]ut as they near this figure… they experience long-term economic stagnation, divisions between rich and poor become serious, corruption is rampant, and they fall into the ‘trap.’”
The MIT literature, with the benefit of slightly over ten years of work, has made heavy reference to Latin America’s experience in the 1980s in the bulk of empirical observations, but other recent work has focused on the specific problem of growth slowdowns from (formerly) high-performing countries such the Baltic States (
The policy prescriptions offered in support of breaking out of the “trap” have also varied according to the region and/or the institution doing the examination, although much research has tended towards recommending “strategic, proactive and coherent government policies for the advancement of social and firm-level capabilities” (
In relation to the BRICS countries of Brazil, Russia, India, China, and South Africa, the middle-income trap and its policy prescriptions have taken on extra importance of late as growth slowdowns have become more persistent across these countries. Not surprisingly, China, as the biggest economy by far of the grouping, has been the prime target of investigation in relation to the MIT, with many authors attempting to attribute China’s recent slowdown (and prospect of future slowdowns) to the conditions associated with the trap (see
Given the experience of China and the reality facing the rest of the BRICS, the purpose of this paper is to examine both the conceptual underpinnings of the middle-income trap and its policy prescriptions in relation to the BRICS countries. This analysis casts a critical eye towards the idea of a middle-income trap as a new or even useful concept in international development; using case studies from the BRICS countries themselves, I show instead that the effects commonly attributed to the MIT are nothing more than old wine in new bottles, predicted by standard growth and economic theory. More importantly, these issues do not require innovative or “new structural” approaches to overcome them, but a reliance on two simple fundamentals: prudent macroeconomic policy and fostering effective economic institutions. Indeed, the danger of the MIT literature is that it purports to offer countries a way to leap-frog these pre-requisites (
The term “middle-income trap” is attributed to economists Indermitt Gill and Homi Kharas, which began as an empirical observation in a publication for the World Bank in 2007 examining the differing growth paths in East Asia in the 1990s (
“During the last 50 years, many countries have moved from levels of income that are associated with abject poverty to levels that have earned them middle-income status. But, during this time, outside of Europe, only a handful have gone from low-income to high-income status. The part of the world that has been most disappointing is Latin America, where many countries reached middle-income levels and then, essentially, stopped growing. And the part of the world that has most notably defied this tendency is East Asia” (
Since these seminal articles, the literature on MIT has grown and the phrase itself has entered the lexicon of economic growth. Of course, reaching middle-income status by itself is not enough to be “trapped,” and in fact is a more welcome development than the alternative of grinding poverty and subsistence living. Thus, as a further step,
Where the “trap” comes in is as Gill and Kharas predicted, where growth rates do not equal the “escape velocity” needed to break free of the current level of development and grow towards high-income status. Indeed, evidence that has been accumulating in the so-called “growth slowdown” literature that these rates of growth have generally not been achieved in emerging markets (hence the “trap”), and countries that once did grow at a rapid pace have stalled out within the middle-income band. It is here that much recent research has been devoted to explaining this phenomenon.
The theorized reason for this slowdown is that poorer countries are characterized by a “large pool of unskilled labor” that, as part of a first wave of growth, “is transferred from subsistence-level occupations to more modern manufacturing or service activities that do not require much upgrading of these workers’ skills, but nonetheless employ higher levels of capital and embedded technology,” such as heavy industry (
The catch, however, is that a country may only coast on the developed world’s technology for so long. Moreover, this approach carries the seeds of its own demise; assuming that there is a large pool of unskilled labor, once it is drawn into medium-skill sectors that are aided by technology, the pool of “surplus” labor shrinks rapidly, leading to excess demand, wage growth, and, inevitably, a loss of labor-cost competitiveness.
The recent focus on the MIT and the corresponding empirical research isolating its boundaries has highlighted an important phenomenon in the growth of nations. However, there still remain many issues with the way the MIT is currently framed that make this concept somewhat problematic for policymakers. The three main issues are:
Lack of originality. The MIT is not exactly a new concept in economics and appears to be a remix of the idea of Solow growth model’s focus on diminishing marginal returns.
Timing is everything. How and when a country becomes stuck in the MIT appears to depend entirely upon the eye of the beholder.
What about institutions? The MIT literature, while acknowledging that “good institutions” are necessary, have been methodologically imprecise on which institutions are crucial.
The first, and possibly most damning criticism that can come from an economist, is that the MIT (at least as encapsulated in the current literature) is perhaps not really a new phenomenon. Growth slowdowns are part and parcel of economic growth theory (indeed, diminishing marginal returns is the fact underpinning all of economics), as standard growth models predict convergence or a more rapid rate of growth from lower income levels to higher incomes that tapers off as countries become more prosperous. The basic lessons of the Solow growth model as taught to any macroeconomics class and stressed by empirical research from the 1990s is that countries converge to their own steady-state and thus have normal periods of slow growth (
The reason behind this slowdown can also be traced back to diminishing marginal returns, as accumulation of capital to labor can only take a country so far. During the period of increasing accumulation, economic gains can be brilliant, but they rarely last in the long run: Eventually there are not enough workers to run all the machines. This point, made in the context of the Soviet Union by Paul Krugman and in East Asia by
To be fair, this point has been anticipated by some examining the MIT: The World Bank echoed the research of
However, seeing this view of development as different from “decreasing marginal returns to investment in physical capital” is close to somewhat arbitrarily drawing hard-and-fast boundaries that cannot apply in the real world. While accumulation of technology is necessary, especially for the rapid-growth phase of a country, it simply cannot cause growth effects without a corresponding increase in capital accumulation. Indeed, the effect noted by researchers above merely postulates a reallocation of labor across sectors (generally agriculture to manufacturing) coupled with technological advances imported from others, which are then supported by capital accumulation to the new technology as the source of growth (as the endogenous growth model of
If we look beyond the issue of growth accounting, there also are issues within the MIT regarding growth stability. Recent economic research has concluded that macroeconomic stability is a necessary (but not sufficient) condition for sustained economic growth and development.
This, unfortunately, has been the growth trajectory for many emerging markets over the past 50 years (and not a constant climb and then plateau, as the MIT literature implies). Additionally, it is clear that not all growth is created equal. Indeed, slow growth can be more sustainable than continuous rapid growth, mainly because if the former is observed after initial stages of capital accumulation, it can be symptomatic of inflated growth (through monetary or fiscal stimulus) rather than of that underpinned by productivity gains. This is especially true if, as several economists have recently proposed in cutting-edge research, it could be lack of growth that is the true “natural” state of an economy, not sustained growth (
The second problem related to the MIT is that the definitions for this concept are rarely precise and often depend on the specific observer; in fact, using a highly restrictive set of assumptions, Ye and Robertson (2016) note that there are really only seven countries that fit a definition of an MIT in their growth paths. For example, Israel is believed (as in the World Bank study) to have graduated from the middle-income club over the past five decades. However, this country had already been on the margin of being high-income: In 1960, its GDP per capita was 46% of that of the US. More importantly for the MIT story, Israel’s GDP per capita also stagnated through repeated wars and oil embargos (as shown in Fig.
GDP per capita relative to the US: Israel and Botswana, 1967–2016 (percent of US GDP per capita, constant 2010 US$).
Source: World Development Indicators, author’s calculations.
The example of Botswana, also shown in Fig.
Given the lack of uniqueness of the issues involved with the MIT and the nebulous timing issues surrounding the concept, the last reason in our critique of this concept is all the more relevant: What factors cause a country to be trapped which are distinct from bad policy? What could be done differently to avoid the trap? Current theories focus on diminishing technological transfer (the fact that one can only free ride off of the developed world’s technology for so long) or a shrinking pool of “surplus” labor that leads to excess demand, wage growth, and, inevitably, a loss of labor-cost competitiveness (
The biggest issue neglected in prescriptions on overcoming the MIT concept deals with the “mezzanine issue” of institutions, the components of the national economy that mediate and influence both its macroeconomic and microeconomic facets (see Fig.
It is these distinctions that also condition the effects of institutions on emerging markets and their growth paths. In particular, property rights are perhaps the most important economic institution, underpinning all others; as
Given that the recent buzz over the MIT hinges on its novelty, the comparison with existing theories of economic growth is wounding but not fatal, as are the worries about timing (a semantic issue) and the role of poor institutions. More difficult to tease out from the MIT concept, however, is how the countries that entered into the trap are to exit it. It is here that the MIT suffers its greatest loss as a guide for development, as cases often used to prove the trap are in and of themselves not unique, nor are their solutions. In particular, the countries often cited as being caught in the inexplicable trap face the very same policy and institutional problems that would predictably lead to their plight. This section takes a look at case studies from the BRICS countries to illustrate that the conceptual novelty of the MIT is not actually novel.
The countries that are often cited as examples of the MIT show that even this most basic of economic lessons has been ignored around the world (a point made by
After a bloody independence from the British Empire in 1947, India immediately took a path that seemed enticing at the time to many underdeveloped countries, into the arms of socialism. The several-decades’ long dalliance with a planned economy, including the creation of the “licence raj” (where every action in the economy required permission from some bureaucrat) led to “average” growth (that is, growth similar to many of its developing-country peers) during the 1950s and 1960s (
GDP per capita relative to the US: India, 1960–2016 (percent of US GDP per capita).
Source: World Development Indicators, author’s calculations.
The main reason that India appeared to even reach the plateau of “lower middle income” was largely attributable to the economic liberalization that India undertook in 1991 to finally unleash the power of its natural advantages. As
However, the “take-off” phase of India’s growth was short-lived and has been debated by economists. For example, research by
These dividends continued into the 1990s, but diminishing marginal returns were already catching up and by the second half of the 1990s, growth had slowed again. Tariff rates increased an average of 10 percent from 1997–2002 as second-order reforms, such as labor market flexibility, remained untouched; coupled with the lack of infrastructure, India’s growth began to once again return to “normal” levels… except in the 1990s, and especially with the example of China rising, these rates were anything but normal (
Over the last ten years, as noted above, India has finally climbed into the “middle income” category, with a very unique and odd path that somewhat contradicts the MIT literature: as just noted, TFP grew in the 1980s and slightly slowly in the 1990s, but this was not coupled with an increase in capital accumulation, which should have predated the productivity gains (
No region perhaps typifies the tired conceptual problem with the MIT than Africa which, admittedly, has mostly been caught in an “underdevelopment trap.” As shown in the last section and in the introduction, the region that, on the aggregate, had the worst growth performance over the past 50 years was subSaharan Africa. In contrast to East Asia, which had several high-flying performers staggered over the entire period, or Eastern Europe and Central Asia, which saw boom-bust periods, SSA saw only one recognized success story (Botswana) and countless failures. These failures have not just been regular problems of growth slowdowns — they have been spectacular: according to the World Bank, Liberia’s per capita GDP in 1996 (in constant US$2000) was a near-invisible $58 ($30 lower than China directly preceding the Cultural Revolution in 1964), while the Democratic Republic of the Congo (DRC) has failed to post a per capita GDP higher than $100 for its entire existence.
However, the raison d’être of the MIT argument is not that some countries grow while others do not; it is that some countries start to grow then stall. Thus, for our purposes, countries that have never grown, such as DRC and Liberia (and, indeed, the vast majority of African countries), are less interesting in regards to the MIT than those that have and no longer do. However, these countries are harder to find in SSA, as most African countries either have not yet attained the US$1,000 per capita GDP threshold, or have been as (again) Botswana, which has grown by an average of 4.81% since attaining the US$1,000 per capita GDP threshold and 3% since it crossed the MIT threshold of US$3,000 per capita. A better example of the middle income trap is Gabon, which saw its per capita GDP peak in 1976 at $8,594 but declined precipitously over the next ten years to settle in the US$4,300 range (where it has been since 1997). Namibia also meets the criteria, although it reached the “stall” threshold a bit sooner than most: after attaining a per capita GDP of $2,263 in 1980, the country saw its standard of living decline and then slightly rebound, reaching a GDP per capita in 2016 that is merely 21% above its 1980 level.
But it is perhaps Namibia’s large and well-known neighbor, South Africa, which has shown the most signs of the MIT. As Fig.
GDP per capita growth in South Africa, 1960–2016 (constant 2010 US$).
Source: World Development Indicators.
The reasons for this growth slowdown were attributed by
Of course, all of these explanations are probably true to some extent and more a question of sequencing than anything else: Manufacturing would be less profitable due to union power, and a sector in decline would be less likely to attract much investment. However, these explanations miss a key issue in South Africa’s growth, and that was that the country itself retained many of its sanctions after the international community had let them go; that is, while in 1994, the country underwent a series of trade liberalization reforms, it never went all the way in liberalizing. As of 2009, the country’s average tariff rate was still twice the European Union’s, with the tariff structure distributed throughout the economy and few goods spared (
As noted above, in the economic literature, the importance of “good” institutions for growth has been widely recognized: These fundamental goals of creating correct incentives are what makes an institution “good,” and one of the key institutions that comes under the heading of “good” is the broad-based institution of economic freedom.
The former communist countries of Central and Eastern Europe and the former Soviet Union, and above all one of the driving forces of the BRICS, Russia, are perhaps the states with the most interesting growth paths — paths that show the importance of proper institutions. With the fall of the Soviet Union at the end of 1991, a wave of hope surged throughout the region that growth and democratization would be soon forthcoming. With the hindsight of 20 years of independence, however, while both occurred in Central and Eastern Europe, the reality is that neither really occurred in the Central Asian successor states. Indeed, it is questionable if the Central Asian states “transitioned” at all economically or politically, given that Kazakhstan has the same leader it had during the last days of the Soviet Union, and the other two have seen two coups (Kyrgyzstan) and a cult of personality to rival that of Stalin or Mao (Turkmenistan). In reality, much of Central Asia has moved to independence but not really “transitioned.”
This does not mean that there has not been growth, although the Soviet apparatus has been dismantled in some countries more than in others. As just noted, there has been a substantial divergence between the countries of Central and Eastern Europe (CEE) and those that actually were a part of the Soviet Union in growth paths: As Fig.
GDP per capita growth in transition economies, 1992–2016 (annual % growth).
Note: Country grouping definitions are taken from the OECD, with the exception that CEE does not include the Baltics, who are separated out. Source: World Development Indicators; author’s calculations.
Heritage Index of Economic Freedom scores, CEE in 1995 v. FSU in 2000.
CEE countries | 1995 | FSU countries | 2000 |
Romania | 42.85 | Turkmenistan | 37.60 |
Albania | 49.68 | Uzbekistan | 38.13 |
Bulgaria | 50.03 | Belarus | 41.29 |
Poland | 50.70 | Tajikistan | 44.83 |
Hungary | 55.22 | Ukraine | 47.81 |
Slovakia | 60.36 | Azerbaijan | 49.83 |
Estonia | 65.25 | Kazakhstan | 50.35 |
Czech republic | 67.79 | Russia | 51.84 |
Georgia | 54.34 | ||
Kyrgyzstan | 55.70 | ||
Moldova | 59.57 | ||
Armenia | 63.03 |
In terms of institutional development in the FSU, in many countries only a bare minimum of important economic institutions are in place. For example, the most important economic institution of all, property rights, has shown remarkable resilience against improvement: According to the Heritage Foundation’s sub-index of property rights, on a scale of 1 to 100 (with higher numbers indicating better protection of property rights), the highest non-Baltic former Soviet republics in 2016 were Moldova and Georgia, each with a score of 40. Moreover, not only have property rights not been protected, their status has worsened in the FSU almost immediately since the basics of the transformation were complete (Fig.
Decreasing property rights in the FSU, 1995–2016 (Heritage Index of Economic Freedom “property rights” score).
Note: FSU includes Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. Source: Heritage Index of Property Rights; author’s calculations.
This explanation of developing, but by no means developed, institutions as the reason for growth in the past decade is also consistent with the performance of the FSU countries in the wake of the global financial crisis, who have suffered somewhat more than the CEE countries. With economies based more on primary commodities and natural resources, the FSU countries are more susceptible to price swings such as those that hit the world in 2008–2009 or the fall in the price of oil since 2014; thus, the growth experience that had started suddenly ground to a halt when the rest of the world pulled back its demand for commodities. They also, however, have had something to fall back on when the world economy picked up steam again: As Fig.
GDP per capita relative to the US: major post-Soviet economies (percent of US GDP per capita, constant 2010 US$).
Source: World Development Indicators; author’s calculations.
This reality of resource dependence and minor institutional change may provide the key for the past and future of growth in the Commonwealth of Independent States (CIS). It appears that just enough structural reform was done internally to unleash the power of “rapid” growth; coupled with the boom in energy prices, the countries of the FSU saw the capital accumulation they needed to take them through to middle-income status. Indeed, according to official statistics, Russia and Kazakhstan have not been in the low-income category since independence, while Ukraine has moved between categories a few times and finally ensconced in the middle-income category again in 2006. However, even though absolute growth rates may have been relatively higher in the FSU over the past decade, the degree of convergence with developed economies has been maddeningly slow, as can also be seen in Fig.
This paper has attempted to take a deeper look at the “middle-income trap,” note the issues with its current formulation, and, more importantly, isolate commonalities across BRICS countries that have stalled in their growth. From the analysis presented in the previous sections, two major lessons can be learned from the BRICS experience:
Macroeconomic stability may not be sufficient to prevent a growth slowdown, but just because some level of growth has been achieved, it does not mean it is time to throw out macroeconomic stability as a policy goal. Simply put, macroeconomic stability is necessary at all levels of development, and governments are advised to keep their eyes on maintaining macroeconomic stability (especially in regards to inflation) at all times. Even growth that has been achieved can be wiped out by just one experience of high levels of inflation, and thus, in order to avoid the MIT, macroeconomic stability (including fiscal prudence) must be adhered to. This includes avoiding inflationary temptations (unlike Argentina, Turkey, and other countries that have fallen into the trap), while keeping the overall size of government low (as in Poland and Estonia). The experience of Russia continues to prove this, as difficulties inherent in economic transition were a huge macroeconomic shock that, once calmed down, led to growth, but repeated economic troubles (such as the currency crisis in 1998) and reliance on primary commodities (since 2008) have kept growth in check.
Recognition of this reality is even more crucial given the experience of developed countries during and following the global financial crisis, where it appeared that the “old rules did not apply,” and stimulus spending was injected without a thought as to the consequences in inflation, asset bubbles, and fiscal prudence. With continued sluggish growth in the OECD (led by the United States, which has an open-ended fiscal and monetary commitment to growth stabilization, if not macroeconomic stabilization), the dangers of macroeconomic instability are even more pronounced. Emerging markets, which do not generally have the luxury of a large market or attractiveness to Chinese investors, would be cautioned to avoid the policy moves currently on display in the developed countries; perhaps emulating the OECD countries would be the easiest way to make an emerging market fragile, and thus more prone to being stuck in the MIT.
The other common thread in these periods of macroeconomic stability is that they were all home-grown, that is directly resulting from policies consciously enacted in the particular country and not imposed by outside conditions or actors. Of course, a case can be made for emerging markets specifically that some instability can be imported; given their small size on the world stage and the fact that they are mostly price-takers and not price-makers, they can be susceptible to larger macroeconomic conditions. However, it has also been the most open countries that have seen the most consistent growth patterns upward.
While trade may not necessarily “create” growth, being a second-order effect of economic activity (there must be investment and production before there is anything to trade), the attitudes toward it are a signal of a government’s commitment to free and open economic policies. East Asian countries have been successful in achieving high and sustained rates of economic growth since the early 1960s because of their free-market, outward-oriented economies (
On the other hand, trade protection and avoidance of competition is a one-way ticket to underdevelopment, mainly because a) trade restrictions shrink the market for producers in a particular country to the domestic market, b) restrictions often bring a whole host of other distortions with them (including the creation of trade-licensing bureaucracies and corruption), and c) a country that closes itself off to trade often pursues other growth-dampening policies as well (that is, trade restrictions are rarely the only distortion a government imposes). Too many BRICS countries continue to cling to ideas of import substitution and government-directed industrialization instead. Due to India’s “Fabian socialism” and license regime for any sort of international transaction, the country stayed on an incredibly slow growth path for decades, only seeing an improved trajectory once it began to liberalize its trade. South Africa remains another powerful example of this, as do most of the FSU countries (led by Russia, who is famous for weaponizing trade). Thus, closing off a country behind protectionist walls means cutting off a country’s economy from potential consumers that can drive growth.
A key thread running through our examination the BRICS countries (echoing
Growth of government in the BRICS, 1992–2016 (% p. a.).
Source: World Development Indicators; author’s calculations.
This remains a problem because, as our examination of Russia showed, policies that encourage the growth of market-oriented economic institutions should be pursued, a reality which is difficult to find in an environment of continued government intervention. The most important economic institution would be property rights, coupled with other business environment reforms that can help these institutions to emerge and thrive. As shown in our analysis of the FSU transition economies, many of these crucial “good” economic institutions are still lacking, while time has been spent on “bad” institutions: A key example of this is the power of labor unions in South Africa, who have created labor market rigidities that stymied the internal reallocation of labor needed to respond flexibly to changing market conditions. Other countries, urged on by economists such as Joseph Stiglitz, have also focused on “bad” institutions that do not contribute to growth, such as tax administration, at the exclusion of other expenditures that could have aided growth. The evidence is ample that property rights are more necessary for sustained growth and should be prioritized.
In making this assertion, we come back to the reality that exotic solutions to the MIT are not necessary. As always, it appears that economies need to focus on the fundamentals, a prescription which is too often lacking nowadays. But it is the only way to escape any MIT.