Is there a middle income trap?

Concerns about the so-called “middle-income trap” have recently emerged among many middle-income countries, particularly after the term was coined in 2007 by two World Bank economists.  Worried that they may become “trapped” at the middle-income level, these countries are seeking a set of policies that can help them achieve strong and sustained growth and eventually help them join the league of high-income countries.

In our recent paper, we try to shed some light on both issues. First, we do not find that countries are trapped at middle income. “Escapees” – countries that escaped the middle-income trap and obtained a per capita income higher than 50% of the U.S. level – tend to grow fast and consistently to high income, and do not stagnate at any point as a middle-income trap theory would suggest. In contrast, “non-escapees” tend to have low growth at all levels of income. In other words, while the existence of a middle income trap implies that growth rates systematically slow down as countries reach middle-income status, no such systematic slowdown is apparent in the data. Second, we provide some descriptive and econometric evidence for a different set of “fundamentals” that enable middle-income countries to grow faster than their peers. We find that faster transformation to industry, low inflation, stronger exports, and reduced inequality are associated with stronger growth.

Not many countries graduated from middle income. Figure 1 shows countries’ long run changes of their income relative to the U.S. The log of per capita income relative to the U.S. in 1960 is on the x axis, with the 2009 value on the y axis. Each axis is divided into three areas, representing the three income groups.  Low-income, middle-income, and high-income countries are those that have PPP GDP per capita less than or equal to 10%, between 10% and 50% and above 50% of U.S. PPP GDP per capita.  Countries in the top-middle quadrant (in red) are those that “escaped” from middle income to high income over this period. The list of escapees includes Greece; Hong Kong SAR, China; Ireland; Japan; Puerto Rico; the Republic of Korea; Seychelles; Singapore; Spain; and Taiwan, China.  Two countries that nearly make the list (the top of the middle quadrant) are Portugal and Cyprus, which are still classified as middle income in 2009.

We find little evidence of a middle income trap. Figure 2 shows the average annual growth rates at different per capita income levels relative to the U.S. (shown in the x-axis). The blue columns are the average growth rates for countries that ever escape from middle income to high income, and the orange columns represent growth rates for those countries that never escape.  The escapees do consistently much better than their non-escapee counterparts, and they do not exhibit significant signs of slowing down. In contrast, non-escapees have low and stable growth over all levels of income: they too do not show signs of slowing down at middle income. Others, including those in this blog , similarly raise doubts about the existence of a middle-income trap.

Another graph reinforces the notion that countries do not slow down at middle income levels (relative to the U.S.). Figure 3 shows a scatter plot of countries’ subsequent 10 year average growth against (log of) countries’ initial income relative to the U.S. in 1960, 1970, 1980, 1990 and 2000. Evidence for a middle income trap would imply a U-shaped curve, with countries systematically slowing down at middle income levels. We do not see such evidence.

If one believes different sets of policies are needed at different stages of development, the above evidence suggests that “escapees” successfully change and adopt appropriate policies to consistently grow from low to middle to high income.

The question remains of what set policies are needed to lift countries from their middle income level. While we stay away from policy recommendation, we examine a series of “fundamentals” for middle-income countries that seem to be associated with higher growth. Our descriptive analysis shows the following are associated with high growth for middle-income countries (1) economic structure, namely a faster transformation from agriculture to industry; (2) export-orientation; (3) lower inflation and external debt; and (4) decreases in inequality and the age dependency ratio. Our cross-country econometric analysis also confirms that growth in middle-income countries is positively associated with industrialization, openness and equality. Interestingly, we do not see a clear role of education and innovation in both types of exercises.

This post first appeared on the World Bank’s Future Development Blog

Author: Ha Minh Nguyen is an Economist in the Macroeconomics and Growth Team of the Development Research Group. 

Image: People wait next to their water containers for the delivery of water in shanty town Pamplona at Villa Maria Del Triunfo, near Peru’s capital Lima, March 20, 2010. REUTERS.