How to prioritize policies to overcome the “middle-income trap”
Historically, the Global Competitiveness Index (GCI) has pointed toward one major way to prioritize policy reforms: dividing the Index into three subindexes (basic requirements, efficiency enhancers, and innovation and sophistication factors) while also classifying countries into three groups according to per capita income. For lower-income countries, a higher weight is given to basic requirements; for the middle-income group, the priority is efficiency enhancers; for higher-income countries, the focus is on improving innovation and sophistication.
However, as the World Economic Forum revises the Global Competitiveness Index, other ways to contribute to the debate about policy prioritization to boost inclusive growth in emerging and developing markets and industrialized countries alike are being looked at—a debate that is especially urgent as the Fourth Industrial Revolution disrupts patterns of development and opens new paths to development. Following a session at the World Economic Forum on Latin America 2016, the Forum and the OECD Development Centre are exploring new methodologies to identify policy priorities in the region by combining GCI data with recent OECD Development Centre research.
For Latin America, an especially challenging scenario is the “middle-income trap”: it is common for countries to grow rapidly in their early stages of development, only to stagnate when they approach middle levels of per capita income. Different sources of growth become more important at this stage, and countries can struggle to prioritize the right policies to make the necessary adjustments.1 In the region, only Argentina, Chile, and Uruguay have overcome the middle-income trap or are close to doing so.2 Several other Latin American countries were already in the middle-income range as early as 1950, but these countries have not advanced beyond that range, and the region’s average per capita income growth has remained weak in comparison to the OECD average (see Figure 1).
Whether a country falls into or escapes from the middle-income trap depends on a range of many variables, from its general economic and legal environment and macroeconomic stability to integration and the effectiveness of productive development policies. The OECD Development Centre conducted empirical research to shed light on the most important policy areas, statistically analyzing the experiences of emerging economies and the OECD countries that have graduated to higher-income status since 1985. The Centre defines middle-income as between US$2,000 and US$11,750, measured in 1990 constant levels and adjusted for PPP, as in Felipe et al. (2012). Using fixed thresholds at constant PPP prices allows us to compare the current characteristics of middle-income Latin American economies to those of countries at the time they graduated to high-income status: Israel (1986), Singapore (1988), Ireland (1990), Spain (1990), the Republic of Korea (1995), Portugal (1996), Greece (2000), Chile (2005), Kuwait (2005), Qatar (2005), Uruguay (2012), Malaysia (2014), and Poland (2014).
The Centre uses linear discriminant analysis to find the linear combination of institutional and economic features—covering institutions, the structure of production, demographic variables, and macroeconomic indicators—that characterize countries that did and did not evade the middle-income trap.3
Preliminary results show that the variables that best separate these sets of countries are the rule of law, the index of productive capabilities, and investment. These policy areas seem to exhibit robust results, because most countries are correctly ascribed to their particular income category based on a larger group of growth determinants, not exclusively on per capita income.
The analysis also points to differing policy priorities for economies in Latin America and the Caribbean. For instance, Chile lags behind in terms of productive capabilities and the size of the manufacturing sector; in Mexico, improvements to the rule of law are highlighted; in Colombia and Peru, the challenges are linked to productive capabilities, the size of the manufacturing sector, public revenues, and the rule of law. The Forum and the OECD Development Centre are collaborating to extend this research by including new variables, broadening the country sample, and testing novel empirical methodologies.
Contributed by Angel Melguizo and Sebastian Nieto, OECD Development Centre. We would like to acknowledge the contributions of José Ramon Perea, formerly with the OECD Development Centre and now at the World Bank, and member of the research team.