A phantom trap awaits Bangladesh
Other countries in Southeast Asia such as Indonesia, Thailand and the Philippines have also experienced the “middle-income trap” phenomenon. But India is perhaps the most intriguing example
The surprising and almost meteoric economic rise of Bangladesh has been one of the greatest success stories of economic development in the past few decades.
This burgeoning growth was finally validated when the United Nations General Assembly passed a resolution allowing Bangladesh to graduate from the ranks of the least developed countries (LDCs) to the developing country grouping.
Even though it was a momentous occasion, a lingering sense of uncertainty was present among the policymakers of the country.
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Many countries have previously displayed similarly drastic growth and achieved the rank of middle-income countries. But most of them have never been able to take the leap necessary to become a high-income country, remaining as a middle-income country for almost 40-50 years.
In fact, out of 101 middle-income countries that existed in 1960, only 13 would go on to become high-income economies in 2008, almost 50 years later. There are, of course, later additions to this list.
Countries like Argentina, Turkey, South Africa or Mexico showed boundless potential when they were becoming middle-income countries. But since then, their economies have failed to live up to their supposed potential. Some countries like South Africa and Turkey have even begun to regress.
This phenomenon may seem strange at first glance. Why would seemingly prosperous countries suddenly fail to sustain their growth?
To explain this pattern, economists Indermit Gill and Homi Kharas introduced the idea of a "middle-income trap" in 2007 by examining different economies in Latin America, the Middle East and East Asia.
The factors and walls that build the middle-income trap
Low-income countries experience rapid growth because their economies are still behind and cannot efficiently use all the resources at the disposal of these countries. As a result, when these countries receive even a low amount of investment, their economy begins to grow exponentially.
Coupling that with cheap labour costs and basic technological advances, it can further accelerate their growth.
Many economies also experience a significant reallocation of resources, from traditional sectors with low output to export-oriented highly productive sectors. This can be another catalyst for rapid economic advances.
But once these economies reach the middle-income level, they begin to stagnate. They experience a rise in wages and as a direct result, the rural labour force of these countries flock to the cities to get these lucrative wages.
As cheap labour becomes scarce, the production cost in these middle-income countries begins to increase. As a result, investors shift their capital to other low-income countries, which do not have such high production costs.
Concurrently, these middle-income countries often do not have infrastructure and resources for research and innovation, as they had previously focused mainly on manufacturing. The workers in these countries also do not possess sophisticated technological skills. As a result, they also lose their ability to compete with high-income countries.
This lack of competitiveness is demonstrated mainly in the slowdown of economic growth in these countries.
In an analysis of all growth slowdowns between 1960 and 2005, it was discovered that rapidly growing economies often experience disruptive slowdowns when they near the per capita income level of $10,000-11,000 (Tk 8,56,715-9,42,386) and $15000-16000 (Tk 12,85,072-13,70,744).
Other countries in Southeast Asia such as Indonesia, Thailand and the Philippines have also experienced this phenomenon. But India is perhaps the most intriguing example.
In May of 2019, Rathin Roy, an economic advisor to Prime Minister Narendra Modi warned that India's growth is faltering at its low-income levels. India's factory output had shrunk and wages began to decrease. According to Gill, without a significant course correction, India cannot sustain a 7%-8% annual growth.
Should Bangladesh worry?
As Bangladesh is fast approaching this threshold, it may cause concern for many policymakers. But surprisingly, some of them disagree with the middle-income trap model.
Upon close examination, it becomes evident that even the countries that are said to be trapped in the middle-income loop have experienced a steady increase in per capita income, this would contradict the trap like pattern.
Additionally, economist David Rosenblatt showed that the transition from middle-income to high-income does not take longer than the low-income to middle-income transition.
For example, it took 45 years for Bangladesh to gain recognition as a developing country. Therefore, it is logical to assume that Bangladesh would take a similar amount of time to transform itself into a high-income country.
"It is now accepted as a fact that rapidly growing, low-income economies slow down once they reach the middle-income threshold. As a result, any long-term economic policy must take this reality into account"
But economists and policymakers still prefer to construct policy while anticipating the middle-income trap. Dr Mustafizur Rahman, distinguished fellow at Centre for Policy Dialogue said, "It is now accepted as a fact that rapidly growing, low-income economies slow down once they reach the middle-income threshold. As a result, any long-term economic policy must take this reality into account."
Besides the lack of competitive advantage, Dr Rahman also identifies a lack of diversification as a catalyst for the middle-income trap.
"Low-income economies often focus on one sector or focus on exporting to one specific destination," Dr Rahman added, "As a result, when they lose their advantage in that particular sector or export destination, their economies begin to fall apart."
Bangladesh has already declared its intention of becoming a high-income country within 2041. Dr Rahman has some reservations about this endeavour.
"We cannot be certain about this," he added, "Bangladesh has to experience a steady 10% growth over the course of 20 years to become a high-income country that quickly. It is extremely challenging, but that does not mean it cannot be done."
In fact, the countries that have escaped the middle-income trap, namely South Korea and Taiwan, have always grown rapidly. The speed of their transformation is often credited to several underlying factors such as low inflation, rapid industrial transformation, quality education and reduced inequality.
It is not only necessary for Bangladesh to replicate these traits but adopt new policies to bring the best out of the resources available to us. "Innovation and education will be the key for transforming Bangladesh into a high-income economy.", Dr Mustafizur Rahman remarked, "It is crucial to remember that we will have to compete with advanced economies to become a high-income country. That can only be done through innovative solutions to our problems."
The middle-income trap is a confusing conundrum. But that does not take away from the necessity to prepare for the next transition, Bangladesh has to complete that in order to maintain its steady and speedy rise as an economic powerhouse.
