Enhancing Structural Reform to Escape from Middle Income Trap

Wayne Chen

          Proposed by China the host economy of APEC 2014, avoiding the Middle Income Trap (MIT) was adopted as one very important issue requiring all APEC economies' attention and action. As illustrated by China at the first Senior Official Meeting that escaping from MIT is crucial to boost economic growth in the Asia-Pacific and initiating structural reform is the inevitable course. In this light, the APEC New Strategy for Structural Reform (ANSSR) can serve well as guidelines to assist APEC economies move forward the development ladder and meanwhile facilitate sharing of best practices and ideas on conquering the MIT. As a result, MIT and ANSSR are highlighted in the agenda of "Promoting Innovative Development, Economic Reform and Growth", a priority area for the APEC 2014.

MIT as a Trap on the Development Ladder

          According to the World Bank, economies with per capita income of US$1,036- US$12,615 are considered in a middle-income status, and MIT refers to the situation in which a middle-income economy fails to leap into high-income status. Aiyar et al. (2013) argue that middle-income economies are disproportionately likely to suffer from growth slowdowns. The relative frequency of economic slowdown period for the middle-income status is significantly higher than the low-income and high-income groups. As a result, only 13 of 101 middle-income economies in 1960s escaped from MIT and entered high-income phase by 2008. In the Asia-Pacific region, 5 economies completed the leap from the middle to the high income stage of the development ladder, namely Japan, Korea, Taiwan, Hong Kong, and Singapore.

          Yiping Huang argues that MIT is a critical issue for APEC where a large number of developing economies fails to overcome MIT and thus undermines social equity and efforts on trade and investment facilitation. On the other hand, MIT also appears as an opportunity to APEC. Firstly, considering APEC member economies are diverse in terms of development ranging from under development to high income status and 5 of them have escaped from MIT. APEC is in a unique position to assist economies transcend the obstacle of development by improving exchange of views and best practice sharing. Furthermore, given that structural reform is a fundamental work in conquering MIT, particularly on industrial structure and manufacturing patterns, ANSSR can contribute substantially to individual economies as well as the Asia-Pacific region as a whole.

Determinants of MIT

          Empirical research demonstrates at least 6 important factors lead to growth slowdown, they are institutions, demography, infrastructure, economic environment and policies, economic structure, and trade structure.

          The existing, completeness and quality of legal institution is essential to attracting FDI and financial liberalization for domestic entrepreneurs. Protection of property rights and contract enforcement, for example, is the foundation to boost economic performance. Age distribution of the population is another factor correlates to economic slowdown, in particular, the demographic dividend. A positive impact of the working age ratio was found on economic growth. The correlation comes from higher production of people of working age compared to labor outside this age group as well as higher saving rates increase domestic resources available for productive investment. Skilled labors are needed and should be cultivated through quality education systems, more importantly the avocational education, and training to continuous support industrial transformation and meet the need of changing manufacturing patterns.

          A wide range of macroeconomic factors are also related to economic growth and slowdown. Encouraging domestic investment, e.g. through mobilizing local savings, is crucial to economic growth considering cross-border capital inflows may be more volatile. Competition policy is considered important to enhance openness and transparency of local market and protection to foreign investors and thus greatly benefits long-term growth and reduces economic shocks. The economic structure refers to formal employment and output in sectors. The World Bank's World Development Indicators demonstrate that employment, output and add-in value expand in the industrial sector while the agricultural sector shrink along the way of economic development. However, this structural change also creates risk of slowdown. For MIT economies, production activities need to transform from exporting natural resources and essential goods to higher add-in value and capital/knowledge intensive industries. Similarly, MIT economies also face further distance and regional integration and are required to learn to deal with external shocks, e.g. economic crisis, in the regional and global sphere.

Structural Reform as a Solution

          The factors illustrated above create needs and challenges facing economies reached middle income status in moving forward to higher grade to which ANSSR aims to contribute. The main objective of ANSSR is to improve openness and transparency of policy environment which is essential to introduce FDI and partners to local business. Given that there is no one size for all remedy for MIT problem, ANSSR serves an open platform upon which APEC economies of a wide range of development are encouraged to exchange experience and best practice for regional prosperity.

          Moreover, APEC growth strategy also plays an indispensable role which illustrates economics need to purse innovative and inclusive growth which is aligned with industrial structural reform of MIT economies. However, at present ANSSR is more focused on policy environment and the connection with growth strategy need to be further forged to contribute to the MIT task in an effective manner.

References

1. Aiyar S., Duval R., Puy D., Wu Yiqun, and Zhang L., 2013, Growth Slowdowns and the Middle-Income Trap , IMF.

2. Huang Y., 2014, the Middle-Income Trap: Policy Implications for the APEC Economies , 2014/SOM2/EC/DIA/002, APEC Policy Dialogue on Middle Income Trap, 10 May, Qingdao, China.