In a publication of the Asian Development Bank in 2011 entitled Asian 2050: Realizing the Asian Century, the phenomenon of the “middle income trap” was first clearly defined. Middle income trap refers to countries stagnating and not growing into advanced countries of high-income level. In the last 30 years or so, many middle-income countries, a good number in Latin America, have been caught in a situation in which they are unable to compete with low-income, low-wage economies in manufacturing exports and are also unable to compete with advanced economies in high-skill innovations. Such countries cannot make a timely transition from resource-driven growth, with low-cost labor and capital to productivity-driven growth.
The classic example is the contrast between South Korea on the one hand and two middle-income countries — Brazil and South Africa — on the other, over a 30-year period (1975 to 2005). In 1975, South Korea was still a low-income country with less than $1,000 per capita while South Africa in the same year already had per capita incomes three times that of South Korea. By 2005, South Korea’s per capita income ballooned to over $20,000 while those of the two middle-income economies failed to grow above $10,000, clearly trapped in their middle-income status.
For perspective, let us cite some data from an article by Jesus Felipe entitled “Tracking the Middle-Income Trap: What Is It, Who Is In It and Why?” (March 2012). In 2010, out of 124 countries with available data, there were 52 middle-income countries, of which 35 were caught in the middle-income trap. There were four income groups of GDP per capita that were surveyed in the article. Using 1990 purchasing power parity dollars, the categories were as follows: low income ($2,000 and below); lower middle-income ($2,000 to $7,250); upper-middle income ($7,250 to $11,750); high-income (above $11,750).
In 2010, there were 40 low-income countries in the world, 38 lower-middle income, 14 upper-middle income, and 32 high-income. The paper calculated the threshold number of years for a country to be considered as being caught in the middle-income trap. A country that becomes lower-middle income (i.e., that reaches $2,000 per capita) has to attain an annual average growth rate of per capita income of at least 4.7% to avoid falling into the lower-middle income trap (i.e., to reach $7,250, the upper-middle income threshold). A country that reaches upper-middle income (attains $7,500) has to grow at an average annual rate of per capita income of at least 3.5% to avoid falling into the upper-middle income trap (i.e., to reach $11,750 which is the high-income threshold). Avoiding the middle-income trap is, therefore, a question of how to grow rapidly enough so as to cross the lower-middle income segment in at most 28 years and the upper middle-income segment in at most 14 years. We shall consider these indicative figures in assessing how long, if ever, it will take the Philippine economy to attain high-income status.
To complicate matters, these figures have been slightly modified in 2020 figures. Today, the low-income threshold is $1,036 and below; lower-middle income is $1,036 to $4,045; upper-middle income is $4,045 to $12,535. A country with a per capita income in nominal terms (not purchasing power parity) of $12,535 or more is considered today as high-income. Before the pandemic struck, the Philippines was on the road to attain upper-middle income status by 2021. Unfortunately, the big decline of GDP of -9.1% in 2020 has temporarily delayed this transition. Depending on how fast we can recover our GDP annual growth of 6% to 7% (or more), it may take us another three to four years to cross the threshold to upper-middle income category.
In 2019, our per capita GDP in nominal terms was already at the level of $3,511.94 as compared with Vietnam that registered a per capita income of $3,372.52 in the same year. Because Vietnam was able, at least in the beginning, to manage the pandemic challenge more efficiently, its economy was one of the few in the world to attain a positive growth of GDP in 2020 so that last year, its GDP per capita of $3,497.51 was already exceeding ours which dropped to $3,372.53. In addition to its more efficient response to the pandemic, I attribute Vietnam’s surpassing us to other factors: their State has been very responsive to the needs of their small farmers for the required resources to improve their productivity (Vietnam achieved the admirable feat of surpassing Brazil in coffee exports in less than a decade). Another reason why Vietnam has outperformed us and will continue to be ahead of us in per capita income growth is its being much more open to foreign direct investments than we are. In the last five years or so, the volume of FDIs entering Vietnam has been more than double ours. As our government will have to struggle to bring down the high debt-to-GDP ratio that has resulted from massive borrowings during the pandemic, it will be very difficult to continue funding the Build, Build, Build program in the coming years without our having recourse to massive amounts of foreign direct investments, especially in public utilities, infrastructure, and the digital sector. This is one reason why we have to remove the many restrictions that still exist against FDIs. Otherwise, we can be caught in the middle income trap for a long time.
Assuming that we can recover our average annual growth of 6-7% in GDP by next year, it will take us up to 2025 to become an upper-middle income economy that will be at the range of $4,046 to $12,535 per capita. If we can maintain that average for some 22 years, we shall attain the status of a high-income economy before 2050, a time horizon during which the millennials and centennials of today can reasonably expect to still be alive (life expectancy during their generations will be about 81 years for women and 79 years for men). I arrive at these figures by assuming that the average population growth rate annually will slow down to 1% annually. Given a GDP growth rate of 6% annually, that means per capita income will grow at 5% annually. At that rate, the GDP per capita of a little over $4,000 in 2025 will grow to a little over $12,000 (the threshold for a high-income economy) in 22 years.
In addition to the strong fundamentals that explained our having been able to grow at an average of 6.4% from 2010 to 2019, as celebrated by the World Bank, it is important that we add to these strengths what the Leader (Editorial) of The Economist advised all emerging markets to adopt post-pandemic. Let me quote from the closing lines of the Leader: “… the principles of how to get rich remain the same today as they ever were. Stay open to trade, compete in global markets and invest in infrastructure and education. Before the liberal reforms of recent decades, economies were diverging. There is time yet to avoid a return to the needless hardship of old.”
To be continued.
Bernardo M. Villegas has a Ph.D. in Economics from Harvard, is Professor Emeritus at the University of Asia and the Pacific, and a Visiting Professor at the IESE Business School in Barcelona, Spain. He was a member of the 1986 Constitutional Commission.