Middle-Income Trap: Lessons from Emerging Asian Economies

1. Middle-Income Trap:Lessons from Emerging Asian Economies Professor SuthiphandChirathivat Chairman, Chula Global Network Chulalongkorn University April 2014

2. Messages • Asia’s rise in global importance with new emerging economies aiming at moving beyond the middle-income trap (MIT) • Asia has a wealth of experiences with • Korea (ROK), recently, joining the club of developed countries • Malaysia and Thailand, still in the high middle-income countries • China and India, emerging economic powerhouses of Asia, also in the middle-income categories • Malaysia and Thailand, as interesting cases, on how to graduating from the MIT. • Challenges for policymakers can be achieved through lessons learnt from building proper approaches to ensure sustained and inclusive growth

3. 1. Development Experiences of Emerging Asian Economies

4. Context of Development’s Level among Emerging Asian Economies • Japan was the first to be a high income country • Then Korea (ROK), Singapore, plus H.K., China and Taipei were followed in the late 20th century • A number of latecomers, almost all ASEAN , China, and India, have attained middle-income status. The question remains, not all, but some, rather than the others, will be able to moving forward the high-income club, in coming years. • If not, a developmental trap or a middle-income trap could occur.

5. Figure 1: Development Stages of an Economy A–B: Traditional society, underdevelopment, facing poverty trap. B–C: Initial development stage, escape from poverty trap, initial development of markets. C: Middle-income level. C–D: Continuing sustained growth to high-income level (D). C–E: Stagnation or low growth—the middle-income trap. Note: GDP = Gross Domestic Product. Source: Tran Van Tho(2013)

6. Figure 2: Pattern of International Competitiveness of a Sustained Growth Economy Note: ICI = International Competitiveness Index. Source: Tran Van Tho (2013)

7. Figure 3 : Comparison of GDP/Capita Growth in 8 Latin American and 10 Asian Economies: 1900–2000 Source: Gill and Kharas (2008).

8. Emerging Asian Economies in Transformation • Emerging Asia, rapid change over decades, linked to outward-oriented development strategies (Kawai and Wignaraya (2013), Athukorala (2011)) • Key shifts still occur since the latest global financial crisis: • Further rise of East Asia by PRC, Korea and ASEAN • Growing attempts to “Look East” by India • Growing regional and domestic income/demand for capital and consumption goods • Widening and deepening of value chains and production networks • Wealth by luck, like labor-abundant and natural resources, rather than development, like skills, innovation, ,institutions, no longer acceptance • Requirement of policies to overcome the development trap or middle-income trap.

9. Table 1: ASEAN in transformation • Source:Compiled from CIA World Factbook 2012

10. Table 2: ASEAN 2030 • Source:ADBI (2012), ASEAN 2030 Toward a Borderless Economic Community-Draft Highlights, Tokyo: Asian Development Bank Institute., p.35.

11. 2. Tracking the Middle-Income Economies: Determining Threshold

12. World Bank Income Classification • GNI per capita as metric to measure economic progress and thresholds for different income groups • World Bank data for 2010: lower middle-income (1,006-3,975 US$), upper middle-income (3,976-12,275 US$), and high income (12,276 US$ or above) • Number of low-income countries has decreased over time from 1950 up to 2010. • Number of high-income countries, particularly, the late 1980s and 2010, also increased in Asia, namely, Korea, Singapore, Chinese Hong Kong and Taipei.

13. Transition to Middle-Income Growth • Number of years in lower middle-income level before graduated to upper middle-income level • China, PR, 17 years, from 1992 to 2009, 7.5% • Malaysia, 27 years, from 1969 to 1998, 5.1% • Korea, 19 years, from 1969 to 1988, 7.2% • Taipei, China, 19 years, from 1967 to 1986, 7.0% • Thailand, 28 years, from 1976 to 2004, 4.7% • Rapid growth and export orientation, top priorities of policymakers (Schuman (2009))

14. Figure 4 : Cross Country Comparison* Source: IMF staff calculations. * t=0 is defined as the year when the GDP per capita for a particular country reached 3000 U.S. dollars in PPP terms.

15. 5 Asian Economies Graduated to High- Income Level • Japan, 9 years, from 1968 to 1977, 4.7% • Hong Kong, China, 7 years, from 1976 to 1983, 5.9 % • Singapore, 10 years, from 1978 to 1988, 5.1 % • Taipei, China, 7 years, from 1986 to 1993, 6.9% • Korea, Rep. of, 7 years, from 1988 to 1995, 6.5% • They all put 10 years or less to graduate from high middle-income level

16. Emerging Asian Economies in the Middle-Income Experiences • Threshold of 28 and 14 years for the lower middle-income and upper middle-income traps • Malaysia is borderline case, already 15 years in UM until 2010 • China, PR, and Thailand, avoiding the upper middle-income trap? China has 12 years, Thailand, 7 years, from 2010 • India, Indonesia, Viet Nam, still has more years, as they are in lower middle-income group

17. 3. Lessons Learnt for Policy Concerns from Empirical Justification

18. From Conceptual Framework to Empirical Evidence • Solow (1987) debated difficulties in detecting the benefits of innovation in GDP statistics while we are all talking about economic progress • Garret (2004), effects of globalization on middle-income economies demand skills and institutions to improve cutting-edge technological innovation • Gil and Kharas (2007) argued MIEs are squeezed between low-wage competitors that dominate in mature industries and rich country innovators that dominate in industries undergoing rapid technological change

19. Table 3: Research and Development Expenditure (% of GDP) Source: World Bank 2011.

20. Table 4: Number of Patents Granted as Distributed by Year of Patent Grant Source: US Patent and Trademark Office 2011.

21. From Conceptual Framework to Empirical Evidence (Continued) • Kharas and Kohli (2011) defines MIT as how countries stagnate and fail to grow to advanced-country levels • Ohno (2009) refers to the stage the countries fail to upgrade human capital • Other studies refers to growth during transition, like; Spence (2011), difficult phase with 5,000-10,000 $ income per capita; Filipe (2012), why some countries grow faster than others?; Eichengreen and al (2011), why fast growing economies slowdown?

22. Table 5: Share of Tertiary Graduates in Engineering, Manufacturing, and Construction (in parentheses are shares of graduates in social sciences) Note: Figures are shares in total tertiary graduates. Source: United Nations Educational, Scientific and Cultural Organization 2011.

23. Why Countries Falling into the MIT? • Different approaches lead to different views • In general, broad approach focusing on overall development strategies • Meanwhile, framed approach looking at analyses around symptoms of an economy facing the MIT • Either way, each has the merit in properly addressing the issue

24. Why Countries Falling into the MIT? (Continued) • Kharas and Kohli (2011), most countries fall into the MIT because they fail to adopt new growth strategies once they reach middle-income status. MIE need to focus more on demand-side strategies rather than supply-side strategies. With escalating wages, MIEs lose cost competitiveness in exports. New strategies are then needed to develop new products, processes and markets. The connection between income distribution and macroeconomic growth is another possible source of MIT, “ domestic demand may grow slowly than potential GDP, and this either results in stagnation, or….a growing debt burden of the middle and lower classes.”

25. Why Countries Falling into the MIT? (Continued) • One of the major symptoms of a MIT economy is overall slowdown in growth and productivity • Eichengreen, et al (2011) suggest that growth slowdowns are essentially productivity growth slowdowns (mostly explained by a slowdown in the rate of TFP growth, much more than by any slowdown in physical capital accumulation) • Agenor and Canuto (2012) characterize MIT as talent is misallocated and innovation stagnates. Public policies to improve access to advanced infrastructure, enhance the protection of property rights and reform labor markets are essential to escape or avoid the MIT.

26. Figure 5: Labor Productivity and Wages in 2000 Note: In both labor productivity and wages, figures of each country are calculated as percentages of the US levels which are shown by the 45° line. Source: United Nations Conference on Trade and Development (UNCTAD) 2002.

27. Figure 6: Change in Korea’s International Competitiveness Index Source: Calculated from United Nations, various years.

28. Figure 7: Labor Productivity and Wages in 2006 Note: In both labor productivity and wages, figures of each country are calculated as percentages of the US levels, which are shown by the 45° line. Source: United Nations Conference on Trade and Development (UNCTAD).

29. Figure 8: International Competiveness Index of Two Groups of Industries in Malaysia Source: Calculated from United Nations, Comtrad Database, various years.

30. Figure 9: International Competiveness Index of Two Groups of Industries in Thailand Source: Calculated from United Nations, various years.

31. 4. Policy Challenges for Emerging Asian Economies

32. Some Stylized Facts of Emerging Asian Economies • IMF working paper (2013) draw attention about recent performance of middle-income countries in Asia lies somewhere between the extremes of East Asia and Latin America. • Malaysia has clearly been more successful than the Latin American comparators • Thailand’s trajectory is comparable to the initial growth path of countries like Brazil and Mexico • China’s trajectory has so far outstripped even that of the earlier East Asian success stories

33. “Growth Slowdown Risk” Map for Seven Emerging Asian Economies • Malaysia, the Philippines, and China would face a larger risk of growth slowdown stemming from institutions • Vietnam, India and Indonesia are most at risk of a slowdown arising from a lack of transport and communication infrastructure • On trade, India could do more to pursue regional integration, while Thailand and the Philippines are relatively well integrated. • Some Asian economies are less well-positioned than others and have therefore greater room for reducing risks of a growth slowdown further down the road • Room for improvement on institutions, with some of them also in need of more and better infrastructure • On macroeconomic factors, while Asia’s recent growth has typically benefitted from its comparatively strong capital inflows and increased investment rates, these also come with risks

34. Table 6 “Growth Slowdown Risk” Map for Asian Middle-Income Countries Source: ShekharAiyar, Romain Duval, Damien Puy, Yiqun Wu, and LongmeiZhang (2013), “Growth Slowdowns and the Middle-Income Trap” IMF Working Paper.

35. Recent Experiences of Malaysia and Thailand • Obviously, both represent well the MIEs, moving from low- to middle-income level by leveraging cheap labor and competing on costs • However, they differ from Korea (ROK) in the 1990s when it became a developed country, as for now, they are much more emerging economies under the globalization era with a more volatile and uncertain world, while, economic growth unevenly shared, so they face pressure from domestic income distribution, resource allocations and environmental degradation. • Both face difficult choices in a competitive global market to increase investment and productivity, move forward high-value exports, and boost internal consumption

36. Recent Experiences of Malaysia and Thailand (Continued) • As outlined earlier, economic downturns for Malaysia and Thailand can also be related to labor shortages, low-quality education provision, inability to productivity improvement, low levels of technological research and innovation, poor environment for enabling SMEs and more. • Rapid economic development has not matched up with political institutions’ set-up, thus allowing politicians in Malaysia and Thailand to use public funds to gain or maintain political office, and enduring patronage networks to hold back democratic development • World Bank (2010) outlines economic incentive and institutional regime in both countries as follows:

37. Figure 10: Relative Position of Association of South East Asian Nations (ASEAN) on Economic Incentive and Institutional Regime in Malaysia and Thailand Source: World Bank 2010.

38. Contrasting Malaysian and Thai Case Studies • Malaysian colonial history and political system established after independence, including Bumiputra and the ruling Barisan National coalition. Thailand’s proud independence, but more tumultuous politics, including recent democratic unrest and crises. • Malaysia’s natural resource revenue affords a level of state involvement in industry and investment that is not seen in Thailand, while level of authority vested interests in Malaysia’s state government is not matched by Thailand’s concentrated bureaucracy and economy. • Absolute poverty has been reduced in both cases, but not relative poverty in certain geographical areas. Thailand, as more widespread and more populated country, has perhaps more difficulties to deal with this kind of problem, while its fiscal policies also suffer a more appropriate change when needed as compared to Malaysia.

39. Contrasting Malaysian and Thai Case Studies (Continued) • Inequality in Thailand has remained high by regional and global standards, as compared to Malaysia which is more targeted on the bottom of 40 per cent of the income distribution by the NEP. • Quality of education and inequalities in access to education is more problematic in Thailand than in Malaysia. Thai education system fails to produce enough graduates with skills needed by industry, thus leading to skilled labor shortages and limit economic growth. • Enduring inequalities in both Malaysia and Thailand can be related to wider political and social context of each country, contributing to unequal growth include the concentration of high-value economic activity in limited geographic areas and poor enabling environments for SMEs, which restrict their abilities to improve productivity and move up the value chain.

40. Reshaping Policies to Overcome the Middle-Income Trap • Both countries need policies to address real concerns in research and innovation capability, quality and appropriateness of human resources via education and productivity improvement, inequalities and proper access to arising economic opportunities, for example. • Both still suffer from better institutions dealing with changing democracy, dynamic markets and good governance that support a new era of middle-income growth • Pay greater attention to investment in infrastructure development that is still insufficient, and to nourishing resources to targeted sectors as well as to improving business environment with a more sustainable and inclusive path

41. Reshaping Policies to Overcome Middle-Income Trap (Continued) • Malaysia “Wawasan 2020” with its New Economic Policy to be reformulated and Thailand toward a service/knowledge-based BOI’s new industry investment promotion strategies. • Risks and danger for decline in investment and distortions caught by the political economy for both Malaysia and Thailand which might not be able to cope with dynamic changes in comparative advantage structure toward higher skill- and more innovative-intensive product contents. • Unlike Korea (ROK) in the 1990s, today’s requirements of a proper understanding of a new landscape of middle-income growth, although with more global competition and uncertainties with up- and down- movement, but is still needed a more inclusive and sustainable way with proper policy orientation and action

42. Summary • Emerging Asia’s growth practices might get caught in the middle while moving toward a high-income status in a global society and knowledge landscape that is changing very fast. • Deeper knowledge needed to find out what could cause overall economic slowdowns, so not to falling into the middle-income trap, as there are various experiences and lessons to be learnt. • Unlike Korea (ROK), cases of Malaysia and Thailand are interesting, however, also placing at different time and different economic, political and social context. • Policy formulation such as R&D, human capital, institutions, investment, leading to a sustainable and inclusive growth.

43. Selected References • Eichengreen, Barry, Donghyun Park and Kwanho Shin (2011), “When Fast Growing Economies Slow Down: International Evidence and Implications for China,” NBER Working Paper no.16919 (March). • Chirathivat,S. and Ng. C.Y. (2009), Emerging Asia’s Growth Practices, Chula Global Network, Chulalongkorn University • Jesus Felipe (2012), “Tracking the Middle-Income Trap: What is It, Who is in it, and Why? Part 1,” ADBI Economics Working Paper Series No. 306, Tokyo: Asian Development Bank Institute. • ShekharAiyar, Romain Duval, Damien Puy, Yiqun Wu, and Longmei Zhang (2013), “Growth Slowdowns and the Middle-Income Trap,” IMF Working Paper. • Tran Van Tho (2013), “The Middle-Income Trap: Issues for Members of the Association of Southeast Asian Nations,” ADBI Working Paper 421, Tokyo: Asian Development Bank Institute. • VijayakumariKanapathy, PasukPhongpaichit, HerizalHazri and PornthepBenyaapikul (2014), Middle-Income Trap: Economic Myth, Political Reality Case Studies From Malaysia and Thailand, Kuala Lumpur: The Asia Foundation.