Trapped in the middle? Developmental challenges for middle-income countries

By José Antonio Alonso, Professor at Universidad Complutense and member of the Spanish Co-operation Council and José Antonio Ocampo, Professor at Columbia University, and former UN Under-Secretary-General for Economic and Social Affairs and Finance Minister of Colombia

The intense growth enjoyed by a group of emerging economies during the last two decades drove some analysts to predict the beginning of a new stage of generalised economic convergence. In their vision, more and more middle-income countries (MICs) were likely to reach high-income status in the near future, taking advantage of the new opportunities provided by access to financial markets, information technology and international trade, including the development of global value chains.

Unfortunately, data have not confirmed these optimist predictions. Actually, up to now, economic convergence has been a selective opportunity for a small group of countries, and rather a generalised tendency for the whole group of MICs. Moreover, there is growing evidence that trespassing the low-income threshold and achieving middle-income status is not enough for countries to converge toward high-income levels. Few MICs have successfully completed that transition in recent decades, with the majority getting stuck in the middle-income group, thus facing what has come to be called the middle-income trap.

It must be admitted that the concept of a middle-income trap does not have a univocal meaning. Basically, it refers to the specific obstacles that MICs face in maintaining a sustained process of convergence to a high-income status. For many authors these obstacles emerge when countries reach a certain level of income per capita (between USD 5000 and USD 15000), as they need then to consolidate a more complex productive structure and change their growth regime, moving from one based on the accumulation of factors to another oriented toward continuous productivity improvements. Other authors, however, consider the middle-income trap to be associated not so much with an absolute level of income, but with a larger set of difficulties that countries located in the intermediate places of the international income ladder face in sustaining a process of convergence toward upper positions.

Differences between these approaches go beyond statistical criteria, because while the first group assumes that the causes of the trap are mainly endogenous, the second group sees these causes as referring to a combination of domestic and international factors. In this last vision, asymmetries in global markets (in the technological, financial or regulatory fields) are additional factors in explaining the growth constraints that MICs face.

Whatever the approach is adopted, the conclusion is similar: only a handful of countries have successfully moved from the middle to the high-income status over the past three decades. In this count we should put aside countries with idiosyncratic conditions, such as those that became European Union members, a group of tiny island states whose GNI relies mainly on services, and some oil-producing countries. After excluding these cases, the convergence club is integrated by between four and eight countries (depending on the criteria adopted), including Chile, the Republic of Korea, Panama, Trinidad and Tobago and Uruguay.

The scarcity of successful transitions cannot prove, by itself, the existence of middle-income traps, but it is enough to reach two other conclusions. Firstly, economic convergence seems a more complicated, lengthy and hazardous process than most simplified versions of the traditional growth models tend to suggest. Secondly, as international evidence suggests, MICs face severe challenges in sustaining a continuous path of progress: they can enjoy periods of intense growth, but frequently punctuated by deep economic setbacks.

This truncated development path seems to be associated with the inability that many MICs have to adapt their institutions and policy responses to the specific problems that emerge as they move ahead in their transformation process. The problem is not linked with absolute shortages, but with the asymmetries and bottlenecks that emerge in the process of change. Even if the literature offers an ample array of potential issues, most of them could be integrated in the five following areas.

First, how to design and implement a sophisticated macroeconomic policy in a more demanding international context. Macroeconomic stability is a necessary (but not sufficient) condition to facilitate a convergence process. Achievement of this objective entails the maintenance of consistent macroeconomic policies that favour domestic savings and investment, avoid excess external indebtedness, and preserve basic equilibria, while designing effective counter-cyclical macroeconomic policy frameworks. However, MICs particularly suffer the consequences of boom-bust cycles of international financing, the narrowness of their domestic financial markets, and the fragility of the institutions in charge of financial regulation and supervision.

Second, how to promote a sustained process of productive diversification and technological change. It is not possible to sustain a continuous growth process if countries are unable to increase the levels of productive diversification and technological sophistication. Achieving this objective requires developing effective national innovation systems, and sometimes exploring new technologic routes different from those employed by the leaders. It also requires improving the educational levels of the population and technological capacities of the labour force, particularly oriented (in the case of MICs) to strengthen secondary, vocational, and university education.

Three, how to create efficient and sustainable infrastructures. Infrastructure development is a strategic objective to facilitate productive change, to promote environmental sustainability, and to improve associated distributive parameters (both socially and geographically). As the COVID-19 crisis has made clear, improving the digital infrastructure and access of all social actors to it is particularly important. Overcoming the shortcomings in this field requires an investment effort, which in turn needs not only domestic resources, but appropriate international financial mechanisms.

Four, how to build a more credible and efficient institutional framework embedded in a more cohesive society. Development is a complex process that requires economic change accompanied by institutional reform. However, the latter does not always respond with a dynamism consistent with economic change. This problem is especially pronounced in the case of MICs, leading to fragile institutions and limited foundations of the social fabric. Informality is but one manifestation of this dissonance. Additionally, to consolidate development achievements, improve the quality of institutions, and promote social stability, it is necessary to combat the levels of social inequality that characterise a large number of MICs. Strengthening education should be aimed precisely at promoting equal opportunities; but it is likewise necessary to strengthen the fiscal capacity to finance the universalisation of basic social services.

Finally, to overcome development obstacles, MICs will need not only appropriate national responses, but also changes in international rules. The international system has managed to define those support mechanisms required by the poorest countries to emerge from their vulnerable situation, but no similar effort has been developed to identify the support mechanisms and instruments required to encourage the convergence process of MICs. Thus, it is necessary to correct this lack of reform in the multilateral sphere, in the fields of trade, development financing, international monetary arrangements, and global tax co-operation.

Certainly, more analytical work is needed to unequivocally demonstrate the existence of middle-income traps. Even so, the debate around middle-income traps, although inconclusive, has made a positive contribution to the development agenda by revitalizing reflection on the active policies required to promote the progress of countries in the middle stages of the development process.