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The Middle-Income Country Trap: definition, indicators, challenges
Annette O. Pelkmans-Balaoing & Rob van Tulder
29 April 2013
Summary
The so-called Middle-Income Country Trap (MICT) has lately been a much-discussed theme in both
academic literature and popular media, especially in East Asia. After decades of rapid growth, a
number of middle-income countries have been experiencing wage increases, thereby compromising
their competitiveness in the high-volume, low value-added segment of manufacturing exports.
However, transitioning into the niche of technology and innovation-based products and services is
hindered by insufficient skills and entrepreneurship needed to aggressively open up new markets.
This is the middle-income country trap as the World Bank defines it: countries being squeezed out by
the low-wage economies in mature industries on one side, and by the more technologically advanced
countries specializing on innovation-intensive sectors on the other.
The problem of MICT is not new, as the World Bank has earlier used it to analyze the stagnation of
some Latin America and Middle East countries after a period of relatively high growth. What is new is
the manner in which the MICT is being depicted as a competitiveness problem instead of a purely
income trap. Needless to say, these are two sides of the same coin, certainly in today's context.
However, the countries that have recently expressed some apprehension about this phenomenon are
precisely those with robust growth such as Malaysia, China, Vietnam, Thailand, Indonesia, India,
South Africa, Turkey, etc., and could therefore be hardly typified as being at risk of landing in a trap.
Still, the dependence on exports as driver of rapid growth, together with the perceived difficulties in
carving out a strong global market niche for higher value-added exports, create doubts as to whether
these countries could replicate the kind of growth surge that catapulted countries like South Korea to
a high income status.
For lower middle-income countries experiencing modest growth, there are considerable catch-up still
to be realized by simply improving governance and increasing infrastructure spending critical to
raising productivity. However, the same competitiveness squeeze attributed to MICT is palpable in
cheap-labour-dependent sectors such as electronics and textiles & clothing, which are major
contributors to the export earnings of these countries. Thus, the MICT phenomenon could potentially
encompass a large part of the developing world, prompting the World Bank (2010) and the Asian
Development Bank (2011) to draw greater attention to this growth ailment.
Who are in the middle-income country trap?
In an extensive World Bank (WB) analysis of the growth prospects of East Asia, Gill & Kharas (2007)
refer to the middle-income trap as the inability of countries to transition towards greater
specialization in knowledge-intensive sectors, naming China, Indonesia, Malaysia, Philippines and
Thailand as being the more vulnerable countries. However, the evidence has been rather anecdotal,
with both the WB and ADB using the apparent stagnation of middle-income countries, and the rarity
of an “escape” as evidence of the existence of a trap. Figure 1 is a typical illustration of the crowded
middle, while Figure 2 refers to recent World Bank (2012) estimates showing that only 13 countries
out of 101 countries classified as middle income in 1960 were able to transition to high-income by
20081.
1 Equatorial Guinea, Greece, Hong Kong SAR (China), Ireland, Israel, Japan, Mauritius, Portugal, Puerto Rico, the
Republic of Korea, Singapore, Spain, and Taiwan, China.
Figure 1 The Crowded Middle, GNI per capita 1962 – 2010
Source: World Bank Development Indicators, various years.
Figure 2 Per capita incomes relative to the US, 1960 & 1980
Source, World Bank, 2012
Still, the question remains as to what income stagnation operationally means. A recent ADB study by
Felipe (2012) analyzes historical income transitions from 1950 till 2010 and estimates the threshold
number of years for a country to be in a middle-income trap, or the average number of years that
countries register as lower and upper middle-income before graduating to higher income status. He
finds that lower middle-income (LM) countries must grow at least 4,7% annually per capita, within a
period of maximum 28 years to avoid falling into a lower MICT, while for upper middle income (UM)
countries, the target is 3.5% per capita growth rate within a 14-year period. Table 1 shows the status
of selected East Asian countries, with the Philippines and Malaysia falling under the lower and upper
MICT, respectively, and the rest facing possible risks of being in the MICT.
That some structural forces are at play can be gleaned from the paucity of transitions to higher
income levels. Only 9 countries that were classified as LM in 1950, managed to reach UM status by
2010, and from those who were UM in 1950, only 4 graduated into high-income status since 1980
(Korea, 1988; Taipei, 1986; Chile, 1992; Mauritius, 1991).
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Paradoxically, the ease with which some countries crossed over from LM into UM could lead some to
think that the MICT problem is largely a question of (domestic) structural transformation. With good
governance, LM countries that are far from the technology frontier and endowed by abundant labour
could reap significant productivity dividends from sectoral allocation and technology catch-up largely
from foreign machinery imports. Felipe therefore expects Malaysia to escape the upper MICT soon,
and sees China and Thailand avoiding it altogether.
Table 1 MICT Status for Selected East Asian Countries
Philippines
Malaysia
Cambodia
Indonesia
Myanmar
Vietnam
China
Thailand
MICT status
LM trap
UM trap
LM risk
LM risk
LM risk
LM risk
UM risk (?)
UM risk
2010 per
capita GDP Years as LM
3,054
34
10,567
27
2,529
6
4,790
25
3,301
7
3,262
9
8,019
17
9,143
28
Years as
UM
15
2
7
Ave growth
2.5
2.6
8.2
3.9
9.0
6.1
8.9
3.6
Source: As compiled from Felipe (2012).
It is interesting to note, however, that the countries most concerned about the MICT are precisely the
fast-growing countries such as China, Turkey, Malaysia and Vietnam. This suggests that the current
concern about the MICT is less about the current rate of growth being out of synch with average
historical rates or duration of income transitions, but more about the uncertainty in the ability to
sustain the growth rates required in order to catch-up in the near future. The pace and nature of
globalization today, the great difficulty of generating structural transformations that are also
accompanied by decisive bursts of technological progress, the long lead-time needed to develop
social and firm-level capabilities, are just among the multitude of reasons why breaking through the
so-called glass ceiling (Ohno, 2009) is relatively infrequent and exceptional.
How to escape the MICT
While a deep and thorough scientific scrutiny of the MICT is still scarce, there is hardly any
disagreement about the menu of policy cures countries need to consider. First on the list is the
diversification of exports away from goods based on low wages and thus a greater push towards
upgrading and innovation. Government initiative is seen as critical in providing higher levels of
investment in education, science & technology, and physical infrastructure, as well as in facilitating
access to financing venture enterprises and grassroots innovators. Local entrepreneurs, on the other
hand, must develop and adopt innovative production processes and step-up capacity to introduce
new or improved goods and services. For lower-middle income countries, more basic reforms are
needed in the area of public governance and institutional development, banking & financial systems,
among other things. The result is a daunting policy agenda that all the more demonstrates why such
a trap exists in the first place.
Role of Exports
Differences in economic performance across countries are generally explained by variable rates of
productivity, which in turn, depends on the ability of countries to continuously shift their
specialization towards sectors with higher technological content, scale economies and opportunities
for learning and innovation. Not surprisingly, many studies have shown that the distinctive element
that separates the countries that succeeded in escaping the MICT and those that did not is the
capacity to specialize in a range of sophisticated or high-tech products. ADB (2012) find that South
Korea, one of the few developing countries to recently transition out of middle income, managed to
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acquire comparative advantage in a substantial range of these sophisticated goods, while countries
such as Malaysia and the Philippines were successful only in electronics.
The diversification exports has in fact become one of the most important policy objectives of
developing countries especially in the last three decades of pursuing export-oriented income growth.
But as countries move from lower middle, to upper middle income, there is a critical juncture wherein
countries must gradually move away from a diversified product space and towards specialization. The
important concern is how economies can navigate themselves along that precarious threshold where
competitiveness can no longer be driven by labour-intensive production of wide range of
standardized goods, and productivity must shift to allow more investments in building know-how to
create new competitive niches in more technology-intensive goods.
It is well-known that the development of technology either requires huge public investments
(because markets will fail in the face of externalities) or a big enough market to assure private firms
that sufficient profits could be earned to cover the high initial fixed costs, such as R&D. Moreover,
the generation of better capabilities is characterized by path dependence, and the attainment of the
critical level of skills enabling economies to develop new high-value product varieties entails a long
gestation period. Together, they help explain why innovation and upgrading lie at the core of the
MICT problem.
For these reasons, Foreign Direct Investments are often seen as the shortest and cheapest route to
technological and industrial upgrading. Countries engage in a race to attract foreign capital in
anticipation of the knowledge spillovers that these are expected to generate. However, the benefits
of FDI are themselves subject to a host of threshold conditions such as institutional/governance
quality and sufficient absorptive capacity of the domestic workforce.
That upgrading is not an automatic result of high rates of FDI can be seen in sluggish change in valueadded trade patterns.
While FDI has resulted to the growing specialization of Malaysia, the
Philippines, and Thailand on technology-intensive sectors such as electronics and automobile, the
prolonged concentration on low productivity, low value-added input varieties simply show that
producing ‘rich-country’ products, as Hausmann, et all (2007) calls it, is no guarantee for growth if
economies carry on performing poor-country tasks. As table 2 demonstrates, Malaysia has been
devoting more than a third (more than half, at its peak) of its export production to electronics for two
decades now, while the Philippines has moved to a rather extreme form of specialization, especially in
the last 15 years or so. In the last decade, only nine to ten 6-digit HS sectors of electronic goods
account for 60%- 70% of the Philippines’ total exports. The result is a dualistic product space with
huge distances between traditional exports and high-tech exports largely operating in enclaves.
Table 3 Relative importance of electronic products in total ASEAN exports, 1982 - 2010
1982
1987
1992
1997
2002
2007
2010
Malaysia
13.26
22.24
36.72
50.86
56.30
44.14
39.08
Philippines
2.84
9.40
16.04
61.28
71.97
64.13
63.88
Thailand
4.69
9.65
21.68
30.39
32.06
27.28
24.45
Source: Computed from WITS database.
Following the development of new databases on value-added a promising strand of literature has
emerged to analyze topics such as Global Value Chains / production networks, regional integration,
technological spillovers and upgrading, among others. One surprising finding by Meng, Fang &
Yamano (2012) for instance, is that while ASEAN-East Asian trade in the last two decades has greatly
intensified especially in intermediate parts, trade in value added (TiVA), has in fact declined from
1995 to 2005. Intermediate goods production accounts for more than 60% of total international TiVA,
with Europe trading the most value added. What is worth noting in Table 3 is that although intra-
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Asian trade in value added in intermediate goods has significantly risen, especially relative to the
performance of Europe, NAFTA, and South America, the linkages with ASEAN has declined. IntraASEAN TiVA also posted negative trends in an era when production networks were seen to have
further accelerated ASEAN economic integration.
This provides yet another indicator of the slow pace of upgrading experienced by ASEAN producers in
regional value chains. Thus, while trade in intermediate products have intensified, especially between
ASEAN and East Asia, ASEAN local producers continued to be specialized in low value-added segments
of production, thereby reducing their share in total intra-regional TiVA.
Table 3 Bilateral TiVA share in total TiVA in terms of intermediate goods across regions (%)
ASIA 1995
Asia
Asia 2005
% Change
Total
Asia
ASEAN
East
Asia
Total
Asia
ASEAN
East
Asia
Total
Asia
ASEAN
East
Asia
6.9
1.8
4.6
7.1
1.1
5.1
2.8
-37.9
11.9
ASEAN
1.6
0.4
1.2
1.6
0.3
1.0
-2.5
-14.3
-10.3
East Asia
4.5
1.3
2.8
4.6
0.7
3.4
3.4
-46.6
21.4
Rest of Asia
0.8
0.1
0.6
0.9
0.1
0.7
11.3
-7.7
10.2
2.9
0.7
1.9
2.6
0.3
1.8
-10.5
-52.3
-5.3
NAFTA
3.7
0.6
2.7
2.4
0.3
1.8
-34.2
-50.0
-34.7
World
16.7
3.5
11.6
17.8
2.3
12.8
6.3
-34.3
9.9
Europe
Source: Selection from table 4, Meng, Fang & Yamano, 2012
Upgrading and Innovation
The most obvious escape route out of the MICT is to hasten and facilitate upgrading through
innovation and technological catch-up . However, various indicators in technological preparedness
and knowledge creation do not appear to point towards this direction. Global Competitiveness Indices
(GCI) from 1994 till 2012, for instance, show declining trends for most of the middle-income ASEAN
countries. As can be seen from table 4, this is largely the result of lower performance in areas related
to technology and innovation.
Table 4 Sub-indicators of the Global Competitiveness Ranking, 2011-2012, for selected ASEAN
Basic
Readiness
Total
Efficiency Enhancers
Innovation Sophistication
higher
educ.
goods
market
Labor
Fin’l.
dev
technolg
rdns
market
sze
Business
sophistication
Innovation
Cambodia
97
120
58
38
74
110
93
90
85
Indonesia
46
69
67
94
69
94
15
45
36
Malaysia
21
38
15
20
3
44
29
20
24
Philippines
75
71
88
113
71
83
36
57
108
Thailand
39
62
42
30
50
84
22
47
54
Vietnam
65
103
75
46
73
79
33
87
86
In terms of knowledge generation, wide disparities in spending in R&D can also be found. While
Korea, Singapore and Taiwan allocate 2 percent or more of their GDP on R&D, middle-income
countries such as Indonesia, the Philippines and Thailand spending do not go beyond the 0.1 – 0.2
percent mark (Brahmbhatt & Hu, 2007). Not surprisingly, patent applications by local firms are
minimal, and most are undertaken by foreign firms. In Malaysia, the Philippines and Vietnam, for
instance, 81%, 95% and 92%, of patent applications in 2010 are initiated by foreigners, respectively
(WIPO, 2010).
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Indeed, firm-based studies on innovation activities show that foreign firms in middle-income
countries undertake most of the activities related to innovation, such as the introduction of a new
product or upgrading of existing one, and introduction of new technology that improves efficiency of
current production. And yet when asked to identify their key origins of technological innovation, only
an average of 7% of local firms in middle-Income ASEAN indicated foreign parent firms as their main
source. Most firms rely on technology embodied in new machineries, and as Keller (2002) showed,
imports explain two thirds of the rate of technological diffusion among catch-up economies.
Table 5 Key Sources of Technological Innovation, 2003 (% of firms)
Cambodia
Indonesia
Malaysia
Philippines
Thailand
Ave
Embodied in new machinery
42.1
48.7
49.9
43.0
33.1
43.4
Cooperation with clients
11.9
15.1
8.6
9.7
17.2
12.5
By hiring key personnel
14.5
17.9
11.4
14.2
3.0
12.2
Developed within the firm locally
16.1
4.7
7.2
8.3
19.4
11.1
Transferred from parent
6.0
2.7
11.0
4.3
11.9
7.2
Developed with supplier
1.6
7.0
5.2
5.0
7.2
5.2
Other
7.8
3.9
6.7
15.5
8.2
8.4
Source: World Bank Investment Climate Surveys (Malaysia, 2002; Thailand, 2004), as replicated from
Brahmbhatt & Hum (2007).
Theoretically, few would argue against the potential for positive spillovers to emerge from closer
interaction between technologically superior foreign firms and their developing-country counterparts.
The empirical evidence however, is mixed. One important element of an active policy approach to
the MICT is therefore a better understanding of the transmission mechanisms for knowledge transfer,
as well as the conditions that promote or hinder the proper functioning of these processes.
Global Value Chains (GVC)
The Global Value Chains literature is helpful in getting a clear grasp of the context in which
interactions between foreign and local firms occur. One recurring theme is that the circumstance of
local firms could indeed be precarious: in the same manner that countries could specialize on the
right or wrong type of products, developing-country firms could likewise integrate themselves into
the right or wrong type of GVCs, certainly from the perspective of the impact on overall growth.
Kaplinsky (2004) re-visited the idea of immiserizing growth when firms insert themselves in GVCs that
operate in sectors with declining terms of trade, such as furniture, toys and footwear. The entry of
China as producer of mass manufacturing products has further hastened such a trend. Local firms
could also find themselves specializing in a very narrow function within a highly competitive value
chain, thereby increasing their vulnerability to market shocks. Moreover, most of value-added could
be appropriated in the design and branding sections of the chain, so that the room to increase valueadded for local partners is effectively limited.
The extent of subordinance of local suppliers, and hence, the opportunities for upgrading significantly
depends on their initial capabilities or competence. Equitable power-sharing and cooperation, is
more common whenever supplier and lead firms possess complementary assets. On the other hand,
so-called ‘captive suppliers’ on a quasi-hierarchical relationship with their global partners often
operate in the realm of non-standard products using buyer or client-specific technology. Local
suppliers face significant switching cost, and are thus locked-in a network that is highly controlled and
governed by foreign lead firms
The task of upgrading and gaining market niches with higher value-added is not made easier by the
current concentration of market power by few parameter-setting buyer firms and first-tier firms. In
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electronics, a handful of global contract manufacturers dominate the market, and their scale and
scope of operations would be difficult to challenge even by developed-country entrants. For MICT
economies, operating in the lower-tiers of the value chain and also often detached or distant from the
more demanding and sophisticated markets of their end products, the relevant question is how to
identify a realistic trajectory towards upgrading given these constraints and considering that the
policy space and resources to actively intervene may be minimal.
That local firms need to build-up their own competencies to access more knowledge is an inescapable
fact. As studies have shown, local firms have been unable to reach the threshold of absorptive
capacity to take advantage of whatever spillovers FDI might have had to offer. Human capital
development should undoubtedly be high in every middle-income country policy agenda. The notion
of a trap, however, lies in the fact that the cumulative nature of skill/capability development confer
advantages to countries where FDI have already put the virtuous cycle of economies of scale and
productivity into motion, thus making catch-up further more difficult for late-comer countries.
The extent of the challenges facing local firms in the upgrading path calls for greater effort to analyze
the nature and sequence of knowledge flows embedded in various types of MNE activities, assess the
opportunities for adaptation and assimilation for local firms given the technological gaps per sector.
This process requires an industrial policy that facilitates more systematic coordination and efficient
interaction among key players. Much stress is often placed on the role of government, and yet, with
the growing share of industrial activity owned and controlled by multinational enterprises, it is hard
to conceive a viable strategy out of the MICT without taking into account the role of these firms in
industrial growth as well.
Towards this end, the so-called Investment Development Path (IDP) framework that links MNE
activities with industrial policies (Narula & Dunning, 2010) is particularly informative. It stresses the
importance of policy orientation that leads to a clear industrial policy, as opposed to a passive
outward/export-oriented FDI-dependent strategy. Attention is also given to understanding the
nature and extent of linkages (through equity or non-equity associations) MNEs have with local firms
in order to identify areas where the learning potential is greatest. In essence, this approach closely
links policies towards MNE investment with a clear industrial policy. Instead of adopting a general,
one-size-fits-all approach, it takes the heterogeneity of MNE activities explicitly into account so as to
fine-tune these policies to the specificities of sectors and countries.
Regional Economic Integration
Regional economic integration can also have a critical role to play in enhancing the environment for
upgrading in so far as it can raise the potential returns to technological investment. By improving the
locational advantages of countries, it can likewise strengthen the bargaining positions of local firms
and governments in aiming for more beneficial learning linkages with MNEs.
The proliferation of new regional integration agreements (RIAs) reveals that many governments
indeed see them as a driver of growth by inducing more scale economies and capital accumulation,
mainly through FDIs. Global producers, in turn, are drawn towards these bigger regional markets for
both consumer and producer goods and services, with freer trade potentially resulting to a significant
reduction of transaction costs. Regionalism and the globalisation of production networks are
therefore two intertwined forces, both fed by the relentless pursuit of scale economies, which in turn
is expected to boost productivity and cost competitiveness for firms, and faster rate of overall growth
for participating countries.
There are a number of ways participation in an RIA can enhance the strategies of countries to escape
the middle-income trap. There is the well-known "training ground" motive for RIA, which states that
a bigger regional market could help producers reach a scale of industrial production that would
eventually enable them to be competitive in the global market, whilst maintaining some WTOcompatible protection from non-RIA competition.
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As mentioned earlier, an RIA can also influence the strategic decision of foreign investors as to where
to locate their production hubs. Moreover, entry in a RIA acts as a signal to foreign investors that the
necessary economic conditions exist to induce efficiency and competitiveness in firms. A bigger
market increases the likelihood that a critical mass of manufacturing activity could develop in the
region, thereby bolstering the confidence of foreign and local investors alike.
A catch-up strategy based on RIA membership is not without risks, however. Countries enter a
regional agreement, with certain ambitions of being the hub of higher value-added production. What
happens when a key member is faced with the threat of falling output in some targeted sectors due
to the agglomeration of production in another member country? One could also not ignore the
threat of a worst-case scenario for members, that is, the combination of full liberalization, falling
investments, and a market for consumer goods but a periphery status when it comes to production.
This puts the importance of national industrial policies back to fore. A rather passive approach that is
dependent on the static & dynamic effects of regional integration could be precarious since the
clustering and the dispersal of manufacturing production are two sides of the agglomeration coin, or
alternatively, the development of hubs, imply the creation of peripheries as well. This leads the
discussion back to the issue of governance quality and the role of Industrial Policy in the process of
catch-up growth.
Role of a pro-active Industrial Policy: lessons learned from successful transitions
The challenge to create the capabilities and institutional incentives to diversify production and
exports, and then further integrate in global value chains with clear prospects of increasing local value
added through innovation, is one which only few middle income countries were able to face. For
those who are able to successfully realize the transition to a high-income status, a common feature is
a strong leadership (pro-active) role of governments in galvanizing the necessary political consensus
to design and implement an industrial policy, or a deliberate path towards higher growth.
Gerschenkron’s (1962) analysis of the 19th century industrialization of the relative “backward
economies” of Germany, France and Italy seem to apply to the 20 th century NICs, when he concluded
that a take-off to rapid growth is only possible if government takes on radical measures to engineer
the transformation of the productive forces within the economy.
Among the lessons distilled by Foxley & Sossdorf (2011) from case studies of Finland, South Korea,
Spain, Portugal and Ireland is that the stress on facilitating a better functioning of market forces
through sound macroeconomic discipline is not sufficient for catch-up growth. Tackling market
failures in the credit and labour markets, as well as mustering the massive and continued investments
in education and innovation, requires a strong and effective Industrial Policy, which in turn, hinges on
the capacity of leadership to forge broad-based political and social agreements. This consensusbuilding directed towards reforms has been the exceptional feature of Finland’s transformative
experience.
There are at least four elements of the industrial policies of successful ‘caught-up’ countries. First is
an active, massive and sustained improvement of education; second pertains to some form of control
of the labour market; third is the role of credit rationing; fourth is the quality of governance which
encompasses not only consensus-building, but also effective implementation of the policy vision set
and the role of proper sequencing of reforms.
One area where huge gaps between the caught-up high-income and catching-up middle income
countries continue to exist is in the investment in human capital and innovation. It is a long-term
policy that high-growth countries now clearly benefit from. Finland and Ireland implemented
profound educational reforms in the mid 60s that addressed both the improvement of coverage and
quality, while governments of countries like South Korea, Singapore and Taiwan kept a firm control
over the educational system, ensuring that educational expansion is systematically linked to the
needs of industrialization. South Korea, for instance undertook a campaign to promote vocational
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education in the early 70s during the implementation of its Heavy Chemical and Industrialization Plan
(HCIP), which resulted to a three-fold increase in the flow of graduates into the labour market. The
stress placed on technological upgrading is mirrored in the policy efforts to increase the technical
skills of the future workforce. By 1980, more than one in three junior college students were enrolled
in natural sciences or engineering. Moreover, South Korea also enacted a law requiring large firms to
train 15% of their workforce. The result is a 90% increase in craftsmen 5 years after the enactment of
the said law. Taiwan’s so-called ‘narrow gate’ policy was a deliberate attempt to expand vocational
education. As a consequence, the shares of general relative to vocational education shifted from 6040 in 1960 to 40-60 in 2000.
The work of Singapore’s Vocational and Industrial Training board highlights the government’s role not
only to provide education as a public good, but also to that of coordinating the supply and demand
for skills. Pushing up the skill spectrum of the workforce was seen as critical in Singapore’s industrial
policy, since this serves to attract the kind of investments that demand higher skills.
Speaking of demand, it is further pointed out that investments in education reached above-average
rates relative to other developing countries not only because of greater provision but also because of
higher demand for access to education. Kuznets (1988) traces the low level of inequalities in Taiwan,
South Korea and Japan from the promotion of land reform, active measures to increase agricultural
productivity, and a more dispersed manufacturing sector that benefitted the rural poor. The more
equitable distribution of income not only ensured that even poor families can invest on education,
but also that education was seen as a viable means towards social and economic mobility.
Flexible and open labour markets were also seen as an essential prerequisite to export
competitiveness. However, for countries such as South Korea and Taiwan, cheap and abundant
labour was also the consequence of labour union repression. Both countries in the early 1970s
outlawed strikes, which made unions ineffective in addressing problems such as long working hours,
low pay and poor working conditions. Intervention in South Korean labour market even came in the
form of establishment of wage-price guidelines during Chun’s rule in the early 1980s. But there were
also more benign measures to prevent rigidities and fragmentation of the labour market. Finland, for
example, reduced the employer cost of lay-offs while increasing unemployment insurance and
introducing various safety nets. Clearly, MICT governments today face a more difficult challenge in
designing labour policies that conform to generally accepted social standards while responding to the
pressure to attain competitiveness. Moreover, measures that enhance labour welfare and gender
equality not only have positive impact on labour productivity, but more importantly, these serve to
ensure that growth is inclusive.
Another commonality found in success stories is the State’s approach towards credit. Countries such
as Finland and Japan suppressed interest rates and rationed credit, while for South Korea, credit
allocation and foreign-loan guarantees were indispensable instruments since large firms lack the
financial affiliates that Japanese conglomerates or Keiretsu have. Most developing countries have
experimented on administrative rationing of credit in the form of development or State investment
banks, so it is clear that addressing the market failures in credit provision is a necessary but not a
sufficient condition for catch-up growth.
There is hardly any discussion of successful income transition or of rapid growth in general that does
not begin and end with the crucial importance of governance and institutional-building. As earlier
pointed out, there are numerous developing countries that have attempted to embrace the growth
recipes mentioned above. And yet, only a happy few are able to reap the full benefits of these
policies. No one would deny the importance of historical luck, or proximity (and/or integration) to a
huge markets, or even the initial external conditions around the period of transition, but viewing the
experience of caught-up countries from a longer term perspective, it is clear that the leadership role
of governments and their credible commitment to nation-building explain to a large degree why these
countries have succeeded where many have failed.
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There are many dimensions in which the theme of governance is tackled in literature, but let us focus
here on the twin importance of political intelligence and the political will to implement a consolidated
vision. As Hirschman (1975) points out in his famous treatise on policy-making in Latin America: the
understanding of a problem and motivation to attack it are two necessary inputs into policymaking
and problem-solving, but that the timing of these two ingredients could be significantly out of phase:
understanding can pace motivation, but in other situations motivation to solve a problem may arise in
advance of adequate understanding. By political intelligence and political will, we therefore allude to
Hirschman’s concepts of understanding and motivation.
Great stress is placed on the importance of political and social consensus, saying that this is critical in
avoiding economic stagnation and pessimism. The mechanism might very well be that of generating
new understanding of how to move ahead, which often results from broad-based consultations.
“Advantage Finland”, for instance, was a comprehensive study aimed to study future industry
prospects and produce inputs for the re-designing of Finnish industrial policy in the early 1990s
(Rouvinen, 1999). The resulting new industrial strategy that came out of this exercise was then
implemented in the context of industry clusters, which fostered ownership and interactive problem
solving. This shows that understanding is not only a question of knowledge but of broad consensus
about the roots of the problem as well. Motivation, on the other hand, can be derived not only from
the political will of the top echelons of government, but also from the shared commitment of various
stakeholders, as demonstrated by the Finnish industry cluster exercise.
In the case of Japan, South Korea, Taiwan and Singapore, much reference is made to the role of pilot
agencies in the formulation of policies based on in-depth study, and the implementation of the
resulting policy objectives. Japan’s Ministry of International Trade and Industry or MITI, the Economic
Planning Board of South Korea, Taiwan’s Council of Economic Planning and Development, and the
Singapore Ministry of Trade & Industry are all powerful government bodies whose agenda are often
said to dominate that of other ministries (Green, 1999). These centralized coordinating bodies were
said to be critical in the development of a cohesive vision for achieving rapid economic growth, which
was then further elaborated into more detailed programs of action by specialized committees. The
particular importance of administrative guidance is also underlined, adding that the strength of South
Korea, for instance, lay not so much in planning but on effective implementation.
Apart from internal factors, the international political and economic climate during the takeoff period
of South Korea, Taiwan and Japan also dictated the realm of policy possibilities available to their
governments. Late-movers among middle countries might learn from the leadership and
organizational stance of these successful countries, but most of the policy menu involving subsidies,
tariffs, financial control, etc., are no longer replicable in the increasingly rule-based global trading
environment of today.
Finland’s industrial policy demonstrates how in the current WTO-era, ‘old-style’ policies consisting of
subsidies for ailing firms, curbing competition, targeting and sheltering strategic industries or national
champions must make way for a new policy approach that instead lay the ground for more auspicious
framework conditions and better functioning of markets. It is centered on the cluster concept
wherein focus is given to broad-based upgrading through the creation of inter-firm/sectoral linkages
instead of targeting specific industries.
The cluster approach is also heavily dependent on the dialogue and partnership formed between
government and business policymakers, as well as researchers. The virtue of this approach is that the
trust or confidence built between parties lowers transaction costs (between public and private; but
also between firms linked in a supply chain), which in turn reduces risks and help encourage firms to
increase investments. Finland’s example demonstrates how these types of multi-sectoral networking
create collective assets and develop built-in mechanisms for correcting different types of market
failures.
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Singapore and Ireland undertook a broad-based capability building approach, while Chile, Jordan and
Domenican Republic opted for a more sectoral tack in upgrading. The optimal level of intervention is
in fact a theme that cuts across much of the literature on catch-up growth. There does seem to be
some agreement on the inadequacy, especially during the takeoff period, of an approach that limits
government role to fulfilling the Washington-consensus policy agenda centered on the proper
functioning of markets and the provision of public goods.
Instead of Government acting primarily as a facilitator that enables private actors to better exploit the
country’s comparative advantage, a considerable body of literature espouses a more deliberate
stance especially towards upgrading and development of social and firm-level capacities. The shift
towards a knowledge-based economy requires a qualitative jump in capabilities, and this step
significantly increases the demand for visioning, planning and especially, coordination. Paus (2012)
also argues that the development of national innovation system, for example, involves a daunting
effort to assemble a complex network of activities from research & innovation, to patent creation and
commercialization involving layers of institutions, that a fragmented and weakly-guided approach will
hardly lead to any meaningful change in the status quo.
The unpredictability in the way technological change triggers new areas of comparative advantage
also underscores the wisdom of adopting a more broad-based approach to upgrading. Still, the
economic motive to concentrate efforts and stimulate agglomeration forces in key sectors, as well as
the political appeal of being perceived to possess a coherent strategy centered on national
champions, make the practice of sectoral targeting hard to resist. Mortimore & Vergara (2004) argue
that there are right circumstances under which targeting winners might be a successful strategy. This
is certainly the case when compared to policies that merely passively relied on FDI inflows to move
the country past the knowledge threshold. But serious government programs that target winners
through R&D and other infrastructural support can be extremely costly and might not be justified
given the more basic social demands on scarce public resources. The randomness in the movement
of technological change further adds risks in supporting sectors that may be today’s winners but
tomorrow’s losers.
The fact that the usual growth drivers of middle Asia are losing their old potency presents new
opportunities for policymakers to tap new sources of growth. This is the subject of Petri’s (2012 )
inquiry, and he argues that these new drivers do not necessarily require as large a leap in
technological status as many would expect. The growing pool of middle class consumers is
experiencing a relatively rapid rise in incomes, which will translate into a huge potential demand for
goods and services. More importantly, these products would be typically of the labour-intensive
varieties, and offer a better match with current comparative advantage and levels of technological
capabilities. This allows a more gradual and less costly initiatives to build up knowledge, but still
requires deliberate and coordinated public-private strategies to capture this new expanding demand.
The importance of the quality of institutions and governance have attracted considerable research,
certainly after ample evidence reveal that the large variation in the growth performance of countries
can be explained more by institutional variables rather than differences in physical capital and
educational attainment. Chauffour (2011) reviews the economic performance of more than 100
countries over the past thirty years, and find that economic freedom and civil and political liberties
are the principal reasons why some countries achieve and sustain better economic outcomes.
Rodrik (2004, 2006), espouses the view that structural transformation is not an automatic process
that one can expect once markets are made properly functioning. The role of institutions from this
perspective is not only to support markets in its natural tendency to direct resources towards
activities of comparative advantage, but also to shape the national structure of production by pushing
the limits set by factor endowments.
In the context of the MICT, one can extend the discussion on the quality of governance beyond the
usual themes of rule of law, corruption, and public good provision. As pointed out earlier, good
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governance also implies the capacity to craft and implement a visionary policy that generates broad
consensus among key public and private actors and directs scarce resources towards new niches of
competitiveness. Rodrik (2004) also describes industrial policy as more of a process where the public
and private sectors jointly diagnose the economic hindrances and propose means to overcome them.
This requires innovative “public-private institutional arrangements” that facilitate communication and
coordinate joint action.
One of the crucial governance challenges for countries facing the MICT is how to develop a more proactive, vision-driven industrial policy in an era of shrinking policy space. As earlier discussed, relative
to the transition from traditional exports to labour-intensive manufacturing exports, the shift to
products containing more skills and technology is decisively more difficult, thus requiring a more
active policy to motivate, mobilize, coordinate key institutional players.
EMIT Research Agenda
The on-going NWO-WOTRO research programme, entitled, 'ESCAPING THE MIDDLE-INCOME
COUNTRY TRAP (EMIT): a firm-level analysis of the Philippines and Thailand',2 aims to investigate the
themes discussed in this paper through an interdisciplinary approach. Six subprojects are designed to
examine the following research propositions: (1) MICT is systemic / structural; getting out of it
requires proactive solutions; (2) new institutional arrangements/solutions, like Public-PrivatePartnerships need to be developed to achieve higher growth trajectories; (3) possibilities of upgrading
for local firms depend on the governance structures of the global value chains on which they are
involved in; (4) successful (e.g. productive, innovative) firms share common characteristics across
sectors; (5) countries suffering from MICT suffer from lack of understanding of the locational
strategies of multinational enterprises (global value chain); (6) MNCs firms face difficulties in
formulating their strategies towards middle income countries like Thailand and the Philippines; (7)
firms that are more responsive to workers’ needs tend to be more competitive; (8) labor migration
policies directly impact on the competitive position of firms and countries.
2 The research consortium implementing the project is composed of the Erasmus School of Economics
(coordinating institution), Rotterdam School of Management, University of the Philippines (School of Economics
& College of Social Science & Philosophy), and the Asian Institute of Technology (Thailand). The duration of the
project is from 2011-2015.
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