Growth Slowdown and the Middle-Income Trap in Asia
James Riedel
Johns Hopkins University
and
Fulbright Economics Teaching Program
For presentation at the
National Economics University of Ho Chi Minh City
21 October 2015
Motivation
In Vietnam, one often confronts the view that comparative advantage leads to a dead end,
where prosperity is limited to the level of productivity of unskilled labor in labor-intensive
manufacturing (Vietnam Competitiveness Report 2010).
The World Bank (2010, p.7) takes the same view: “For decades, many economies in Asia,
Latin America and the Middle East have been stuck in this middle income trap, where
countries are struggling to remain competitive as high volume, low-cost producers in the
face of rising wage costs, but are yet unable to move up the value chain and break into fastgrowing markets for knowledge and innovation-based products and services”
More sophisticated versions of the same argument (Hausmann and Rodrik, 2003) appeal to
market failures similar to those invoked to justify import-substitution industrialization in the
1960s, in particular learning and coordination externalities that inhibit spontaneous
industrial development and movement up the ladder of comparative advantage.
All of these arguments lead to the same conclusion: without an activist industrial policy,
progress into and beyond the middle-income range will be stymied—lower middle-income
countries will be stuck at the bottom rungs of the ladder of comparative advantage.
Questions
What constitutes a middle-income trap?
Growth slowdown in the middle income range?
What explains growth slowdown in the middle-income range?
Natural consequences of catch-up?
Growth-inhibiting policies?
Political constraints?
What is the evidence of a middle income trap?
What is the evidence that countries get stuck on the bottom rungs of
the ladder of comparative advantage?
Growth slowdown due to natural causes: two competing theories
Natural consequences of catching up with more advanced countries
Diminishing returns to capital-deepening (Solow convergence)—closed economies
Diminishing returns to technology catch-up (Lucas convergence)—open economies
Diminishing returns to the reallocation of labor from agriculture to industry—all economies
Solow: Diminishing returns to capital deepending
Long-run rate of growth
of per capita income (y)
Initial level of y across countries
Lucas: Diminishing returns to technology catch up
and labor reallocation from agriculture to industry
Annual rate of growth
of per capita income (y)
Per capita income (y) over time
Cross-country convergence
• Convergence is observed among
open, not closed, economies
• Solow capital-deepening
convergence applies, in theory,
to closed economies, not open
ones. But in closed economies
convergence does not occur.
• Lucas technology catch-up
convergence applies only to
open economies, and it is only in
open economies that
convergence occurs.
• In short, openness and
technology catch-up are the keys
Source: Lucas 2009, p. 7
Growth slowdown in Asia
The consensus view:
• Taiwan and Korea avoided the middle
income trap
• Malaysia and Thailand are in the middle
income trap
Both groups slowed down but Taiwan and
Korea at per capita income of about
$9,000, while in Malaysia and Thailand at
about $4,000…but does this necessarily
mean they are in a MIT?
Why Malaysia and Thailand are trapped:
• In Malaysia, too much emphasis on
redistribution which leads to corruption
(Woo, 2009)
• In Thailand, too little emphasis on
education and too much on mega
infrastructure projects which lead to
corruption (Warr, 2013).
Korea versus Thailand: One stuck in the Middle Income Trap, the other not
Or, is it more a matter of timing
30000
Korea
25000
20000
Thailand
1963-1996
6.0
1973-1996
7.2
6.0
1997-2000
3.9
-1.3
2001-2010
3.6
3.6
15000
2010
KOREA
1998
10000
THAILAND
2010
5000
0
1961
1971
1998
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51
Korea versus Thailand: One stuck at the bottom rung of CA, the other not?
Methodology
Step one: we analyze the relation between Revealed
Comparative Advantage (RCA) and Revealed Factor
(k=K/L) Intensity (RFI) at the product level (SITC 5-digit or
1,200 products). For every sample country (j) and every
year (t) for which we have data we estimate the relation
between RCA and RFI across products (i):
RCA
Step one
RFI
Theory predicts that in low-wage, capital scarce countries
𝛽 < 0 and for high-wage, capital abundant countries 𝛽 >
0. As a country becomes more capital abundant (and y
rises), 𝛽 is predicted to rise along with y.
Step two: For each country individually and for a panel of
20 countries we estimate the relationship between 𝛽 and
y using parametric and non-parametric methods.
Step Two
Korea versus Thailand: One stuck at the bottom rung of CA, the other not?
Estimates of 𝛽𝑗,𝑡 for manufactured exports of Korea and Thailand
10
KOREA 1975-2010
0
1
-10
-20
-30
-40
-50
-60
3
5
7
9
11 13 15 17 19 21 23 25 27 29 31 33 35
THAILAND 1985-2010
Export diversification in Korea versus Thailand
Number of 5-digit SITC manufactured products exported Korea and Thailand 1963-2010
700
600
Korea
500
400
Thailand
300
200
100
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
0
Political Growth Trap
Those who allege a middle income trap usually attribute it to policy failures. But, if all that is
required to escape a middle-income trap is a change in policy, then how can a country be
considered to be “trapped?”
There must be constraint that prevents or discourages policy makers from taking the
necessary measures to restore growth to its potential long-run rate. Could that constraint be
their own self-interest in growth inhibiting policies?
An hypothesis: Policy makers are rent-seekers and set policy to maximize the rent they earn
from exercising discretionary power to grant privileges to favored firms and individuals (e.g.
licenses, land-use rights, contracts, employment, etc.)
Rent (R) depends on policy (P) via two channels:
• The higher P, the less discretionary power in the hands of the authorities, the smaller
the scope for rent-seeking
• The higher P, the fewer distortions in the economy, the larger the economy, hence the
larger the scale of rent seeking.
Motivation
Formally, the model is:
1
𝑅 = 𝑅 𝑃, 𝑌 𝑃 . .
(2) 𝑅𝑃′ < 0 𝑅𝑌′ > 0
R
𝑌𝑃′ > 0
3 𝑑𝑅 𝑑𝑃 = 𝑅𝑃′ + 𝑅𝑌′ ∙ 𝑌𝑃′
The first term on RHS of (2) is negative
(scope effect), the second term (scale
effect) is positive. If the income effect
of policy reform is subject to
diminishing returns (𝑌𝑃′′ < 0) the scale
effect dominates initially at low
income and the scope effect
dominates subsequently at high
income—yielding an inverted-U
relationship between R and P.
P
P*
The relation between corruption and per capita income
0.50
0.45
Cambodia
Laos
Inverse of Corruption Index
0.40
Vietnam
Indonesia
0.35
0.30
India
Thailand
China
0.25
Malaysia
0.20
Japan
Korea
0.15
Hong Kong
0.10
Singapore
0.05
0.00
0
10000
20000
30000
Per Capita GDP in 2005 International $
40000
50000
The Level of Corruption/Rent-Seeking and Per Capita Income
100
Index of the Level of Corruption/Rents Per
Capita
Malaysia
90
80
Thailand
70
Indonesia
Korea
Taiwan
China
Singapore
Cambodia
60
Vietnam
50
Laos
Hong Kong
40
India
30
0
10000
20000
30000
Per Capita Income
40000
50000
Final Observations: