The Unassuming Economist

From Tony Blair Institute for Global Change:

“Since the early 2010s, economists and policymakers have noted that several countries are stuck in what has come to be known as the “middle-income trap”. Three main explanations are posited:

1. Lack of structural transformation and weak industrial policies: the level of development of productive capacities, which includes the level of export sophistication, the change in their composition through comparative advantage and the state’s role in industrial upgrading.
2. Lack of human-capital development and innovation: the unsuccessful transition to innovation-based growth (from factor-based growth), notably due to lack of investment in research and development (R&D) and education.
3. Poor governance, weak institutions and an extractive political economy: the low quality of institutions and government effectiveness, and the role of political economy and political stability in explaining countries’ development paths.

While few countries have succeeded in their transition to the high-income level – based on gross national income (GNI) – including the East Asian “tiger economies” of South Korea, Taiwan, Hong Kong and Singapore, the development trajectory of several countries currently in the middle-income trap validates the explanations cited in the academic literature on the subject. In this paper, we highlight the development paths of successful countries like South Korea, and of middle-income countries that are in the trap or at risk of being trapped, such as Malaysia, Brazil, Tunisia, Morocco, Vietnam and Bangladesh.

There are three factors that have contributed to South Korea’s success: a well-planned and consistent government policy combined with effective implementation, conditional support to companies that ensured the reduction of the rent-seeking approach, and an effective channelling of public resources, together with an early transition towards innovation, including a focus on short-cycle technology-based sectors.

The experiences of Malaysia, Brazil, Tunisia, Morocco, Bangladesh and Vietnam highlight that economic growth is not enough to enable countries to move up the income ladder. It is essential to have a commitment to industrialisation, to strengthening the rule of law and to moving away from an extractive political economy, and this must be set against the backdrop of political stability and equality. In addition, the level of investment in both human-capital development and innovation is a significant variable in determining countries’ development paths and in explaining their middle-income trap.

Latin America – with the notable exception of Chile – has failed to make the transition from middle-income to high-income status. In this paper we take the example of Brazil which, in common with much of the region, had – in the 1960s – been predicted to achieve a level of growth that would ultimately have led to it reaching the high-income level. However, poor levels of investment, low take-up of tertiary education, political instability and high inflation have all conspired to leave Brazil mired in the middle-income trap for more than half a century.

Ghana and Kenya, both of which have the potential to become the dominant hubs in west and east Africa respectively, have witnessed relatively high economic growth over the past decade and have transitioned quite recently to the lower-middle-income status. Both countries have the capacity to become pre-eminent centres of innovation and to help drive growth and trade in neighbouring countries. However, their current growth is not geared towards economic transformation, and there are signs that both countries are at a high risk of remaining trapped at the middle-income level. Productivity in agriculture remains low and exports of goods are concentrated on natural resources (oil and gold in Ghana and unprocessed agricultural products in Kenya) with only a small number of technology-intensive products. Moreover, the level of human-capital development remains relatively low compared with other lower-middle-income countries such as Tunisia and Morocco. Services play an important role in both economies but most jobs are in low-productive service sectors such as wholesale and retail. The digital economy and other highly productive sectors such as financial services have significant potential for growth in both countries, given the emerging technology hubs in Accra and Nairobi, but they currently represent a small share of service exports and don’t create enough jobs fast enough.

It is essential for both countries to invest in industrialisation by focusing on agri-processing, manufacturing and high-value-added tradable services enabled by information and communications technology (ICT) and other innovations, following a consistent, pragmatic and visionary approach. For industrialisation to be successful, it is important for political leaders to consider it as a political project to transform the economy by building productive industries, rather than seeing it as a technocratic reform. This political project requires strong political coalitions, institutional capacity and alignment within government for effective implementation, areas where both Ghana and Kenya can significantly improve. In parallel, there is a need to improve critical enablers for industrialisation, including agriculture transformation, human-capital development, energy access and reliability, while ensuring macroeconomic stability and a business environment conducive to entrepreneurial activity.”

From a NBER paper by Pierre Bachas, Matthew H. Fisher-Post, Anders Jensen and Gabriel Zucman:

“How has globalization affected the relative taxation of labor and capital, and why? To address this question we build and analyze a new database of effective macroeconomic tax rates covering 150 countries since 1965, constructed by combining national accounts data with government revenue statistics. We obtain four main findings: (1) The effective tax rates on labor and capital converged globally since the 1960s, due to a 10 percentage-point increase in labor taxation and a 5 percentage-point decline in capital taxation. (2) The decline in capital taxation is concentrated in high-income countries. By contrast, capital taxation increased in developing countries since the 1990s, albeit from a low base. (3) Consistently across a variety of research designs, we find that the rise in capital taxation in developing countries can be explained by a tax-capacity effect of international trade: Trade openness leads to a concentration of economic activity in formal corporate structures, where capital taxes are easier to impose. (4) At the same time, international economic integration reduces statutory tax rates, due to increased tax competition. In high-income countries, this negative tax competition effect of trade has dominated, while in developing countries the positive tax-capacity effect of international trade appears to have prevailed.”

Source: Project Syndicate

In a recent column, John H. Cochrane of the Hoover Institution and Jon Hartley of Foundation for Research on Equal Opportunity write about the US’ long-ignored issue of supply-chain bottlenecks contributing to raging inflation today.

“The return of inflation is an economic cold shower”

They write how sclerotic growth in the country is not so much due to the “secular stagnation” of demand-side factors, but more due to clogging of the economy’s productive capacity. “The United States needs infrastructure. The problem is not money. The problem is that building anything in America has become almost impossible, owing to the thicket of regulations and lawsuits that will stop or drive up the costs of any project.” Barriers such as rocketing housing costs, deteriorating quality of public education, restrictive labor laws, trade protectionism, and other things all add to the problem. The authors also discuss some solutions to systematically eliminate such challenges.

From a NBER paper by Hites Ahir, Nicholas Bloom and Davide Furceri:

“We construct the World Uncertainty Index (WUI) for an unbalanced panel of 143 individual countries on a quarterly basis from 1952. This is the frequency of the word “uncertainty” in the quarterly Economist Intelligence Unit country reports. Globally, the Index spikes around major events like the Gulf War, the Euro debt crisis, the Brexit vote and the COVID pandemic. The level of uncertainty is higher in developing countries but is more synchronized across advanced economies with their tighter trade and financial linkages. In a panel vector autoregressive setting we find that innovations in the WUI foreshadow significant declines in output. This effect is larger and more persistent in countries with lower institutional quality, and in sectors with greater financial constraints.”

Source: VoxEU CEPR

Abstract:

The real pay of typical workers has grown much more slowly than productivity over recent decades in several developed economies. This column uses data from the US and Canada to examine whether productivity growth actually benefits typical workers by raising their pay. The authors find strong evidence of linkage between productivity and pay in the US but more mixed evidence for Canada, possibly due to it being a smaller, more internationally open economy. Overall, the findings suggest that measures to boost productivity growth are important for raising pay for the average and typical worker.