If you are interested in economics, you are probably familiar with the term “middle-income trap”. To refresh our memory, it argues that low-income countries could relatively easily move up to become a middle-income one, due to mainly cheap and unskilled labor force and demographic dividend. However, they face difficulties in carrying reforms, mainly those regarding productivity gains, which would help them to move higher, thus being trapped in middle-income category. After reading some articles arguing that the difference between emerging and advanced economies might never disappear, we have decided to explore the subject a little bit.
First, some definitions… There is no clear-cut rule about which countries are considered as advanced (or developed, or high-income) and which are emerging (or developing, or low&middle income) among different parties. For example IMF’s “emerging and developing economies” cover 152 countries, while the World Bank’s equivalent “low and middle income countries” means 139. In fact, even these specifications, especially “emerging” countries has started to be criticised recently. This year, the World Bank had announced that it would no longer use the terms “advanced” and “emerging” economies, since they were outdated.
Furthermore, we don’t have much indicators for measuring when an emerging market economy is promoted to “advanced” status. Among those few, the most accepted one can be said to be the World Bank’s “low”, “middle” and “high” income country groups. It assumes that high income countries were those with Gross National Income (GNI) per capita more than 6000$, in 1987 prices. The World Bank deflates this number each year with the average inflation rate of advanced economies (G5, until 2001 and G3, since then), carrying the high income threshold to 12475$, at 2015. For our first graph, we use the IMF’s inflation forecasts to extend this threshold until year 2021.
Since we have set our target to be rich (!), we can assess the emerging markets’ (upper high income group according to the World Bank) performance relative to this target, for the past 28 years. Looking at the next graph, this performance could be easily divided into two parts. During the first period covering 1987-2001, we see an almost horizontal movement, suggesting that the emerging markets were not so successful in closing the gap with advanced economies. However, after 2001, we see an impressive convergence, even the 2008 crisis fails to stop.
We can attribute this strong performance to several key factors, among others: (1) China’s accession to WTO in 2001 and then rapidly integrating herself to global trade, (2) the positive spillover of strong growth in advanced economies and (3) positive effect of price supercycle on commodity exporters, mainly the result of previous two factors.
However, as the positive effects of these factors slowly vanish, the convergence between emerging and advanced economies slow down and the emerging economies fail to close the gap with advanced countries in 2015, for the first time since 1999. Of course, the slow down in China, as well as recessions in Brazil and Russia, has a great role in this. Nevertheless, the stalling of the convergence is disturbing, especially given the fact that the high income threshold had not grown (and even decreased marginally) in 2014 and 2015.
Yet, it does not make great sense to draw conclusions by looking at only one years’ outcome (anyways, your good old author always tends to see the glass half-full). We can still expect the convergence to continue, as development theory suggest that emerging markets could keep growing at a higher rate than advanced countries. Let’s see if medium-term outlook confirm this… Here we employ the growth differences between country groups, in terms of per capita GNI rates by the World Bank and total GDP by the IMF. Our next graph confirms the story above until 2015; a sluggish performance until 2001, a fast convergence after that and, most recenlty, a sudden slowdown.
The IMF forecasts, covering the 2016-2021 period, suggests some pick up in convergence between emerging and advanced economies. However, this pick up does not match the strong performance of 2000-2010 period. Moreover, we should note that the difference between the growth rates of per capita GDP (or GNI by the World Bank) would be lower, due to faster increase in population in emerging markets. As one would notice, the above graph supports this argument, with the convergence of per capita GNI mostly stays under that of total GDP growth.
In fact, we were already feeling the problem with emerging markets growth for the past years and this is the main reason that structural reforms were getting a permanent slot at the top of their agendas. However, these round of structural reforms are easier said than done.
The previous round of structural reforms, taken mostly during 1990’s and early 2000’s, were generally regulatory measures, which had transformed the institutions and the financial system and/or efforts, which helped building sound fiscal systems, etc. These reforms helped emerging markets to lay a solid ground and escape the 2008 crisis relatively unharmed.
However, this time the necessary structural reforms are generally related to productivity gains, like education, labor market or technological advances. These usually might require some short-term pains for longer term gains, which is not a pleasant preference for many governments. It is hard to find politicians, who would risk losing the next elections, in favor of a bright spot in future history books. Therefore, not many emerging market economies choose to adopt these reforms and, as a result, they get trapped in middle-income category.
To summarize this long post, emerging markets are going through a difficult period. They need to be more productive, if they want to catch advanced countries sometime. However, it is not easy to take those steps, particularly at a global economic conjoncture, which is not supportive.
“I am sorry my dear child, we will stay poor for a while…”