Middle Income or MIC Trap


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

In recent years, the term middle income or “MIC” trap has entered common parlance in the development policy community – particularly, in East Asia where concerns about slower growth following the 1997 regional financial crisis prompted concerns of a protracted period of subpar performance. The term itself often has not been precisely defined in the incipient literature. In some cases, the phenomenon is described in terms of relative “catch-up” with the United States or some other rich country reference (Woo, 2011; Lin and Rosenblatt, 2012). In others, it is based on stagnation or painfully slow growth in absolute income levels. For example, Felipe et al (2012) establish a definition based on the number of years a country takes to move from one income category to another, based on absolute thresholds for low, lower middle, upper middle and high income countries. The “middle-income trap” is the phenomenon of hitherto rapidly growing economies stagnating at middle-income levels and failing to graduate into the ranks of high-income countries.
In terms of development strategy or the microeconomic determinants of growth, a number of authors have focused on the peculiar position of MICs within the global supply chains. The basic idea is that incomes (and wages) in MICs have increased enough to require graduation from low-skilled labor intensive activities, but MICs have not yet developed national innovation systems -- or perhaps not even accumulated enough physical and human capital – to compete with high-income countries in more sophisticated products (Gill and Kharas, 2007; Jankowska et al, 2012; Yusuf and Nabeshima, 2009; and Woo, 2009). This line of inquiry leads directly to policy discussions of what needs to be done (Kharas and Kohli, 2011; Shijin et al, 2012; Xiaohe, 2012; Flaeen et al, 2013) to transition successfully from middle income status to high income status. Aiyar et al (2013) define the middle income trap as a special case of growth slowdowns and explore some of the determinants behind these slowdowns.
Whether one takes a relative or absolute approach to thresholds has very strong implications for descriptive statistics. For example, from a relative perspective, the Latin America and the Caribbean (LAC) region is often cited as the classic case of a MIC trap phenomenon: a review of either the regional aggregate or individual countries shows that income per capita relative to the United States did not progress during the 20th century. Figure 2(a) uses Maddison data to track the progress of the LAC aggregate’s ratio as well as Colombia – the latter simply as an example.
  On the other hand, if one uses an absolute definition, then one might reach the conclusion that today’s high-income countries themselves were stuck in a “MIC trap” for much of the twentieth century. Figure 2(b) uses 2008 income per capita (in constant PPP adjusted dollars) for Colombia (still somewhat below the world average) and Poland (a recent “graduate” from MIC status, by World Bank standards) and compares the G7 economies to Colombia and Poland over the last century. One sees that it was only in the late 1950s that the G7 economies surpassed the recent income per capita of Colombia, and it was only in the 1970s that they all surpassed Poland.
What characterizes a middle income country (MIC)?
 Quite literally, MICs are defined as the middle of the distribution of countries ranked by per capita income. One could also imagine using some other metric, or metrics, of economic development to define the “middle class.” Scanning a variety of dimensions, a “typical” MIC would have income per capita of about $4,000, an adult literacy rate of about 70 to 93 percent, infant mortality of about 19 to 50 per 1,000 live births, and life expectancy is around 65-72 years.2 In terms of economic structure, the typical MIC possesses a wide variety of productive sectors–ranging from still large primary sectors to industries that may be highly developed—or even at the technological frontier globally. A typical MIC still has substantial shares of its population toiling at relatively low productivity occupations, with limited access to capital, and with earnings that are relatively low on a global scale. On the other hand, one could argue that there is also a great dispersion across many of these socioeconomic characteristics among MICs. In brief, MICs are countries that made substantial progress in social and economic outcomes, but still lag significantly behind the rich countries in most social and economic indicators.
Most of the social indicators mentioned above are positively correlated with countries’ income per capita. The simplest way to establish thresholds for MICs would be on that basis. The World Bank classifies a country as a MIC if its income per capita (Gross National Income, in accounting terms) is greater than $1,005 and less than $12,275.
Indian economy may Fall into a 'middle-income trap'
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.
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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 in May 2013. 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.
How Can Emerging Markets Avoid The Middle-Income Trap?
                       Developing countries experience such rapid growth for several reasons. First, they invest in imported technology that allows them to be more productive. This is more or less copying the know-how of developed economies, skipping over the painful process of reinventing the wheel. Second, their labor costs are lower relative to developed countries, allowing them to produce labor-intensive goods more cheaply. Third, they are able to tap into a population working in inefficient or non-industrial sectors of the economy, such as agriculture. Fourth, they operate export-dominated economies that emphasize capital-intensive growth.
At some point, emerging markets will have picked all of the low hanging fruit that has provided them with such consistently high GDP and productivity growth rates. The "easy wins" will be exhausted as rural labor sources are utilized and investment in more urban factories leads to saturation. As the supply of migrant or cheap labor declines, high levels of demand will increase wage rates. This will reduce the competitive advantage enjoyed by many export-driven industries. This is especially the case in industries dominated by high volume orders with low costs.
For emerging economies, a wealth of historical perspective can provide some potential strategies to keep growth alive:
- Investment in infrastructure, such as roads, should continue in order to connect industrial centers to more far-flung internal markets.
- Regulatory institutions protecting companies that innovate must be developed, signaling to firms that creating products and services able to be patented is a viable investment.
-  Investments in education a wider proportion of the population, as well as the development of higher education institutions linked to science and industry will help develop the next generation of entrepreneurs.
- Monetary policy will eventually have to allow currencies to fluctuate with market conditions more, as an emphasis on keeping exchange rates artificially low distorts the economy and pushes capital to the same industries as before.
Businesses and consumers will have to be given greater access to credit, which will help develop a domestic market.
- Emphasize the development of industries outside of commodities.
- Governments will have to loosen the top-down approach to directing the use of capital and development of industries, allowing smaller operations to flourish and limiting continued investment in industries with low returns.
- Domestic markets will have to be open to a level of international competition, removing implicit government protection on businesses that cannot compete or use capital efficiently.
- Encourage institutions that fight corruption.

Saturday, 12th Sep 2015, 09:40:34 AM

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