Growth Slowdown and the Middle-Income Trap in Asia James Riedel Johns Hopkins University and Fulbright Economics Teaching Program For presentation at the National Economics University of Ho Chi Minh City 21 October 2015

Motivation In Vietnam, one often confronts the view that comparative advantage leads to a dead end, where prosperity is limited to the level of productivity of unskilled labor in labor-intensive manufacturing (Vietnam Competitiveness Report 2010). The World Bank (2010, p.7) takes the same view: “For decades, many economies in Asia, Latin America and the Middle East have been stuck in this middle income trap, where countries are struggling to remain competitive as high volume, low-cost producers in the face of rising wage costs, but are yet unable to move up the value chain and break into fast- growing markets for knowledge and innovation-based products and services” More sophisticated versions of the same argument (Hausmann and Rodrik, 2003) appeal to market failures similar to those invoked to justify import-substitution industrialization in the 1960s, in particular learning and coordination externalities that inhibit spontaneous industrial development and movement up the ladder of comparative advantage. All of these arguments lead to the same conclusion: without an activist industrial policy, progress into and beyond the middle-income range will be stymied—lower middle-income countries will be stuck at the bottom rungs of the ladder of comparative advantage.

Questions What constitutes a middle-income trap? Growth slowdown in the middle income range? What explains growth slowdown in the middle-income range? Natural consequences of catch-up? Growth-inhibiting policies? Political constraints? What is the evidence of a middle income trap? What is the evidence that countries get stuck on the bottom rungs of the ladder of comparative advantage?

Growth slowdown due to natural causes: two competing theories Natural consequences of catching up with more advanced countries Diminishing returns to capital-deepening (Solow convergence)—closed economies Diminishing returns to technology catch-up (Lucas convergence)—open economies Diminishing returns to the reallocation of labor from agriculture to industry—all economies Long-run rate of growth of per capita income (y) Initial level of y across countries Annual rate of growth of per capita income (y) Per capita income (y) over time Solow: Diminishing returns to capital deepending Lucas: Diminishing returns to technology catch up and labor reallocation from agriculture to industry

Source: Lucas 2009, p. 7 Cross-country convergence Convergence is observed among open, not closed, economies Solow capital-deepening convergence applies, in theory, to closed economies, not open ones. But in closed economies convergence does not occur. Lucas technology catch-up convergence applies only to open economies, and it is only in open economies that convergence occurs. In short, openness and technology catch-up are the keys

Growth slowdown in Asia The consensus view: Taiwan and Korea avoided the middle income trap Malaysia and Thailand are in the middle income trap Both groups slowed down but Taiwan and Korea at per capita income of about $9,000, while in Malaysia and Thailand at about $4,000…but does this necessarily mean they are in a MIT? Why Malaysia and Thailand are trapped: In Malaysia, too much emphasis on redistribution which leads to corruption (Woo, 2009) In Thailand, too little emphasis on education and too much on mega infrastructure projects which lead to corruption (Warr, 2013).

KoreaThailand Korea versus Thailand: One stuck in the Middle Income Trap, the other not Or, is it more a matter of timing

Step one Step Two RCA RFI Korea versus Thailand: One stuck at the bottom rung of CA, the other not? Methodology

Korea versus Thailand: One stuck at the bottom rung of CA, the other not?

Export diversification in Korea versus Thailand Number of 5-digit SITC manufactured products exported Korea and Thailand

Those who allege a middle income trap usually attribute it to policy failures. But, if all that is required to escape a middle-income trap is a change in policy, then how can a country be considered to be “trapped?” There must be constraint that prevents or discourages policy makers from taking the necessary measures to restore growth to its potential long-run rate. Could that constraint be their own self-interest in growth inhibiting policies? An hypothesis: Policy makers are rent-seekers and set policy to maximize the rent they earn from exercising discretionary power to grant privileges to favored firms and individuals (e.g. licenses, land-use rights, contracts, employment, etc.) Rent (R) depends on policy (P) via two channels: The higher P, the less discretionary power in the hands of the authorities, the smaller the scope for rent-seeking The higher P, the fewer distortions in the economy, the larger the economy, hence the larger the scale of rent seeking. Political Growth Trap

Motivation R P* P

The relation between corruption and per capita income

The Level of Corruption/Rent-Seeking and Per Capita Income

Final Observations: