The Economic Times: Indian economy may fall into a 'middle-income trap'
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alok agarwal
May 12, 2013, 10:23:16 PM5/12/13
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Stuck in the middle' is never a good ending to a story. Especially
when it comes to economics, we like clear stories of good and evil.
"The Soviet Union
collapsed because it banned private enterprise", or "the US is the
world's biggest economy, because it encourages innovation", are the
kinds of stories we like.
Less compelling is an economy which grew strongly, then stopped growing, well before it became rich. A country which just runs out of steam altogether somehow seems less interesting.
Yet that's the real danger that the International Monetary Fund (IMF) points to, in its regional economic outlook for Asia which it released last week. It pointed out that the fast-growing economies of Asia — from China to India to Vietnam to Malaysia — faced the risk of falling into a 'middle-income trap'.
Which means that average incomes in these countries, which till now had been growing rapidly, will stop growing beyond a point — a point that is well short of incomes in the developed West. Effectively these countries could become 'middle class', and stay that way.
Falling into the Trap
The idea of a 'middle-income trap' is not new. Before Asia, the countries believed to have suffered most from the middle-income trap phenomenon were the hitherto fast-growing economies of Latin America, during their famous 'lost decade' of the 1980s, when growth stalled, industrial production stagnated and unemployment and inflation both remained high.
Growth Slowdowns
Indeed, as the research shows, once a country reaches the middle-income stage (defined as anything between $2,000 and $15,000 per annum per person in what are called 'international dollars' which enable cross-country comparisons), the stakes and risks actually go up. Middleincome economies are far more prone to slowdowns in growth than either low- or high-income economies. The effects of a middle-income trap were there for all to see after the Asian crisis of 1997.
The IMF report points out that while the Asian Tiger economies - Taiwan, Singapore, South Korea and Hong Kong — reached high-income levels, "the experience of several other Asian middle-income economies (MIEs) has been more mixed, reflecting in part the transitory but large effect on living standards of the Asian crisis of the late 1990s.
Malaysia has been more success- ful than Indonesia, with Thailand falling in between, but in all three cases convergence to living standards in advanced economies stalled for a decade after the Asian crisis, regaining momentum only in recent years."
But what causes such growth slowdowns and middle-income traps? The IMF paper and report identify a number of causes — none of which are surprising — from infrastructure to weak institutions, to less-than-favourable macroeconomic conditions.
But the broad, overall cause, says the research, is a collapse in the growth of productivity — the ability for a given amount of labour and capital to produce ever-increasing amounts of output. Such productivity is driven by, along with technological innovations, a range of other factors from higher education and skill levels (more skilled workers are more productive), and also the state of institutions and infrastructure.
Less compelling is an economy which grew strongly, then stopped growing, well before it became rich. A country which just runs out of steam altogether somehow seems less interesting.
Yet that's the real danger that the International Monetary Fund (IMF) points to, in its regional economic outlook for Asia which it released last week. It pointed out that the fast-growing economies of Asia — from China to India to Vietnam to Malaysia — faced the risk of falling into a 'middle-income trap'.
Which means that average incomes in these countries, which till now had been growing rapidly, will stop growing beyond a point — a point that is well short of incomes in the developed West. Effectively these countries could become 'middle class', and stay that way.
Falling into the Trap
The idea of a 'middle-income trap' is not new. Before Asia, the countries believed to have suffered most from the middle-income trap phenomenon were the hitherto fast-growing economies of Latin America, during their famous 'lost decade' of the 1980s, when growth stalled, industrial production stagnated and unemployment and inflation both remained high.
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"The lesson from what happened in Latin America is that you cannot get complacent about growth," says Shekhar Aiyar, a co-author of an IMF paper ("Growth Slowdowns and the Middle-Income Trap") on which the IMF outlook was based. "Just because you are seeing fast growth doesn't mean it will last." The bottomline: just because you made the transition from a low-income economy to a middle-income one, don't expect to easily clear the next hurdle, from a middle- to high-income economy.
Growth Slowdowns
Indeed, as the research shows, once a country reaches the middle-income stage (defined as anything between $2,000 and $15,000 per annum per person in what are called 'international dollars' which enable cross-country comparisons), the stakes and risks actually go up. Middleincome economies are far more prone to slowdowns in growth than either low- or high-income economies. The effects of a middle-income trap were there for all to see after the Asian crisis of 1997.
The IMF report points out that while the Asian Tiger economies - Taiwan, Singapore, South Korea and Hong Kong — reached high-income levels, "the experience of several other Asian middle-income economies (MIEs) has been more mixed, reflecting in part the transitory but large effect on living standards of the Asian crisis of the late 1990s.
Malaysia has been more success- ful than Indonesia, with Thailand falling in between, but in all three cases convergence to living standards in advanced economies stalled for a decade after the Asian crisis, regaining momentum only in recent years."
But what causes such growth slowdowns and middle-income traps? The IMF paper and report identify a number of causes — none of which are surprising — from infrastructure to weak institutions, to less-than-favourable macroeconomic conditions.
But the broad, overall cause, says the research, is a collapse in the growth of productivity — the ability for a given amount of labour and capital to produce ever-increasing amounts of output. Such productivity is driven by, along with technological innovations, a range of other factors from higher education and skill levels (more skilled workers are more productive), and also the state of institutions and infrastructure.
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