The middle-income transition

Middle Income Countries (MIC), by definition, are grouped according to income, which does not necessarily reflect a certain level of economic, political or social development. MIC is, therefore, a very broad and heterogeneous category. Even the division between lower-middle and upper-middle income countries is artificial, since even within these divisions there are countries at different stages of development. Notably, progression of the MICs is not linear and the idea of graduating from low-income to middle-income status can be misleading (Glennie 2013). It does not come, for example, with any significant decrease in poverty. The term middle-income country as defined by the World Bank in 2012 refers to any country with a GNI (gross national income) per capita ranging from $1,035 to $12,616. The group is further divided into lower-middle income countries (in the $1,035-$4,035 range) and upper-middle income countries (in the $4,036-$12,275 range). The World Bank currently classifies 103 countries as middle-income. The middle-income country category is sometimes disputed.
However, there are reasons for using the category of middle-income country. The first reason is that many emerging economies and societies can be said to encounter groupings of similar development challenges which are aligned with their level of income. In this case, examining similarities in different country contexts can provide valuable insight into development policy. The second reason is that MIC is a category of convenience. Existing research gives consideration to MICs as a category, and identifies certain development challenges as belonging to a 'middle-income trap'. A core characteristic of the middle-income trap is the fact that in the current global context, countries on the one hand have wages that are too high to remain competitive in the production/export of labour-intensive, standardised commodity production, while on the other hand, productivity is not high enough to allow them to compete in more technology-intensive production (Ohno 2013). The third reason is that the MIC category poses development challenges in a logic of progression. The category suggests the possibility of attaining high-income country status and gears policy recommendations towards this future objective.
 'The middle-income transition'-- a challenge that dozens of countries are grappling with, is, of late, being increasingly spoken about in Bangladesh. This article attempts to capture some thoughts on this. This article takes an initial look at what this "middle income transition" means and puts forward some ideas drawn from the increasing body of literature on the subject. It explores what factors contribute to economies ending up in this "trap" as well as some of the ingredients that help get out of it.
The middle income trap is a theorised economic development situation, where a country which attains a certain income will get stuck at that level. A developing nation gets "trapped" when it reaches a certain, relatively comfortable level of income but cannot take that next big leap into the high income bracket. Escaping the "trap" requires an entire overhaul of the economic growth model most often used by emerging economies.
The concept behind the "middle-income trap" is quite simple: It's easier to rise from a low-income to a middle-income economy than it is to jump from a middle-income to a high-income economy. That's because when we are really poor, we can use our poverty to our advantage. Cheap wages makes a low-income economy competitive in labour-intensive manufacturing (apparel, shoes and toys, for example). Factories sprout up, creating jobs and increasing incomes. Typically, countries trapped at middle-income level have: (1) low investment ratios; (2) slow manufacturing growth; (3) limited industrial diversification; and (4) poor labor market conditions.
WHY DOES GROWTH SLOW: In the post-world war era, from the 1950s onwards, many economies managed to rapidly reach middle-income status but few went on to become high-income. A very comprehensive study by the World Bank estimated that out of 101 middle-income countries in 1960, only 13 had graduated to high-income status by 2008. It is argued that this was essentially due to a slowdown in productivity growth, and therefore getting out of that situation also depended on productivity growth. The estimates showed that around 85 per cent of the slowdown in output experienced by those countries was explained by a slowdown of growth in total factor productivity, and not merely a slowdown in returns to physical capital.
WHY DOES THIS SLOWDOWN OCCUR: We have what economists call a 'Lewis-type development model'. It simply means that factors and advantages of a country which had helped to generate high growth during the initial phases of rapid development disappear when middle-and upper-middle income levels are reached. For instance, cost advantages in manufacturing that once drove high growth rates start to decline. The economy gets squeezed between low-wage producers on the one hand and high-skilled fast-moving innovators on the other. So, economies in this transition or trap get squeezed between these two and do not have the critical ingredients to edge out of it. In such a situation what becomes critical for an economy is to be able to unleash new sources of growth to maintain a sustained increase in per capita income - not just 8.0 per cent over two years but 8.0 plus per cent over a much longer period.
MIDDLE-INCOME TRANSITION "OPTICS": The "optics" of this challenge refers to what we see in the headlines, the pronouncements and the press releases - by a Central Bank of a country or by donors - which announce that a country has reached or breached a certain GNI per capita threshold. The "optics" certainly do matter and provide a powerful signal domestically and internationally. Yet, it is first important to understand what this entails - what are these thresholds of lower-income, middle-income, and high-income? Different institutions have different ways of looking at it. The leading indicator many refer to is composed by the World Bank using the World Bank Atlas Method. But you will notice some differences, for instance, between the ADB and World Bank's classifications. One will also notice that each year the World Bank would revise the thresholds, in keeping with global price levels. So for instance, if a country's economic authorities announce in 2010/11 that the economy is going to reach middle-income status and go beyond the $ 3,975 per capita to become upper middle-income, in two years' time that goal-post will shift because the threshold to breach lower middle-income to upper middle-income has been revised. So in Bangladesh, for instance, as it stands now we have to breach $ 4,085 to reach upper middle-income, not $ 3,975 that we thought of before.
Organisations like the ADB Institute analyse from the perspective of the number of years that a country is in middle income. But staying at that level beyond a certain number of years leads a country to experience the trap. It is very relative and historic. For example, it could be that country 'A' is in a middle income trap today, if it has been in that group longer than the historical experience of a set of countries.
According to the ADBI literature, a country is in a lower middle-income trap if it has been in that category/group for 28 years and in the upper middle-income trap if it has been in that group for 14 years. Going by this, Bangladesh should only worry about being stuck in the middle income category/group if it is still there in 2041! So, codifying the "trap" is not easy and can be contentious.
This is probably why Nobel Prize-winning economist Michael Spence prefers to call it "the middle income transition" rather than focusing on the specific thresholds of a "trap". His idea of a middle income transition refers to "that part of the growth process when a country's per capita income gets into the range of $ 5,000-10,000".
Meanwhile, the IMF looks at the classification slightly differently - it is based on a set of criteria. In January 2010, Sri Lanka was graduated by the IMF out of what it calls the 'Poverty Reduction and Growth Trust' set of countries -- essentially the low income category -- into "middle income emerging market" status. In Sri Lanka's reclassification, the IMF indicated the combination of factors it considered - firstly, the World Bank's classification, but also whether there has been no declining trend in GNI per capita over the previous five years, whether the country can access international debt capital markets, and whether the country faces serious short-term vulnerabilities on the macro front.
Dr. Jamaluddin Ahmed FCA, is General Secretary, Bangladesh Economic Association, Chairman of Emerging Credit Rating Limited and Past President of ICAB (2010).
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