Income Traps: It’s All About Convergence

A couple of recent papers have come out on “middle income traps”. First up from the World Bank (abstract):

Transitioning from low-income growth to high-income growth : is there a middle income trap?

Is there a "middle income trap"? Theory suggests that the determinants of growth at low and high income levels may be different. If countries struggle to transition from growth strategies that are effective at low income levels to growth strategies that are effective at high income levels, they may stagnate at some middle income level; this phenomenon can be thought of as a "middle income trap." This paper does not find evidence for (unusual) stagnation at any particular middle income level. However, it does find evidence that the determinants of growth at low and high income levels differ. These findings suggest a mixed conclusion: middle-income countries may need to change growth strategies to transition smoothly to high-income growth strategies, but this can be done smoothly and does not imply the existence of a middle income trap.

Translation: No, there’s no such thing as a middle income trap.

Somebody FINALLY Writes A Decent Paper On The Middle Income Trap

I’ve been meaning to cover this since it landed in my inbox last week, but hadn’t found the time. But this new IMF working paper gets a big thumbs up from me (abstract):

Growth Slowdowns and the Middle-Income Trap
Aiyar, Shekhar and Duval, Romain; Puy, Damien; Wu, Yiqun & Zhang, Longmei

Summary: 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 this study we examine the middle-income trap as a special case of growth slowdowns, which are identified as large sudden and sustained deviations from the growth path predicted by a basic conditional convergence framework. We then examine their determinants by means of probit regressions, looking into the role of institutions, demography, infrastructure, the macroeconomic environment, output structure and trade structure. Two variants of Bayesian Model Averaging are used as robustness checks. The results—including some that indeed speak to the special status of middle-income countries—are then used to derive policy implications, with a particular focus on Asian economies.

The Myth of Malaysia’s Middle Income Trap

It’s a stylised fact and almost universally accepted that Malaysia is caught in a middle income trap. But a funny thing happened when I went looking for the evidence – it’ incredibly hard to find. And thinking about the issue made me more convinced that the whole idea is about as real as Hogwarts.

Taken at face value was does the term mean? Simply that a middle-income country stays a middle income country, and doesn’t make the leap into high income status. There’s also the notion of a poverty trap for countries; that low-income countries are unable or unwilling to make the necessary structural changes to achieve a growth “take-off” and start on the long road of development.

Debating the ETP

Last night there was a debate hosted by the LSE Alumni Association, on the key challenges for the Economic Transformation Program (ETP). Moderated by Tan Sri Dr Munir Majid, the panel speakers were YB Tony Pua (MP for PJ Utara), Tan Sri Dr Ramon Navaratnam (former senior civil servant and noted economist), and Datuk Ahmad Zaki  Zaid, (Executive Director of MRCB). Also present were representatives of PEMANDU, the organisation tasked with leading the implementation of the ETP.

As you can imagine, there was a lot of scepticism regarding the ETP and Malaysia’s achievement of high income status by 2020. Questions and comments from the floor were pretty numerous and I think out of the norm for a Malaysian audience – perhaps a reflection of the participants.

The NEM In Numbers: Nominal Versus Real

I’ve been meaning to cover this issue for some time now, but haven’t had the time. It’s very late to be talking about this, but I suppose better late than never.

One of the things that has been bothering me about the New Economic Model is that the public discourse revolves around trying to reach over 6% real growth. That’s largely false, or to be more precise, largely misleading.

Cheap Labour and Capital Outflows

In the Star today:

"Malaysia, the world’s No. 2 palm oil producer, will miss its output target of 18.1 million tonnes because of a shortage of foreign labour even as yields recover, according to a top industry official.

Industry regulator Malaysian Palm Oil Board (MPOB) chairman Sabri Ahmad said yesterday Indonesian plantation workers made better pay at home as more palm oil estates started up there while employers in Malaysia had trouble hiring because of a stricter work-permit process."

I find this more than a little ironic. No doubt this will raise the hackles of those who think the reliance on cheap foreign labour is holding back Malaysia from progressing. What makes the irony even richer is the fact that these low-wage workers can now earn more in their own native country – Malaysia is even losing out to less-developed Indonesia in terms of labour earnings.

Be that as it may, what tickled my funny bone was this: as late as 2007-2008 (IIRC), Malaysia was the world’s largest producer of crude palm oil, but we’ve now been overtaken by Indonesia. Here’s the rub – Indonesia’s rapid development as a crude palm oil producer has been fully supported by Malaysian companies using Malaysian capital. Most of our biggest palm oil producers have a significant presence in Indonesia, with up to 50% of their total production coming from there.

So our cheap foreign labour “shortage” in estates is being indirectly caused by the very same companies who are complaining about it. Funny how the world works, innit?

The Middle Income Trap

Dr Fong Chan Onn has a long article in today's Star on why Malaysia is in a middle income trap, and some of the things we can do to get out of it.While I have my doubts about some of his reasoning - lower inflation results in lower wages? really? it's not about demand and supply?- the article forms a good preface of the new economic model that the government will announce this month. Worth the investment of time to read.

His proposals:

1. Phase out price controls and subsidies
2. Institute a high wage policy
3. Innovative incentives for high tech activities
4. IT infrastructure and public R&D centres
5. Leverage on Malaysian professionals and experts overseas
6. Emphasize our strategic location
7. Promote green energy
8. Promote medical care and pharmaceutical trials
9. Go downstream in oil & gas

Mostly policies I would agree with, and much what I would expect from the government in due course. I do have a couple of criticisms of his analysis though, of the use in the article of comparing Malaysia against the UK, Singapore, and Hong Kong.

First the wage comparisons are of policemen, teachers, accountants and clerks across the four countries. Note that these are all service occupations i.e. in the non-tradable sector. A comparison here would only be valid if all four countries had a single labour market, where demand and supply would equate the level of remuneration. Since they're not, wages will not necessarily be equalized even assuming the same development policies were pursued. Dr Fong relates that foreign multinationals are willing to leave if foreign (i.e. low wage) workers were restricted from working in Malaysia - this is in the tradable sector, where the labour market is more exposed to international competition. He misses the distinction between the two sectors, as well as the policy implications.

My second critique is one of omission. I think there's a simpler explanation of why Malaysia is in a middle income trap, while the rest of our regional peers have progressed more rapidly. There's a fundamental factor that many commentators appear to have missed in discussing Malaysia's middle income conundrum, and that's the demographic profile of the country.

Here's the median age and dependency ratios of Malaysia against the Asian tigers (all figures are 2009 estimates):

	Malaysia	Singapore	South Korea	Hong Kong	Taiwan
Median Age	24.9	39.0	37.3	42.3	36.5
Dependency Ratio	57.2%	30.4%	38.2%	34.0%	37.7%

Do you think maybe, just maybe, that our population characteristics might have something to do with this? Stay tuned, I'll have much, much more to say on this subject.

Technical Notes
1. Caught in middle-income trap By Dr FONG CHAN ONN; The Star Online February 7, 2010.
2. Population data estimates from the US Census Bureau's International Database.