Growth Strategies to Avoid the Middle-Income Trap

Since the authors of this chapter coined the term in 2006, “the middle-income trap” has been the subject of scores of investigations. The evidence in support of its existence has been mixed, but their original proposition was that of the possibility of a trap, not its inevitability. In this chapter, they emphasize the absence of a functional theory of economic growth in middle-income economies. Solow–Swan models did well to explain growth in low-income countries, and Lucas–Romer models emphasizing endogenous technical change identified the main drivers of growth in advanced economies. Neither class of models has, however, satisfactorily explained successful transitions from one type of growth to the other. The authors suggest that Schumpeterian models proposed by Aghion, Howitt, and others that stress creative destruction and institutional change provide the analytical foundations for a better understanding of growth in middle-income economies. They present evidence that is consistent with the predictions of this approach, and discuss its policy implications.

Economic Traps and Progress in Middle-Income Countries

The chapter discusses the existence of potential economic traps that limit the capacity for middle-income countries (MICs) to converge towards high-income status. It presents an empirical exploration of the two interpretations (absolute and relative) of middle-income traps (MITs) and considers transitions between country categories that occurred during the last three decades. Even if transitions are a rare phenomenon, the authors conclude that evidence is not able to settle the existence of MITs, but it is enough to illustrate the severity of the challenges that MICs face in their development path. The chapter analyses the theoretical arguments offered to justify the presence of these pitfalls, as well as the main policy responses required to overcome them. Even if more analytical work is required, the chapter underlines that the debate around MITs has revitalized reflection on the active policies required to promote growth in MICs. Finally, the chapter presents an overview of the book, underlying the main contributions of each chapter.

Global Value Chains, Preferential Trade, and the Middle-Income Trap

After a period of rapid growth, developing countries often experience a slowdown in growth and productivity, falling into what has come to be known as the “‘middle-income trap.” Production chains in East Asia, North America, and Western Europe have imposed a new model of production. Participating in global value chains became a policy issue. Market friendly trade policies—be it multilateral reductions of tariff and non-tariff barriers or preferential trade agreements with selected economies—are an essential part of this model. The relationship between value chains and regional integration has gained momentum, partly because participation in value chains is identified as a source of competitiveness, much needed for economies facing the middle-income trap. The relationship between preferential trade and participation in value chains as a means to deal with the middle-income trap is the subject of this chapter.

Employment and Labor Markets in MICs

Fostering (formal) employment has been one of the most effective ways to reduce poverty and (until recently) inequality. However various MICs are undergoing, for internal and external reasons, a process of premature de-industrialization. After discussing various interpretations of the informal sector and economy it analyses how economic growth and labor markets in MICs have been evolving in three distinct geographical regions. It points to the need for stronger adoption of managed national and international demand-led growth with the good labor market policies that characterized several of the fast-growing MICs. A productive transformation from commodity production to higher value-added activities is at the heart of the transition and a key factor is the development of domestic innovation capabilities moving up the value chain on a broad enough basis to generate sustained productivity growth that is equally distributed.

Promoting Universal Social Policy in MICs

Most middle-income countries have the financial and institutional resources to reduce poverty and inequality and improve social capabilities. But what is the right policy approach to secure these goals? We argue that to be effective and successful, social policies should be universal, providing the whole population with similar, generous transfers and services. To explore how universal policies can be implemented, we distinguish between the desired policy outputs (coverage, generosity, and equity) and the specific ways to secure them. We then introduce the concept of the policy architecture and analyze its influence on long-term trajectories. The chapter considers the impact of different trajectories on universalism in the long run, distinguishing between a bottom-up strategy that starts from the poor or other alternatives that involve the non-poor from the onset. We conclude the chapter with a call for more research on the interactions between policy design and political struggles.

Centripetal Politics and Institution Building in Exiting the Middle-Income Trap

The policies and institution building needed to overcome the middle-income trap are costly, lengthy, and difficult. At the same time, major social groups in many middle-income countries are fragmented—especially in terms of business and labor—impeding and complicating coalition building. This chapter looks first at these disarticulation politics and how they affect outcomes such as low taxation, and then turns to some exceptional cases of centripetal politics and coalition building in quality infrastructure (testing and research centers) in Asia and vocational and technical education in Turkey and Latin America.

Is There an Institutional Trap in MICs?

As countries progress, they require more complex institutions; however, economic and institutional processes frequently do not evolve at the same pace, as institutions are subject to greater inertia. This problem is particularly relevant in middle-income countries (MICs), as these countries experience episodes of intense economic growth. Therefore, the absence of institutional change can be a cause of a middle-income trap (MIT). The chapter discusses the criteria that define institutional quality, and examines the various ways in which institutional change occurs. Empirical exploration reveals the existence of two anomalous behaviors in middle-income regions: excessive institutional fluidity in Latin America and, in contrast, an excessive institutional stickiness in MENA. Based on prior works, the author explores the macro determinants of institutional quality. His results suggest that per capita income, tax revenue, redistribution (rather than mere inequality), education, and international openness all appear to be strong determinants of institutional quality.

The Disruptive Role of MICs in the Development Cooperation System

The emergence of middle-income countries (MICs) has increased the complexity of the international system and opened the space to a more comprehensive and universal development agenda. Additionally, through their role as providers of South–South cooperation (SSC), MICs have broken the strict donor/recipient duality that has characterized development cooperation policy and have widened the options for poor countries to receive international support. The chapter discusses the new theoretical foundations on which the development cooperation system should be based, as well as the new boundaries in which this policy should be deployed. Based on these changes, the chapter sheds some light on the role that MICs can play in the new development cooperation system, considering their dual role, as recipients and providers, as well as the implications that this engagement has for the rules, standards, and governance of the cooperation system.

National Development Finance in Middle-Income Countries

This chapter focuses on the roles of National Development Banks (NDBs) in emerging and developing economies. They finance investment in sectors key for dynamic and sustainable growth, both through their own lending, and by catalyzing private finance. For NDBs to contribute significantly to avoiding a middle-income trap, there are several conditions: they must be “good,” well-run development banks, their scale must be sufficiently large to help meet investment needs on a significant scale, and there must be a clear national development strategy, for NDBs to implement. This chapter stresses NDBs contribution to financing investment in innovative sectors and infrastructure. This is complementary to supporting provision of public goods, particularly investments that help combat climate change and financial inclusion. NDBs should provide counter-cyclical financing in the busts, when privately-financed investment tends to decline and NDB lending increases to help maintain crucial investment, and in booms, when lending by NDBs should slow down.

Should Middle-Income Countries Implement Environmental Policies?

This chapter analyzes the reasons for middle-income countries to enforce environmental policies and not leaving them for later development stages. It puts into question the premise that low- and middle-income countries should grow first and clean up later. Furthermore, it explains several possible co-benefits for middle-income countries of implementing environmental policies and how the application of international environmental policies and agreements influences them. These potential gains provide strong arguments to enforce environmental policies and facilitate a green transformation in middle-income countries. There are, however, several problems and challenges that may make this transformation difficult. The implementation of environmental policies should be tailored to the economic and institutional context of each country and accompanied by measures allowing an adequate achievement of economic, social, and environmental goals.