Learning From The Economics of Middle Income Traps
The piece on the middle income traps by Agenor http://Agenor, P-R. (2017). Caught in the Middle? The Economics of Middle-Income Traps. Journal of Economic Surveys, 771-91 is very interesting and it gets me thinking how we can do better in predicting a country’s fate in growing its economy and income in the long run. Except of using China as a cautious example of middle income trap, the author is right in many of the reviewed evidences and opinions. My way of putting it: The traps are like shadows that move along with developments such that the higher income an entity gets, the larger the size of the shadow. Note there are multiple traps for each entity, spanning multiple fields and stages and preventing the entity from achieving its goal of high income — a goal that thus far only a minority of nations in the world has reached.
The absolute definition or measure of middle incomes by the World Bank differs from the relative version, in which countries Gross National Income (GNI) are expressed as percent of what in the United States or the OECD club. He is right that the problem with absolute definition is its implicit assumption that GNI is independently grown by each country. This assumption is more wrong today, given the global supply chains and foreign direct investments. China and US trade war has also made it clear that countries compete in the sense that one can and will try to preemptively stall or slow down the growth of another, especially when the two have similar size. However, dependent growth of GNI is not the same as having a “preset distribution that specifies the proportion of countries in each category.” The keyword is “preset distribution,” because a distribution of entities is not predetermined but depends on games of entities.
All About Growth Rates
Escaping middle income traps is all about growth rates. I would point out that maintaining a fixed growth rate is a uphill battle given the ever increasing base of the growth. Growing 6% of an economy that is only $100 billion is much easier than growing at the same rate with an economy size of $1 trillion. Growing out of the poverty trap is like picking the lower hanging fruits. It gets hard to grow out of lower middle income trap and harder of middle and upper middle income traps. Reaching high income is a moving game and you can’t just grow fast for a period and then slow down significantly. One interesting statistic: Of the 101 middle income countries in 1960, only 13 had escaped the trap and entered high income in 2008. The Asian Tigers are among the latter pack while Malaysia and Thailand are two bad examples failing to grow continuously.
High Educational Attainment Versus Labor Intensive Production
One thing unique in Asia is that growth in education may have little to do with economic or income growth. As the author has pointed out, between 1970 and 2010, Malaysia has achieved the highest educational attainment among the Asian Tigers – in 6 years. Yet there has been little change in its pattern of labor intensive production and exports. This is an excellent example how elementary advantage comes and goes faster than packaged ones.
Another example is the fact that I learned this time, that in the country of Morocco for the past three decades growth has been fueled by high rates of public investment, some of these investments are the highest in the world, even by Asian standard, yet with diminishing returns over time.
My take is that it is less of diminishing returns to investments and physical capital, but to anything. In other words, everything will have a diminishing marginal return over time, in relation to its abundance of existence. Abundance does not have to be absolute, only relative to others. This is ultimately why entities compete with packages rather than elementary advantages. Having a nice package of advantages means entities can shift gears when one elementary advantage lost its power while others waiting in the wings are ready to jump in.
Growth Slowdown Is Productivity Slowdown
While we can sit here and debate what is the best definition of middle income traps, there is little secret how high income is achieved: You must grow your economy through innovations, investment and integration — the magic triple “Is”. The last “I” of integration means packaging elementary advantages to achieve the “triple advantages” as my current trade-war inspired paper talks about. The “I” in the middle, the investment, mostly refers to human capital investment, which, as the author pointed, matters ultimately because slow down in economic growth is essentially synonymous to slow down in productivity, with total factor productivity or TFP drops by 86 percent. But productivity slowdown is mainly caused by low quality of human capital more than physical capital. The way to remember this is to link human capital with value adding activities: Human capital is among the most important and the largest factor inputs to determine the value adding activities. Globalization has made human capital even more important because physical capital can be in constant flux in and out of places, seeking the best channels of raising returns. Human capital is much more stickier. The game today is essentially about who can offer the best value adding projects to attract physical capital, but humans are always behind the best (and the worst) projects.
Human Capital Growth The Secret Weapon in National Growth
If human capital growth is the key, there is a good news. We can reliably assess the possibility of sustainable growth into triple advantages by assessing how the country grows its human capital. Based on Malaysia experience, we cannot rely only on institutionalized education in schools and colleges, nor counting the number of tertiary graduates in the work forces. These are easily qualified but weak in getting into the accumulated human capital. We must go one step further back by entering family education or parenting. To the extent parenting is a preinstitutional resource, national growth is largely determined by preinstitutions.
This is another good news because it moves us earlier in growth equation: from productivity growth to human capital growth and from schooling to parenting. Time wise, we see productivity growth later in production, while human capital growth occurs earlier. Similarly, parenting comes before schooling results can be seen in schools and colleges.
More generally, based on the cases of some Latin America and African countries, there are signs for a country to fall into middle income traps even before it really happens. The most important sign is whether citizens and states can work together toward growth goals. Middle income countries achieve their level of middle income oftentimes because state policy changes, pushed by a “strong man” with growth insights that his/her predecessors simply did not have. However, the “strong man” effect will not last long if citizens did not hold the same growth related priority. They will lower down the “policy bonus” of the state after the strong man died or lost power. Everything goes back to the “normal” as it was and thus the “trap state” takes the country over. Now look at China, where citizens actually wanted to change even before the state did and all they needed was a little crack in policy to allow them to pursue their desired course.
Ways of Leveraging Human Capital
What makes human capital the sustainable growth driver? There are two ways of doing it, one on the macro scale and is simple to leverage, while another individual and is more complicated. The “gravity” of the former is high but low for the latter. The author correctly pointed out that before low income countries reach the middle income, high returns to human capital could be obtained through simply shifting labor forces to sectors with higher returns, such as from agriculture to manufacture, and from state owned firms to multinationals or new industries. Interestingly, if Dabla-Norris et al (2013) was right, structural shifting of labor forces out of lower paying farming sector to cities and factories has been the primary way for advanced economies to raise its living standard.
Why Middle Income Traps Are Natural
Strictly speaking, shuffling existing human capital among sectors does not involve new human capital, only the existing one. In that sense the move is not about human capital per se but rather change in human capital policy. Once you are in middle income, reaching for high income requires genuinely new human capital, this time with individuals who are good at making things to happen under great uncertainties, who are not just hungry for money or external incentives but for internal causes.
The middle income becomes a trap exactly because it is easy not to make the self-investment to oneself, to grow and to accumulate one’s human capital. As the author has pointed out, it is easy to do so because the lower hanging fruits were too easy to get, one can simply shift from one lower paying sector like agriculture to a higher paying sector like manufacture and services. It is not obvious for workers to learn and to constantly upgrade their skill sets, all that is obviously needed is to be interested higher pays — interested enough to relocate to where the money is. There must be something else that drive individuals to constantly learn new skills but what is it?
What Controls Quality of Parenting? The Accumulated Choices
That deep driver is installed by parents more than anyone else. It is the parental encouragement of their juniors to get knowledge and to use that knowledge to win respect of others. This is where Chinese differs from others deeply trapped in middle income now, like we see in many Latin American and African countries.
The other advantage of relying on parenting is that there is little room for serendipity in national growth: Good jobs in parenting must be achieved by parental intentions, long term planning and careful implementations over time.
How accumulated preferences or choices matter? China is the best example. Normally with income increases come diversification of preferences. People start thinking of difference things like environment impacts, human rights, better healthcare, social welfare and other things that are socially fashionable like same sex marriage, animal rights, global warming and women’s right for birth controls. These can become distractions of growth, to which China should become highly susceptible given its fast growth in the past. However, so far it has not happened as China still puts growth as its number one goal. It is amazing that even in the midst of the Corona Virus crisis China still pledges to maintain its growth speed. What make China immune?
The answer is accumulated preferences. China would have been just like others trapped in the middle income if its people were not so deeply committed to economic gains. China has kept itself from the influences from the US because its own people are thinking about one thing and one thing only: expanding family fortunes across generations. For them, becoming the largest economy in the world means the most and the only way to win the respect of others. This is mistaken because size of the economy alone would never win the respect. However, it is a good misconception to have, because it keeps the country and its people moving in growth friendly direction and stay on the right track.
How China Grows Human Capital
Merely attributing everything to the pro-growth, pro-materialistic priority among its people is not enough, we must further explain why China has abundant human capital for climbing up the global ladder of productivity. For that we must understand how Chinese parents compete with each other. Installing pro-growth attitude in the juniors only requires parents acting alone, but growing human capital requires teamwork and a culture that gives attention to knowledge, technologies, and innovations. China is in the perfect position for that because its people really care about and admire innovations. They are the minority in this world who pay so much attention to those things, although they are proportionally poor in bringing up original innovations themselves. The secret here is for parents to encourage their own juniors to do well in school, to memorize the boring things from the textbooks and to train to do better than others.
It is funny that the appetite for scientific knowledge is not based on the love of science or truth itself, but rather on the practical need to achieve better grades and beat others in grades. No matter what the original motivation though, once the kids were repeatedly told to pay attention to nerdy things, they will do so for the rest of the lives. No only that, they will respect whoever can do the innovations that they cannot, and will follow them up in life.