Middle-Income Trap: A Structural Interpretation

The problem of the so-called “middle-income trap” - i.e., when countries that have attained a certain level of development find it difficult to make the leap required to become an advanced economy - has become a topic of concern. The World Bank's China 2030 report shows that of 101 middle-income economies in 1960, only 13 became high-income by 2008. An Asian Development Bank study identifies 35 out of 52 middle-income countries - i.e., GDP per capita income of $2,000 and $11,750 - as being in danger of falling into the middle-income trap category (Felipe, 2012). An IMF study identifies “slow growth risk” countries, and tells a similar story (Aiyar et al., 2013).

With emerging economies - especially the BRICS - showing signs of sluggish growth, speculations on why and when are mounting. The policy solutions emanating from the media and working papers and blogs of these international organisations are ripe with high-growth strategies aimed at boosting the drivers of growth as dictated by the endogenous growth theory, and often restricted to “smart” - however defined - technological and innovation policies, as a means to industrial upgrading and enhancing firm capabilities.

The premise of the paper is that the drivers of growth alone cannot fully tackle the problem of the middle-income trap. This is because at the heart of the problem is that despite the on-going efforts to improve the drivers of growth, countries at a certain level of development are finding it difficult to make the leap. This suggests that the the strategies of avoiding the middle-income trap demands path-shifting structural transformation.

Hence, drawing on the recent discussions on the so-called ‘institutional theory of the firm’, the paper embarks on a structural analysis of a successful case, South Korea. As a star performer of the East Asian Miracle, the international development community has examined Korea’s growth experience extensively, and voluminous research exists. The paper recasts its eyes on the transition period - i.e., between the late 1980s and the late 1990s - to process-trace decades of institution-building and reforms. Here, attention is given to the financial system and industrial relations - and their coordination and complementarity - and how these arrangements have impacted leading firms’ resources and dynamic capabilities.

The paper argues that there were incremental but nevertheless transformative institutional reforms in the financial system and industrial relations in the decade leading up to Korea attaining the high-income status. The key challenge in this process was the mis-alignment between the transforming institutions on one hand, and the leading firms’ strategy and behaviour on the other, creating ‘structural inertia’ (Hannan and Freeman, 1984). While firms are not passive institution-takers, nor are they omnipotent actors able to make a clear sense of the transformative reforms, especially when changes are occurring across different areas of economy in a gradual but cumulative manner. The paper concludes by focusing on potential strategies that can faciliate the re-alignment of institutions and firms as lessons for today’s emerging economies facing the challenges of middle-income trap.