Asia and the middle-income trap


Will Asian emerging markets follow Latin America and the Middle East into the middle-income trap? Having enjoyed fast catch-up growth, will they now get stuck, unable to graduate to higher income levels?

Much of East and South Asia is abundant in labour. The East Asian tigers started their catch-up growth by putting armies of initially unskilled labour to work. They shifted rapidly from agriculture to export-oriented manufacturing. Then they moved up the value chain in a ‘flying-geese’ pattern. From the 1980s and 1990s, they inserted themselves in global supply chains.

Until the 1980s, South Asia, unlike East Asia, had Latin American-style import-substitution policies that restricted growth. But then the sub-continent opened up and integrated with the global economy. Growth rates shot up accordingly.

Thus labour abundance has helped ‘globalising Asia’, especially East Asia, to achieve faster and more sustainable catch-up growth, with more widely shared benefits, than land- and resource-abundant Latin America and the Middle East. That puts the region in a better starting position to avoid the middle-income trap.

Now, let’s differentiate middle-income Asia. Following the IMF’s definition of middle-income status (countries with per-capita income of $2,000-$15,000), there are eight countries that stand out in East and South Asia: Malaysia, Thailand, Indonesia, The Philippines, Vietnam, China, India and Sri Lanka. But they are at very different levels of development. So let’s first divide them into ‘high middle-income’ and ‘low middle-income’ brackets. Malaysia is at the top of the high middle-income bracket. Indonesia, The Philippines, Vietnam, India and Sri Lanka are in the low middle-income bracket. China and Thailand are roughly in the middle with per-capita incomes of about $8,000.

Now let’s make a further sub-division, this time within China and India. Both have sub-regions that differ widely in terms of economic development. The ten coastal provinces of China are clearly in the high middle-income bracket, close to Malaysia. But the interior provinces are low middle-income. The more advanced Indian states, mainly in the south and the west, are low middle-income, but the rest of India is low-income. Much of India, like Pakistan, Bangladesh, Nepal, Cambodia, Laos and Myanmar – not to mention East Timor, Papua New Guinea and North Korea -- has yet to escape the ‘low-income trap’.

The World Bank’s landmark East Asian Miracle report’s foremost conclusion is that it is vital to ‘get the basics right’: macro-economic stability, relatively low distortions to domestic competition, openness to external trade, flexible labour markets, and investment in hard infrastructure as well as education. Pace the ‘revisionist’ school of thought, these ‘horizontal’, economy-wide policies are far more important than ‘vertical’ industrial policies to promote favoured sectors and national champions.

Getting the basics right must still be the top priority for low-income Asia – including the less developed states in India. These countries and regions should be in the business of catch-up growth.

At the other extreme, high-income Asia has to rely on productivity- and innovation-based growth. Getting the basics right is still important, but it has to be complemented with more sophisticated structural and institutional reforms. These ‘second-generation’ reforms have to go beyond liberalisation of product markets to encompass deregulation of factor markets (for land, labour and capital). They must also include opening up of services sectors, upgrading ‘soft infrastructure’ (such as higher education and skills), and improving the quality of public administration, regulatory agencies and judicial systems.

So far, only five Asian countries have escaped the middle-income trap: Japan, South Korea, Taiwan, Hong Kong and Singapore. What do the rest need to do to follow them? What do the current middle-income countries need to do? They need a mix of getting the basics right and second-generation reforms. But the balance should differ.

High middle-income countries need to crack on with structural and institutional reforms for productivity-based growth. This applies to Malaysia, Thailand and China (especially its coastal provinces). Low middle-income countries still have to go further with getting the basics right, just as they have more room for catch-up growth. But they must also embark on the simpler, less institutionally demanding second-generation reforms. That applies to India (especially to its more advanced states), Sri Lanka, Indonesia, The Philippines and Vietnam.

This article first appeared in the Autumn 2013 edition of EA magazine.

Tags: Employment
Taiwan and Hong Kong are not countries.

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