INDIVIDUAL SHORT PAPERMIDLLE INCOME TRAP AND COMPETITIVENESS OF NATIONS

________________________________________________________________________

1. IntroductionThis topic is related to the competitiveness of the manufacturing sector in economies that receive a large amount of Foreign Direct Investment (FDI) and have formed a sufficiently large base for producing and exporting manufactured products among the middle-income countries. The challenges analysed here are quite different from and pertinent to a much higher development level than those faced by typical low income countries in Sub-Saharan Africa and other regions, where enticing investors to form an initial industrial base is the main policy objective. East Asias middle income economies, with an aspiration to join the ranks of highly advanced countries, must overcome the barriers that keep them in the middle stage of development.In aggregate, middle-income countries have shown robust growth and made progress in development, although performance varies among them. If history is a reference, countries in this group are vulnerable to being caught in a so-called middle-income trap, where they lose competitiveness compared to low-income countries but lack the technological edge to catch up with high-income countries. The challenge is to redesign development strategies for them with a focus on innovative, sustainable and inclusive growth, gradually shifting to higher value added sectors. Competitiveness depends on the difference between the two, not on the absolute wage level. Wage increase should be a boon to workers, and there is no reason to fear it as long as productivity is improving in tandem.The challenge is to redesign development strategies for them with a focus on innovative, sustainable and inclusive growth, gradually shifting to higher value added sectors. The United Nations system is playing an important role in assisting middle-income countries in their economic and social development, as is indicated by both the replies of Governments to a survey and the reports on specific programmes and initiatives implemented by United Nations agencies.

The fact that developing countries must acquire skill and technology, rather than just offering factory space and cheap labour, can be stated in various ways. Four such arguments are presented below. It can be argued that the only way for a country to remain competitive is to improve labour productivity faster than wage increase. Since the 1950s, rapid growth has allowed a significant number of countries to reach middle-income status; yet, very few have made the additional leap needed to become high-income economies. Rather, many developing countries have become caught in what has been called a middle-income trap, characterized by a sharp deceleration in growth and in the pace of productivity increases. Drawing on the findings of a recently released working paper (Agnor and Canuto 2012), as well as a growing body of research on growth slowdowns, this note provides an analytical characterization of middle-income traps as stable, low-growth economic equilibria where talent is misallocated and innovation stagnates.

2. Literature ReviewEconomic history has shown that few countries that have achieved middle-income status continue to converge to the level of high-income countries. As the policy, institutional, and structural environment evolves, prior strategies and competencies no longer remain effective at generating an equivalent rate of growth. Indeed, strategies based on factor accumulation are likely to deteriorate as the marginal productivity of capital declines, and rising wages will reduce the international competitiveness of many labor-intensive industries. Thus, the new constraints on the economy become more complex as domestic industries rely less on investment and more on innovation. As this process develops, experience has shown that middle-income countries can become trapped no longer able to effectively compete with low-wage competitors in poor countries and still lacking the innovative capabilities to rival high-income economies. As argued in a recent 2007 report by the World Bank, the middle-income trap has become a palpable challenge for several countries in East Asia in particular. The middle-income country trap is a development stage that characterizes countries that are squeezed between being low-wage producers and highly-skilled, fast-moving innovators. Countries caught in this trap tend to grow slower and often fall behind. Cost advantages in labor intensive sectors, such as the manufactured exports which once drove growth, start to decline in comparison with lower-wage poor country producers (Gill I and Kharas H, 2007). At the same time, they do not have the institutions, capital markets, track record, or critical mass of highly-skilled people to grow through major innovations like rich countries. Caught between these two groups, many are without a viable high-growth strategy. In addition, they are faced with new challenges including distribution and social cohesion issues. Therefore, they are hard-pressed to develop new growth drivers (Nungsari and Zeufack, 2009).

Productivity slowdown has been a sound characterization of middle-income traps. Over time in a countrys development process, there emerges diminishing marginal returns to cheap labor and technology imitation; this could be offset if government act early to move from an imitation based economy to innovation based production cycle (see Agnor, P-R and O Canuto 2012). The East Asian experience has illustrated that such policies are central to fostering technological learning, attracting talented individuals into research and development activities, and encouraging the build-up of national and international knowledge networks. Recently, the broader debate over China's innovative prowess and potential development path has intensified. Some observers regard Chinese firms ability to stay close to the world technology frontier and to improve upon and adapt existing innovation as key to the countrys continued growth (Breznitz and Murphree 2011) where the globalization of services is increasingly an important components of Chinas growth (see Roach, Stephen 2013).Only one (South Korea) of the seven countries which were middle-income by 1975 managed to reach high-income status by 2005.

Brazil and South Africa, which had double the per-capita income of South Korea in 1975, have remained at the same level since then. It faced periods of negative growth, which cancelled all earlier progress.

Evidence of the middle-income trap can also be found in the dynamics of occupations and wages across countries. The integration of the worlds labor markets creates big gains for rich and poor countries alike. For example, blueprints of products flow from California to China, while manufacturing goods flow in the opposite direction (see Kharas et at, 2010). The middle-income countries benefit less from globalization (Eeckhout and Jovanovic, 2007). They are not technologically-savvy enough to compete with rich countries and are not cheap enough to compete with China, Vietnam and other dynamic low-income countries. Thanks to communications and transportation technologies, managers, engineers and designers larger in number in rich countries have access to a pool of cheap labor in poor countries. This makes them more productive as they can produce more with the same resources. The higher wages that accrue to high-skilled individuals represent the gains to rich countries of an integrated global labor market.

Poor countries also gain. They produce better and more, thanks to the technology, design and managerial skills brought in from rich countries. The wages of their unskilled rise and this represents their gains from globalization. However, middle-income countries (lower middle-income to upper middle-income) gain almost nothing from globalization as they are likely to experience the smallest change in factor-price ratio or no significant change in the ratio of skilled to unskilled wages (Udomsaph and Zeufack, 2009). Escaping the middle-income country trap is an uphill battle. The move from being a middle-income country (MIC) to being a high-income country (HIC) requires a break from the past in some significant structural shift. Apart from policies that no longer work to elevate them to a high-income economy, many trapped MICs tend to make two common mistakes: either they cling on too long to past successful policies or they exit prematurely from the industries that could have served as the basis for their specialization process (The Growth Report, 2008). Timing is key. Most MICs fail to anticipate the transition and the new demands that come with it. For example, most MICs hold on to a labour-intensive strategy for too long. They artificially maintain noncompetitive firms through a battery of subsidies, continuing to pile up fiscal incentives with no consideration of the take-up rate or efficiency, and continue to make FDI volumes the key performance indicator for competitiveness (Nungsari and Zeufack, 2009).

The second common mistake is a premature shift away from assembly manufacturing before ensuring an adequate supply of high-quality and competitive human capital to support the transition to higher value-added sectors.

3. Middle-Income Traps Past and Present In the postwar era, many countries have managed to fairly rapidly reach middle-income status, but few have gone on to become high-income economies. Rather, after an initial period of rapid ascent, many countries have experienced a sharp slowdown in growth and productivity, falling into what has been called a middle-income trap. To be sure, the World Bank (2012) estimates that of 101 middle-income economies in 1960, only 13 became high-income by 2008Equatorial Guinea, Greece, Hong Kong SAR (China), Ireland, Israel, Japan, Mauritius, Portugal, Puerto Rico, the Republic of Korea, Singapore, Spain, and Taiwan, China (figure 1).

By contrast, although many countries in Latin America and the Middle East reached middle-income status as early as the 1960s and 1970s, a great majority of them have remained there ever since. In Latin America, for instance, income per capita relative to the United States fell almost continuously from 1960 to 2005, especially after the debt crises of the early 1980s. Likewise, economic growth in many Middle Eastern and North African countries has waned and given way to high unemployment, as evidenced most recently by the social and political upheavals that took place during the Arab Spring of 2011.

4. Becoming stuck in the Middle

Formal evidence on growth slowdown and middle-income traps has suggested that at per capita incomes of about US$16,700 in 2005 constant international prices, the growth rate of per capita gross domestic product (GDP) typically slows from 5.6 to 2.1 percent, or by an average of 3.5 percentage points. Using regression and standard growth accounting techniques, this analysis (Eichengreen, Park, and Shin 2011) argues that growth slowdowns are essentially productivity growth slowdowns, whereby 85 percent of the slowdown in the rate of output growth can be explained by a slowdown in the rate of total factor productivity growthmuch more than by any slowdown in physical capital accumulation. Therefore, middle-income traps are not simply the natural implication of decreasing marginal returns to investment in physical capital, as a simple neoclassical growth model would suggest. A common explanation of growth slowdowns is based on a Lewis-type development process (Canuto 2011; Eichengreen, Park, and Shin 2011; and World Bank 2012). In that perspective, factors and advantages that generate high growth during an initial phase of rapid development disappear when middle and upper-middle-income levels are reached, thereby requiring new sources of growth to maintain sustained increases in per capita income.

During an initial phase of development, low-income countries can compete in international markets by producing labor-intensive, low-cost products using technologies imported from abroad. These countries can achieve large productivity gains initially through a reallocation of labor from the low-productivity agricultural sectors to high-productivity manufacturing sectors or to modern services. However, once these countries reach middle-income levels, the pool of underemployed rural workers drains and wages begin to rise, thereby eroding competitiveness. Productivity growth from sectorial reallocation and technology catch-up are eventually exhausted, while rising wages make labor-intensive exports less competitive on world markets precisely at the time when other low-income countries become engaged in a phase of rapid growth. Accordingly, growth slowdowns coincide with the point in the growth process where it is no longer possible to boost productivity by shifting additional workers from agriculture to industry and where the gains from importing foreign technology diminish significantly (figure 2).Figure 2 : Becoming Stuck in the Middle-Income Trap

5. Avoiding the Middle-Income Trap and Moving Up the Income Ladder Building on the model described above, there are a number of public policies that developing countries can employ to avoid or escape from middle-income growth traps. Such measures include developing advanced infrastructure in the form of high-speed communications networks, improving the enforcement of property rights through patent protections, and reforming labor markets to ensure that rigidities do not prevent the efficient firing and hiring of employees. Fundamentally, these policies attract more high-ability workers into the design sector; improve productivity and wages in that sector, and increase a countrys capacity for innovation.

6. Middle Income Traps and the Asian Experience

Only 13 countries were able to transition from middle- to high-income status since the 1960s. Of these countries, five were from East AsiaHong Kong SAR (China), Japan, Korea, Taiwan, China, and Singapore four of which comprise the so called Asian Tigers of the late 20th century. Given their success, it is instructive to reflect on their experience to draw lessons for other middle-income countries seeking to move into high-income status. Interestingly, many of the public policies highlighted above as well as a larger framework for innovation based on technological learning and public sector support of R&D investments can be extrapolated from the East Asian success story. The best practices of these countries are particularly valuable for high growth emerging markets, such as China and other large middle-income countries, which are already showing signs of slowing.

The East Asian economies that were able to escape the middle-income trap, all have succeeded in developing advanced infrastructure networks, particularly in the form of high-speed communications and broadband technology. Due equally to the liberalization of telecommunications networks and related regulatory framework reforms, a number of countries in the region have been able to develop and enhance the availability of information and communications services (Gill and Kharas 2007). To be sure, previous research on regional competitiveness underscores the importance of broadband telecommunications technologies and interactive multimedia. For countries with large export-oriented information equipment industries, such as Japan, Korea, and Taiwan, China, a drive to enhance international competitiveness perpetuated the development of broadband and multimedia industries in domestic markets. Likewise, other economies in the region that were able to escape the middle-income trap, such as Singapore and Hong Kong (China), developed their advanced infrastructure networks to enhance their role as regional headquarters for major foreign multimedia companies (Langdale 1997).7. How to Avoid the Middle-Income Growth Trap To avoid the Middle-Income Trap, it is critical for a country to sustain high rates of economic growth. This task is complicated by the fact that the transformation of Asian economies from rural to urban-based is expected to take place within 50 years, while this transformation took over 100 years in advanced economies (see Aizenman et al. 2012). The economic transitions are occurring much more rapidly than those in the past (see Felipe, 2012). Recent evidence also finds that Malaysia, the Philippines and China will face a larger risk of growth slowdown stemming from institutions; while Vietnam, India, and Indonesia are most at risk of a slowdown arising from a lack of transport and communications infrastructure (see Aiyer et al. 2013). Previous studies of growth slowdowns in fast-growing middle-income countries identify two modes of slowdowns: one in the $10,000-$11,000 range and another at $15,000 - $16,000 (see Eichengreen et al. 2012 and 2013). A growth slowdown is less likely to occur in countries with more diversified economic production accompanied by a skilled population set and high-technology production to avoid the middle-income trap (see Aiyer et al. 2013 and Eichengreen et al. 2013).

The continued advancement of emerging markets will influence the future global competitive landscape in a number of ways. First, domestic markets in emerging economies will assume far greater significance. As a result of rapid growth, developing Asias middle-class population more than tripled from 565 million to 1.9 billion from 1990 to to 2008 (ADB 2010). Second, the steady rise of intra-regional trade is likely to further grow in prominence (Ernst & Young 2013, ADB 2009) with higher anticipated flows of people, goods, services, and technologies. Third, corporations in emerging economies are gaining ground in global markets while also developing new products and services tailored to the needs of developing country customers.Competitiveness is no longer associated only with exchange rates, industrial policies, labor costs, and natural resource endowments. Today, it also includes workforce skills, management of how skills are used and governments ability to formulate and implement education, training, and skills-based policies.Developing Asia therefore needs a robust and market driven skills development system that contributes to competitiveness. Talent and skills are crucial to competitiveness of industries.

Another important indicator is the Global Competitiveness Index (GCI). According to World Economic Forum, which releases the annual global competitiveness report, in its 2013-2014 publication the competitiveness of 148 economies were evaluated providing insights into the main drivers of productivity and prosperity across the world.

8. What Should Policy Makers Do?Policymakers should promote entrepreneurship and innovation to begin reaping the benefits of information networks and skilled labor before the gains from cheap labor and knowledge spillovers are exhausted. Rapidly expanding the secondary and then tertiary education system will be critical in producing graduates with the skills that employers require.

Highly skilled workers and professionals are an indispensable ingredient of high valued added, modern services and manufacturing. The skills crisis is a well-known shortcoming of the middle-income economy. The response "Not enough good people" is a common complaint among business owners in those countries. Attracting highly productive foreign firms to locate production in developing countries is another area that policymakers should devote their focus. Apart from the direct benefits of high wages, imported capital equipment, and substantial tax revenues, the spillovers between these firms and the broader economy are well-documented. The current degree of restrictions

on foreign-owned firms particularly in the services sector might be hindering the potential for FDI to stimulate further growth.

Developing the services sector holds the greatest promise for high impact reform. In particular, providing access to learning and training opportunities to build social entrepreneurs and product innovations will be crucial. The promise of service globalization means that middle-income countries should utilize the market space provided by the Internet to foster business and technological innovations for the global economy. In this respect, the interaction of spatial transformations will be paramount.

The range of modern services that can be digitized and traded globally is constantly expanding. India has been a pioneer, but many other emerging markets are finding it easier to generate productivity growth in services than in industry. This does not happen automatically.

Although the same set of general non-distortionary policies is as important for modern services as for goods, specific strategies for services matter like market integration and the technological changes in information networks. Services expansion provides an alternative growth escalator for emerging markets like Malaysia. The globalization of service has just begun. The modernization of services is a promising way out of the middle-income trap.

9. Conclusion

Talent and skills are crucial to competitiveness of industries. Skills development serving clusters of different but interrelated industries can increase efficiency and sectorial competitiveness. Skills credentials developed and endorsed by industry are crucial for successful transition from school to work.

The rise of technology in manufacturing requires gray collar or knowledge workers for higher value-added product that enable economies to avoid the middle-income trap. Advanced skills are indispensable fora high-productivity economy while medium-skills workers are keys for growth of labor-intensive sectors. Developing skills for the service sector is important for Asia to improve competitiveness in knowledge-intensive services such as financial intermediation computer and information services, legal and technical support, and business services.

The features of East Asias experience in transitioning from middle-to-high-income status provide important lessons for other countries that are attempting to follow suit. The middle-income trap is not an unavoidable outcome; it can be avoided if governments act early rather than late, when the benefits of cheap labor and the gains from imitating foreign technology are all exhausted and decisively to promote innovation. Doing so requires timely implementation of public policies aimed at improving access to advanced infrastructure, enhancing the protection of property rights, and reforming labor markets. These policies are central to fostering technological learning, attracting talented individuals into R&D activities, and encouraging the buildup of national and international knowledge networks. REFERENCES

Asian Development Bank (ADB). 2009. Key Indicators for Asia and the Pacific 2009. Manila.International Monetary Fund (IMF). 2010. World Economic Outlook Database. Available: http://www.imf.org/external/pubs/ft/weo/2010/02/weodata/index.aspxSuggested Citation Jagannathan, S., & Geronimo, D. (2013). Skills for competitiveness, jobs, and employability in developing Asia-Pacifc. Manila: Asian Development Bank.World Bank. 2013. World Development Report: Jobs. Available: http://siteresources.worldbank.org/EXTNWDR2013/Resources/8258024-1320950747192/8260293-1322665883147/WDR_2013_Report.pdf11