Monday, March 4, 2013

Middle-income claptrap

Economic backwardness has its advantages. Latecomers to industrialization can follow the path their forerunners broke before them and perhaps skip some steps along the way. As a result, poor countries can narrow the gap with rich ones. But this happy principle of economic convergence does not always hold sway. Some poor countries fail to get going. Others make quick progress, and then lose their way. The first lot is sometimes described as victims of a “poverty trap”. The second are increasingly described as casualties of a “middle-income trap”.

But is the middle-income trap worthy of the name? Is there something especially treacherous about the levels of development that China is now approaching? Despite the term’s popularity, the theory and evidence behind it are surprisingly thin.

First, the theory. Rich countries boast the best technologies; poor countries the lowest wages. Middle-income countries have neither. Intuition suggests they must struggle to compete with countries above and below them. Poor countries also benefit from moving workers out of over manned farms and into factories, where they are many times more productive. But a decade or two of fast growth will empty the fields of surplus workers, obliging countries to raise productivity within their factories if they are to make further progress. Their economies would seem to face a tricky jump from one growth model to another.

But intuition can mislead. Both pay and productivity exist along a continuum. Countries can remain “competitive” at any level of wages and productivity, provided one stays in line with the other. The evolution from one growth model to another is also continuous. Factories do not wait until the last underemployed laborer has left the farm to begin improving the productivity of the workers who have already arrived. Moreover, as the urban workforce grows in size, a steady flow of new arrivals from the villages makes a smaller proportionate impact.

So much for the theory, what about the evidence? The middle-income trap is rarely defined clearly enough to be tested. Some of its proponents argue that middle-income countries typically grow more slowly than richer and poorer economies. That is claptrap. If anything, they grow faster. The left-hand chart uses the Penn World Tables, which compare incomes across countries and over time from 1950 to 2010. Economies with an income per head of $13,000-14,000 (at purchasing-power parity) achieved per-person growth of almost 2.9% over the next ten years on average. That is faster than the average for any other income level. The Economist

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