Asia's middle-income challenge: An overview
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Estrada, Gemma; Han, Xuehui; Park, Donghyun; Tian, Shu Working Paper Asia's middle-income challenge: An overview ADB Economics Working Paper Series, No. 525 Provided in Cooperation with: Asian Development Bank (ADB), Manila Suggested Citation: Estrada, Gemma; Han, Xuehui; Park, Donghyun; Tian, Shu (2017) : Asia's middleincome challenge: An overview, ADB Economics Working Paper Series, No. 525, Asian Development Bank (ADB), Manila, https://doi.org/10.22617/WPS179122-2 This Version is available at: https://hdl.handle.net/10419/203367 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/3.0/igo/
ASIAN DEVELOPMENT BANK AsiAn Development BAnk 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org Asia’s Middle-Income Challenge: An Overview Developing Asia has undergone a relatively rapid transformation from a region that consisted mainly of low-income economies toward one that is largely middle income. A key challenge for the region is sustaining rapid growth to move further to high income. The experience of newly industrializing economies shows that innovation, human capital, and infrastructure are critical to enabling a quicker shift to high income. About the Asian Development Bank ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to a large share of the world’s poor. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. adb economics working paper series NO. 525 november 2017 AsIA’s MIDDle-INCOMe ChAlleNge: AN OvervIew Gemma Estrada, Xuehui Han, Donghyun Park, and Shu Tian
ADB Economics Working Paper Series Asia’s Middle-Income Challenge: An Overview Gemma Estrada, Xuehui Han, Donghyun Park, and Shu Tian No. 525 | November 2017 Gemma Estrada ([email protected]) is a senior economics officer, Xuehui Han ([email protected]) is an economist, Donghyun Park ([email protected]) is a principal economist, and Shu Tian ([email protected]) is an economist at the Economic Research and Regional Cooperation Department, Asian Development Bank. This paper has been prepared as background material for the Asian Development Outlook 2017 theme chapter on Transcending the Middle-Income Challenge.
Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) © 2017 Asian Development Bank 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines Tel +63 2 632 4444; Fax +63 2 636 2444 www.adb.org Some rights reserved. Published in 2017. ISSN 2313-6537 (Print), 2313-6545 (electronic) Publication Stock No. WPS179122-2 DOI: http://dx.doi.org/10.22617/WPS179122-2 The views expressed in this publication are those of the authors and do not necessarily reflect the views and policies ofthe Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. The mention of specific companies or products of manufacturers does not imply that they are endorsed or recommended by ADB in preference to others of a similar nature that are not mentioned. By making any designation of or reference to a particular territory or geographic area, or by using the term “country” inthis document, ADB does not intend to make any judgments as to the legal or other status of any territory or area. This work is available under the Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) https://creativecommons.org/licenses/by/3.0/igo/. By using the content of this publication, you agree to be bound bytheterms of this license. For attribution, translations, adaptations, and permissions, please read the provisions andterms of use at https://www.adb.org/terms-use#openaccess This CC license does not apply to non-ADB copyright materials in this publication. If the material is attributed toanother source, please contact the copyright owner or publisher of that source for permission to reproduce it. ADB cannot be held liable for any claims that arise as a result of your use of the material. Please contact [email protected] if you have questions or comments with respect to content, or if you wish toobtain copyright permission for your intended use that does not fall within these terms, or for permission to use theADB logo. Notes: 1. In this publication, “$” refers to US dollars. 2. ADB recognizes “China” as the People’s Republic of China and “Korea” as the Republic of Korea. 3. Corrigenda to ADB publications may be found at http://www.adb.org/publications/corrigenda
CONTENTS FIGURES AND BOXES iv ABSTRACT v I. INTRODUCTION 1 II. ASIA’S TRANSFORMATION TO A MIDDLE-INCOME REGION 2 III. SOME EVIDENCE ON THE MIDDLE-INCOME CHALLENGE 8 A. Transitioning to Higher Income: How Long Does It Take? 9 B. Structural Characteristics: Middle Income versus Low Income and High Income 10 C. Difficulties in Overcoming the Middle-Income Challenge 11 D. Newly Industrialized Economies: Exception to the Rule 14 IV. ADDRESSING THE MIDDLE-INCOME CHALLENGE 18 REFERENCES 19
FIGURES AND BOXES FIGURES 1 Population Share by Income Group, Developing Asia and World 2 2 Distribution by Income Class 3 3 Gross Domestic Product per Capita 4 4 World Bank’s Classification of Economies, 1991 and 2015 7 5 Descriptive Statistics by Income Group 11 6 Years as Middle Income, 1960–2014 12 7 Patent Applications 15 8 Knowledge Production: Selected Asian Economies 16 Box Figure: Selected Technological Development Indicators for the Republic of Korea 17 BOXES 1 Income Groupings from Penn World Tables 9.0 and World Bank Data Sets 6 2 Factors Driving Economic Growth Using a Regression Tree 13 3 Lessons from the Experience of the Republic of Korea 17
ABSTRACT Developing Asia has undergone a dramatic shift over the past 5 decades from a region of mainly lowincome economies toward one that is largely middle income. Compared with world aggregate data, developing Asia now has a much greater proportion of middle-income economies. The region faces the challenge of sustaining rapid growth after graduating from low to middle income, and moving further to high income. Evidence shows that it takes longer for economies to move from upper-middle to high income than shifting from lower-middle to upper-middle income. Still, developing Asian economies were able to shift more quickly than the rest of the world, whether the transition is from lower-middle to upper-middle income or from upper-middle to high income. The experience of newly industrializing economies shows that innovation, human capital, and infrastructure all played a vital role in their quicker transformation from middle to high income. Keywords: Asia, economic growth, middle income JEL codes: 010, 011
I. INTRODUCTION Long the fastest-growing region of the world, developing Asia’s economic growth slowed down noticeably since the global financial crisis of 2008–2009. The region’s growth declined from 10.4% in 2007 to 5.9% in 2015. Therefore, the region has not been immune from the deceleration of global growth momentum in the postcrisis period. Even the People’s Republic of China (PRC), which has become the world’s second biggest economy after decades of fast growth, saw its growth fall from 14.2% in 2007 to 6.9% in 2015. Further, in light of Asia’s growing share in the world economy and contribution to its growth, Asia’s slowdown further dampens global economic prospects. At the same time, it is likely that the deterioration of the external environment since the global crisis contributed to Asia’s slower growth. Many Asian economies are export driven, and have been adversely affected by the postcrisis sluggishness of global trade. In particular, Asian exporters were hurt by the failure of the advanced economies, which remain major markets for the region. But internal factors are also at play in the decline in the region’s growth. In this context, it is important to note that sustained rapid growth has transformed Asia from a largely low-income region to a largely middleincome region. Figure 1 shows the share of population in developing Asia and the world living in lowincome, middle-income, and high-income economies in 1991 and 2015.1 In 1991, more than 90% of Asians lived in low-income economies, compared with less than 60% for the world. By 2015, propelled by economic shifts in the region’s largest economies—the PRC, India, and Indonesia—more than 95% in the region lived in middle-income economies. However, growing rapidly tends to become more difficult as the income gap with rich countries narrows. The transition from middle income to high income will not be driven by the same factors that enabled economies to move out of low income. The concept of the middle-income trap crystalizes the notion that growing rapidly can become more difficult after a country moves up from low income to middle income. More precisely, according to the concept, the transition from middle income to high income is inherently more challenging than the transition from low income to middle income. The middle-income trap is firmly rooted in international historical evidence. Some middle-income countries are middle income for a very long time—for example, Latin America—and, hence, the notion that those countries are trapped in middle income. On the other hand, only a handful of countries—newly industrialized economies (NIEs) such as the Republic of Korea—have successfully made the final transition. The confluence of a short-term trend—Asia’s slowdown since the global financial crisis—and a long-term trend—the transformation of Asia into a middle-income region—means that now is a particularly opportune time to revisit the middle-income trap. More broadly, Asia now faces the challenge of continuing to grow rapidly after graduating from low income to middle income. 1 The income groups are taken from the World Bank’s classification of economies, based on gross national income per capita in United States (US) dollars.
2 | ADB Economics Working Paper Series No. 525 Figure 1: Population Share by Income Group, Developing Asia and World Source: Authors’ estimates based on data from the World Bank Analytical Classifications. http://databank.worldbank.org/data/download/sitecontent/OGHIST.xls; and World Bank. World Development Indicators online database. http://databank.worldbank.org/data/home.aspx (both accessed 13 October 2016). In many ways, the middle–high transition is fundamentally different from and more challenging than the low–middle transition. For instance, the government typically plays a more nuanced role in the economy since the private sector is now more developed. Another example is that productivity growth can no longer rely primarily on the low-hanging fruit of reallocating workers from low-productivity agriculture to higher-productivity manufacturing and services. In this paper, we explore some key developmental challenges facing middle-income Asian economies, and puts forth concrete policy options for tackling those challenges. The next section documents Asia’s transformation to a middle-income region over the past 50 years. The third section delves into some key constraints to the growth of middle-income countries. The section also analyzes the factors behind the success of the few countries that were able to transcend the middle-income challenge. The last section lays down some concrete policy options available for Asian economies to overcome the middle-income challenge. II. ASIA’S TRANSFORMATION TO A MIDDLE-INCOME REGION Over the past 50 years or so, developing Asia has undergone a dramatic shift from a region that consisted mainly of low-income economies toward one that is dominated by middle-income economies. Income classification constructed relative to the per capita income of the United States (US) in 1960 indicates developing Asia’s dynamic transition since the 1960s. The income classification is based on 2011 purchasing power parity using Penn World Tables (PWT) 9.0 and covers 107 economies from 1960 to 2014. Out of the 107 economies with data since 1960, 15 are from developing Asia.2 2 These cover 15 economies with income classification from 1960 to 2014, constructed using data from PWT9.0. These are Bangladesh; the PRC; Fiji; Hong Kong, China; India; Indonesia; the Republic of Korea; Malaysia; Nepal; Pakistan; the Philippines; Singapore; Sri Lanka; Taipei,China; and Thailand. 0 20 40 15.5 16.2 75.2 8.7 1.0 2.2 96.2 8.9 90.1 25.6 58.8 60 80 100 1991 2015 1991 2015 Developing AsiaWorld % Low-income economy Middle-income economy High-income economy
Asia’s Middle-Income Challenge: An Overview | 9 A. Transitioning to Higher Income: How Long Does It Take? Empirical evidence suggests that it may take some time for an economy to move up to high income. Felipe, Kumar, and Galope (2017) estimated thresholds that are equivalent to the number of years it took countries to move from lower-middle income to upper-middle income, as well as from upper-middle income to high income. They used the thresholds to determine whether countries are in a middle-income trap. In particular, a country would be considered in the lower- (upper-) middleincome trap if it has been in the lower- (upper-) middle-income group longer than historical experience. One threshold is equivalent to the median number of years that countries spent in moving from lowermiddle-income group to upper-middle-income group, while another threshold was equivalent to the median number of years that it took countries to move from upper-middle income to high income. Felipe, Kumar, and Galope (2017) found that it took about 64 years for economies that became lowermiddle income in 1950 or before to graduate to upper-middle income. The transition was faster for economies that became lower-middle income after 1950, as it took only 28 years for them to graduate to upper-middle income. The faster shift in the postwar period was mainly driven by the East Asian economies, without which the median is 52 years. This study reexamines the thresholds of graduating from lower-middle income to upper-middle income, and from upper-middle income to high income using 2011 purchasing power parity data from PWT9.0 in 1960–2014. Data show that there were 23 out of 107 economies which became lower-middle income and graduated to upper-middle income between 1960 and 2014. The median number of years that it took the economies to graduate from lower-middle income to upper-middle income was 15 years. The transition to upper-middle income was most evident in 2000–2009 when 10 out of the 23 economies moved to upper-middle income. The seven developing Asian economies that were able to shift to upper-middle income were the PRC; Indonesia; the Republic of Korea; Malaysia; the Philippines; Taipei,China; and Thailand. Except for Indonesia and the Philippines, these economies were able to move up from lower-middle to upper-middle income between 9 and 15 years, or no higher than the median number of years for all economies. There is evidence that it takes longer for economies to move from upper-middle income to high income than moving from lower-middle to upper-middle income. Out of the total economies, there were 15 that became upper-middle income and graduated to high income. The median number of years it took these economies to advance from upper-middle income to high income was 23 years, and thus longer than the 15 median number of years of moving from lower-middle to upper-middle income. This pattern was also seen among developing Asian economies that became upper-middle income and graduated to high income; namely, the Republic of Korea, Malaysia, and Taipei,China. While it took the Republic of Korea about 10 years to move from lower-middle income to upper-middle income, it took 13 years for the country to move toward high income. For Taipei,China, the corresponding periods were 10 years from lower-middle to upper-middle income, and 17 years from upper-middle to high income. In general, the shifts in income classification proceeded more quickly among developing Asian economies than the rest of the world whether the transition is from lower-middle to upper-middle income or from upper-middle income to high income. The median number of years for developing Asia in moving from lower-middle to upper-middle income is 13 compared with 17 for the rest of the world. Further, the shift to high income took another 19 years for developing Asian economies compared with 30 years for the rest of the economies. Hence, other economies may learn from the experience of successful developing Asian economies, particularly the NIEs, on how to overcome the middle-income challenge and transition to high income.
10 | ADB Economics Working Paper Series No. 525 B. Structural Characteristics: Middle Income versus Low Income and High Income In this section, we show that middle-income economies are structurally different from low-income and high-income economies. They differ in various important features, including demographic characteristics, infrastructure and human capital levels, finance sector development, and quality of governance. The box-and-whisker plots in Figure 5 show the heterogeneity among different income groups, as well as the variations within each income group. On demographic profile shown in Figure 5a, middle-income economies have a lower share of elderly population compared with high-income economies, but have higher shares than the low income. In particular, the shares of population ages 65 and above have a median of 4.8% in middle-income economies, less than half the 11.9% of the high-income economies, but higher than the 3% of the lowincome economies. Favorable demographics will be an important source of growth among middleincome and low-income economies. This can provide an opportunity for catch-up with the high-income economies, but needs to be complemented by other critical factors that boost growth. The levels of human and physical capital are considered important in driving productivity growth. Middle-income economies, however, tend to fare less compared with high-income economies in these measures. On human capital, the middle income trail the high income by about 3.5 years in terms of median years of schooling (Figure 5b). On physical capital, following direct measures of infrastructure development suggested by Calderón, Moral-Benito, and Servén (2014), the median length of paved roads in middle-income economies is only 3.2 kilometers (km) per thousand workers, substantially shorter than the 21.3 km for high-income economies. Road length in middle-income economies is only somewhat better than that of low-income economies that have median paved roads at less than 1 km per thousand workers. Other infrastructure development measures suggested by Calderon, Moral-Benito, and Serven (2014), in particular, electricity-generating capacity in gigawatts per thousand workers and total length of rail in kilometers per thousand workers, show the same wide gap of the low income and middle income versus the high income (Figure 5c). The finance sector in middle-income economies also lags behind that of high-income economies in terms of both depth and efficiency. Domestic credit to private sector has a median of 26.4% of gross domestic product in middle-income economies. For low-income economies, the corresponding figure is 13.3%. Considered a measure of finance sector efficiency, the bank lending– deposit spread is 6.5% in the middle income, just in between the 4.2% for the high income and 8.3% for the low income. Governance structures are less favorable in middle-income economies than in high-income ones. This is observed from the political constraints index constructed by Henisz (2002) that takes into account the structure of a country’s political institutions and how this affects the choice of future policies. With values ranging between 0 and 1 and a higher number indicating better governance, the median for the middle income is 0.3 while it is 0.5 for high income. The middle-income economies are doing better than low-income economies at a bigger margin than its gap with high-income economies. However, governance quality in middle-income economies tend to have a larger variation compared with either the low-income or high-income economies.
Asia’s Middle-Income Challenge: An Overview | 11 Figure 5: Descriptive Statistics by Income Group GW = gigawatt, km = kilometer, UN = United Nations. Source: Authors’ estimates using data from Cross-National Time-Series (CNTS) Data Archive; Henisz (2002); Penn World Table 9.0; Reinhart and Rogoff (2009); and World Bank. World Development Indicators online database. http://databank.worldbank.org/data/home.aspx (accessed 13 October 2016). C. Difficulties in Overcoming the Middle-Income Challenge It is important to examine the possible factors behind the slow transition among countries that have been stuck at the middle-income level for quite some time. Figure 6 shows the number of years that selected economies in developing Asia and Latin America stayed as middle income between 1960 and 2014. For the large Southeast Asian countries that started as low or middle income in 1960; namely, 6 4 2 (c) Infrastructure indicators Low income Middle income High incomeLow income Middle income High income Years of schooling 1.34 2.49 3.39 7.58 3 2.21 3.75 4.38 6.11 7.69 8.47 9.68 10.77 Low income 000 1 2 3 4 5 10 20 30 40 50 8 Middle income High income Low income Middle income High income Low income Middle income High income Electricity generating GW/ thousand workers 0.02 0.06 0.13 0.33 0.66 1.24 2.53 3.93 5.22 Paved road in km/thousand workers 0.35 0.62 1.05 1.49 3.22 5.33 12.66 21.3 29.74 Railway in km/thousand workers 0.13 0.27 0.54 0.21 0.54 1.18 0.56 1.09 2.34 0 5 10 15 Population 65 and above share in % (UN) 2 4 6 8 10 12 4.75 14.87 11.89 9.72 3.22 (a) Demographic structures (b) Human capital
12 | ADB Economics Working Paper Series No. 525 Indonesia, Malaysia, the Philippines, and Thailand, their middle-income stage has so far averaged around 40 years. In Latin America, countries such as Brazil and Mexico have been middle income much longer, at over 50 years now. Figure 6: Years as Middle Income, 1960–2014 Notes: Numbers beside the horizontal bars are the years as middle income between 1960 and 2014. Economies whose years are in boldface are those who have reached high income, based on the income classification using purchasing power parity in constant 2011 dollars from Penn World Tables 9.0. Source: Authors’ estimates based on data from Feenstra, Inklaar, and Timmer (2015). In Mexico, despite past economic reforms, growth has not picked up substantially. Kehoe and Ruhl (2010) examined why Mexico’s reforms toward openness to trade and foreign investment did not result in higher rates of economic growth, unlike the PRC. Mexico’s opening in the mid-1980s initially resulted in large increases in trade and foreign direct investment, which as shares of gross domestic product reached levels that were comparable with those of the PRC. In the mid-1990s, Mexico was second to the PRC in merchandise trade as well as in foreign direct investment recipients among emerging and developing economies. However, by 2008 Mexico’s ranking had fallen while the PRC continued to surge. Kehoe and Ruhl (2010) concluded that factors like an inefficient finance sector, lack of contract enforcement, and rigidities in the labor market kept Mexico from benefiting from its policy reforms related to international trade and investment. Within developing Asia, Malaysia and Thailand, by the close of the century, achieved high productivity levels that were close to advanced countries, but have failed to sustain productivity Developing Asia People's Republic of China 23 Hong Kong, China 24 Indonesia 31 Republic of Korea 23 Malaysia 45 Philippines 42 Taipei,China 27 Thailand 39 Singapore 29 Latin America Argentina 50 Brazil 54 Chile 50 Colombia 55 Mexico 55 Uruguay 51 2014 2010 1960 1970 1980 1990 2000 Low income Middle income High income
Asia’s Middle-Income Challenge: An Overview | 13 increases. Over the past 2 decades they have maintained similar pattern of labor-intensive production and exports that eventually faced strong competition from low-cost producers such as the PRC and India and, more recently, Viet Nam and Cambodia. They failed to move up the value chain and break into fast-growing markets that are knowledge intensive and innovation based (UNIDO 2009). While Malaysia recorded improvements in average schooling and in key economic indicators such as business climate, infrastructure, and trade openness, its productivity gains have largely lagged behind. The country’s approach toward technology adoption and creation differed with that of the Republic of Korea and Taipei,China—countries that relied on local technology creation supported by their governments and where governments were directly involved in creating winners. In the case of Malaysia, technology transfer and diffusion from multinational corporations was facilitated, but this did not yield in substantial gains relative to the other two economies. Multinational corporations helped in the transition toward higher export sophistication and upgrading, but less to technology diffusion (Cherif and Hasanov 2015). As the middle-income challenge is an issue akin to economic growth slowdowns, Han and Wei (2015) examined the factors driving growth performance. They found that middle-income countries are faced with difference challenges that are conditional on their fundamental and policy conditions (Box 2). Box 2: Factors Driving Economic Growth Using a Regression Tree By using a nonparametric machine-learning approach–Regression Tree, Han and Wei (2015) examine what factors drive economic growth performance. They use real gross domestic product (GDP) per capita from the Penn World Table 8.0 to construct economic growth at the country-decade level. They divided the sample into 5 decades, i.e., 1960–1969, 1970– 1979, 1980–1989, 1990–1999, and 2000–2009. For each country and each decade, they have a decade-average annual growth rate, which is used as the left-hand-side variable of the analysis. For the potential factors, they include both structural factors and policy choices factors. The potential factors are represented by 31 variables, including demographic factors, such as working-age population share (15–64 years old), working-age population growth (15–64 years old), and sex ratio (male/female) from age 0–29; infrastructure factors, such as paved road in kilometer per 1,000 workers, power-generating capacity in gigawatts per 1,000 workers, and railway in kilometer per 1,000 workers; human capital such as years of schooling; financial development factors, such as percentage of domestic credit to private sector in GDP, bank credit to deposit ratio, and bank lending-to-deposit rate spread; macroeconomic stabilities, such as inflation, number of years with either banking or currency crises in a decade, and government debt share in GDP; openness, such as trade share in GDP and foreign direct investment (FDI)/non-FDI inflows; political institutional factors, such as political constraints, ideological polarization, executive constraints, economic freedom, corruption perception index, and democracy scale; external environment such as the growth rate of leading economies; and whether oil exporter economy. For most of the factors, they use their initial values at the beginning of each decade to mitigate endogeneity concerns. Different from the traditional regression approach, the Regression Tree approach allows missing values for right-hand-side variables, which enable us to do horse-racing among many potential growth-driving factors with imposing priory assumptions. Another advantage of the Regression Tree approach is to represent nonlinear relationships between factors. That is, some variables only become constraining/promoting growth when another variable reaches a certain value. All country decades classified in the same ending group will share similar growth performance, which is represented by the average growth rate for that group, and share similar key common features, which are represented by the splitting structure of each branch. continued on next page
14 | ADB Economics Working Paper Series No. 525 Box 2 continued For middle-income country decades, Han and Wei (2015) found different difficulties emerging conditional on the fundamental and institutional conditions. For example, when the fundamental demographics, measured by the share of population 15–64 years, is unfavorable—lower than 58.5%—a relatively high government debt ratio will emerge to constrain the growth performance and generate an expected annual growth rate lower than 1.7%. Meanwhile, for countries having such characteristics, if their financial development is poor too, measured by credit to private sectors, which is lower than 28.8%, they expect to have a negative growth rate as –1.3%. In such circumstances, the scenario facing the country is worse than being trapped: it moves backward. For example, in 1970, Sri Lanka had such conditions and then experienced a –4.46% annual growth in the decade from 1970 to 1980, a serious backward moving. If a middle-income country faces unfavorable demographics with the share of population 15–64 years lower than 58.5%, is there any chance for it to enjoy high growth performance? The answer is yes. If it can manage the government debt ratio within a certain limit (lower than 56%) and the currency and banking crisis in a decade no longer than 1 year, it still can expect to have 3.6% annual growth rate. On the other hand, if enjoying favorable demographics, does the country still face the risk of having stagnant growth scenario? The answer is yes. If a country’s GDP level has reached $5,431 in 2005 purchasing power parity and has fewer political constraints, it still expects to have very looming growth scenario, an annual growth rate of 1.8%; or a country has a high government debt ratio, higher than 41.5%, when the demographics are not in a very favorable situation, that is the share of labor force age population is higher than 58.5% but lower than 64.4%, its expected growth rate is 2.8%, not reaching 3%. Based on the findings, they argued that middle-income countries face different challenges conditional on their fundamental and policy circumstances. Source: Han, Xuehui and Shang-Jin Wei. 2015. “Re-examining the Middle-Income Trap Hypothesis: What to Reject and What to Revive?” ADB Economics Working Paper Series No. 436. D. Newly Industrialized Economies: Exception to the Rule There are key lessons that can be drawn from the experience of NIEs in overcoming the middle-income challenge. In 1960, both Singapore and Hong Kong, China were lower-middle-income economies while the Republic of Korea and Taipei,China were low income like most Asian economies at that time. The transition from middle-income to high-income status, which means exceeding US per capita income in 1960, took less than 30 years for NIEs, which were low income in 1960, or less than the median number of years for all countries. For the two economies that were already middle income in 1960, Hong Kong, China had 24 years and Singapore nearly 30 years as middle income between 1960 and 2014. Like most Asian economies, the Republic of Korea and Taipei,China were both low-income economies in 1960. For Taipei,China, it took 27 years to transition from middle income to high income. For the Republic of Korea, the transition from middle income to high income spanned only 23 years. Economic growth averaged 9% in the Republic of Korea and 9.8% in Taipei,China during their middleincome stage. The experience of NIEs indicates that innovation, human capital, and infrastructure all played a vital role in their remarkable transition from middle to high income. An important factor that enabled the NIEs to achieve high and steady growth is innovation, leading to their rapid technological progress. Both the Republic of Korea and Taipei,China sustained productivity increases through the development of new technologies by local firms, and thus were able to move into higher income levels (Cherif and Hasanov 2015; and Agenor, Canuto, and Jelenic 2012). The drive toward innovation was supported by strong protection of intellectual property rights. In 1990, 5 years before the Republic of Korea became high income, the country’s number of patent applications per 100,000 people was already comparable with that of Germany and the US (Figure 7).
Asia’s Middle-Income Challenge: An Overview | 15 Figure 7: Patent Applications Source: Authors’ estimates based on data from World Bank. World Development Indicators online database. http://databank.worldbank.org/data/home.aspx (accessed 7 November 2016). Direct government support played a key role in spurring innovation among the NIEs. In Taipei,China, authorities had a direct hand in creating innovative firms through the spin-off system, supported by returnees that gained significant experience and networks. The government relied on the following key strategies: (i) fostering close and long-term relationships between small and medium-sized enterprises and multinational corporations, (ii) focusing on public and quasi-public research institutes to spin off firms and create new technologies, (iii) technological leapfrogging at an early stage of development that was decided and led by the government, and (iv) huge investment in training engineers overseas. In the case of the Republic of Korea, the government pushed several chaebols to enter several industries simultaneously and export almost immediately to create global brands. State support included access to credit that was conditional on explicit and quantifiable export targets, and such pressure to export pushed companies such as Hyundai to move faster in terms of research and development (R&D) and technological upgrading (Cherif and Hasanov 2015). In addition to innovation, advanced infrastructure networks also facilitated a rapid pace of transition among the NIEs. Setting up high-speed communication and broadband technology was aided by the liberalization of telecommunication networks and related regulatory reforms. For economies such as the Republic of Korea and Taipei,China that have large export-oriented information equipment industries, the strong drive toward global competitiveness pushed them to develop robust broadband and multimedia industries in their own domestic markets. In the case of Singapore and Hong Kong, China, advanced infrastructure networks boosted their status as regional headquarters for large foreign multimedia companies (Agenor, Canuto, and Jelenic, 2012). Human capital accumulation facilitated innovation among the NIEs and enabled them to transform into knowledge-based economies. Human capital accumulation can contribute to more skilled workers who are capable of utilizing and creating new knowledge. By shifting towards a knowledge-based economy, a country needs to follow a development approach that emphasizes more on the quality of education, including R&D investments in science and technology. Figure 8 illustrates - 100 200 300 400 500 Republic of Korea Singapore Hong Kong, China People's Republic of China Malaysia Thailand Viet Nam Philippines India Indonesia Pakistan Japan United States Germany Patent applications (per 100,000 people) 1990 2014
16 | ADB Economics Working Paper Series No. 525 how high-income Asian economies in general have a stronger position in research and knowledge creation than middle-income economies. The NIE experience shows that combining R&D and human capital investments with a sound institutional environment which provides incentives for efficient use of knowledge can shift an economy from investment-led growth to innovation-led growth. One good example of such a transformation is the Republic of Korea, which moved up to high income on the basis of innovation, human capital, and infrastructure (Box 3). Figure 8: Knowledge Production: Selected Asian Economies Note: Figures in parentheses are averages. Sources: World Economic Forum. 2012. Global Competitiveness Report 2012–2013. Geneva; Dutta, Soumitra, ed. 2012. The Globalization Innovation Index 2012. Fontainebleau: INSEAD. 0246 Thailand Sri Lanka Philippines Pakistan Malaysia Indonesia India People's Republic of China Bangladesh Taipei,China Singapore Republic of Korea Hong Kong, China Quality of science and research institutions High income (5.1) Middle income (3.8) 0246 Thailand Sri Lanka Philippines Pakistan Malaysia Indonesia India People's Republic of China Bangladesh Taipei,China Singapore Republic of Korea Hong Kong, China Quality of education systems High income (4.9) Middle income (4.0) 0246 Thailand Sri Lanka Philippines Pakistan Malaysia Indonesia India People's Republic of China Bangladesh Taipei,China Singapore Republic of Korea Hong Kong, China University/industry collaboration in research High income (5.1) Middle income (3.8) 0 102030405060 Thailand Sri Lanka Philippines Pakistan Malaysia Indonesia India People's Republic of China Bangladesh Singapore Republic of Korea Hong Kong, China Creative output index High income (42.0) Middle income (30.1)
Asia’s Middle-Income Challenge: An Overview | 17 Box 3: Lessons from the Experience of the Republic of Korea The Republic of Korea’s journey toward a high-income economy benefited immensely from the adaptive policies and structural transformations which sustained its total factor productivity and economic growth. The experience of the Republic of Korea resonates more for larger developing Asian economies than the experiences of the other newly industrialized economies because the Republic of Korea itself has a large population—more than 50 million as of 2016. During its period of rapid growth, the country underwent a structural shift from labor-intensive to capitaland technologyintensive industries. From the 1960s until the early 1970s, resource-based light industries spurred the Republic of Korea’s export-oriented growth. Capital-intensive industries, such as heavy and chemical industries (medium and high-technology industries), started to rise in the 1970s, lasting until the mid-1980s when high-technology industries started to surge. Its transition was supported by liberalization efforts. The government initiated key market-oriented reforms in the early 1960s until about the mid-1980s. Then, in the 1990s, it deregulated its finance sector, leading to more competition and better banking efficiency (Williams and Nguyen 2005). Support for human capital accumulation through education reforms also played a critical role in the country’s transition. During the 1960s and 1970s, secondary education was made universal, while vocational and technical high schools were established to meet skills demand of manufacturing industries. In the early 1980s, the Republic of Korea expanded tertiary education to boost human capital and adapt to the transition toward advanced industry. Alongside education reforms, the Republic of Korea built up its research and development (R&D) capacity to enhance human capital. In the 1960s and 1970s, the country passed laws to promote science and technology and established science and technology institutes, adopting the United States graduate education and research system. In particular, the government passed The Science and Technology Promotion Act and The Science Education Act in 1967. It also established the Korea Institute of Science and Technology in 1966 and the Ministry of Science and Technology in 1968. In 1971, the government founded the Korea Advanced Institute of Sciences Act that highlighted R&D and adopted the United States graduate education and research system. During its transition to upper-middle-income status, the Republic of Korea’s knowledge production increased tremendously. The number of patents registration increased from 2,609 in 1981 to 11,683 in 1994 and the number of scientific and technical journal articles increased by nearly six times, from 424 in 1985 to 2,931 in 1994 (Box Figure). In the 1980s, the government encouraged the private sector to participate in R&D activities with policies such as tax subsidy and accelerated depreciation. Even small and medium-sized enterprises were actively involved in R&D, with some small and medium-sized enterprises allocating as much as 10% of total sales to R&D (Park 2000). Development of advanced infrastructure such as mobile telephone and broadband networks was also important in driving innovation in the Republic of Korea by lubricating knowledge creation and dissemination. Thus, various initiatives enabled the country to move toward the production of high-technology goods. Between 1988 and 1994, the country’s proportion of high-technology exports to total manufacturing exports increased from 15.9% to 22.7%. This feat was achieved before the Republic of Korea turned high income in the mid-1990s. Box Figure: Selected Technological Development Indicators for the Republic of Korea Sources: Korea Intellectual Property Office. http://www.kipo.go.kr/upload/en/download/Registrations.xls; and World Bank. World Development Indicators online database. http://databank.worldbank.org/data/home.aspx (both accessed 13 October 2016). 20 40 60 80 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 No. of registrations (thousands) Patents Utility models Designs Trademarks Total 0 0.5 1.0 1.5 2.0 2.5 0 1 2 3 4 5 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Number per 100 people Number (thousands) Scientific and technical journal articles Mobile cellular subscriptions (right axis) Lower-middle to upper-middle-income transition Upper-middle to high income transition
18 | ADB Economics Working Paper Series No. 525 IV. ADDRESSING THE MIDDLE-INCOME CHALLENGE Drawing on the analysis, this section describes the broad contours of the policy options available for Asian economies to overcome the middle-income challenge. The middle-income challenge is a global issue rather than an Asia-specific issue, and middle-income countries across the world are confronted with similar constraints to growth and must pursue similar policies to overcome those constraints. That is, the PRC and Thailand face similar constraints and policy options as Brazil and Mexico. Above all, in order to grow rapidly and eventually reach high income, middle-income economies must foster TFP growth. Although investment will continue to play a major role in economic growth after a country graduates from low income to middle income, productivity growth is likely to play a relatively larger role. While the growth of low-income countries is driven largely by more workers and machines, the growth of middle-income countries depends, to a larger extent, on better,—i.e., more productive, workers and machines. The experience of the NIEs, one of the few economies to escape the middleincome trap, underlines the central role of innovation in the middle-income to high-income transition. Therefore, one key policy direction is for governments to invest in innovation and encourage the private sector to invest in innovation. A specific example is public investment in information and communication technology and broadband. Besides innovation, more efficient resource allocation can also contribute to higher TFP. Investment and TFP growth are not mutually exclusive, and the growing relative importance of TFP in growth does not dilute the contribution of investment to growth. In particular, one type of investment—infrastructure—can foster TFP growth. Infrastructure such as roads, ports, and power plants raises the productivity of the entire economy rather than just specific groups of firms and industries. While Asia has invested heavily in infrastructure in the past, the region still faces huge investment needs in the future. Developing Asia as a whole is in the midst of a demographic transition toward older populations. Population aging further strengthens the case for investing in human capital. To some extent, more skilled workers can compensate for slower growth, or even decline, of the workforce. Having reached middle income, which typically entails deeper integration into the global financial and trade systems, developing Asia will be more vulnerable to external shocks. Therefore, sustaining growth requires resilience against shocks and crises which can derail mediumand long-term growth trajectory. Asia’s journey from middle income to high income will be a much more challenging journey than its relatively fast and smooth journey from low income to middle income. Empirically, very few countries around the world made the final jump from middle to high income although plenty of countries moved up from low to middle income. This stylized fact attests to the difficulty of shifting from an input-based growth model to a productivity-based growth model. Yet some countries, most notably the Republic of Korea and the other NIEs from developing Asia, were able to innovate their way from middle to high income. This gives some cause for optimism about developing Asia’s ability to continue to grow rapidly and eventually reach high income.