Middle Income: It's a trap!

November 06 2023
Jaime Garcia

The region is at a crucial point in its economic development, mired in the so-called "middle-income trap", a state of stagnation where, despite having economic growth, countries are unable to make the leap to a low-income economy. high income due to structural barriers. 

What is the middle income trap?

The middle-income trap occurs when a country achieves initial economic growth but is soon slowed by several factors, such as competition from countries with lower production costs and a lack of innovation and productivity improvement. The region has experienced this phenomenon, as it has not been able to consolidate sustained growth that drives it to high economic income. 

Looking at the performances in the growth of the Gross Domestic Product (GDP) per capita adjusted by purchasing parity during the last decade, it is clear that the Central American region reflected a diversity of performances, where Panama stood out by maintaining an annual growth rate of GDP per capita of 3.75%, the highest among its neighbors and following a trend of sustained growth since the 90s. Costa Rica, although with a slight decrease in its pace, continued to show a stable economy with an average increase of 2.50% annually. 

Meanwhile, Nicaragua and Honduras managed to reverse the lowest trends of the 90s, improving their figures to growth rates of 2.14% and 1.57% annually respectively in the 2010s, evidencing significant economic advances. El Salvador and Guatemala, which make up the intermediate group, also experienced improvements compared to the previous decade, registering growth rates of 2.05% and 1.82% annually, respectively.

Has this performance been good? Comparing with South Korea a country that emerged from the middle income trap, it is found that in 1990 it had a GDP per capita adjusted by purchasing parity of 12,656 dollars (2017 constants), barely higher than the 11,212 dollars of Panama and 9,811 of Costa Rica, but the Asian country had 6.02% average growth in that decade. Thus, 30 years later, in 2022 South Korea has a GDP per capita of 45,467 dollars, with a high level of income, and with a figure much higher than the 33,266 dollars of Panama and 21,987 dollars of Costa Rica, the two countries with the highest per capita income in the region (see figure 1).

Figure 1

Source: Own calculations with data from the World Bank

How to get out of the trap?

The data shows us that there is growth, but we are still dealing with fundamental challenges that restrict sustained and significant growth to make the leap, since what we have had is a result of insufficient investment in innovation and technology, education and training of the human capital that does not meet global expectations, inadequate infrastructure, economic and social inequalities, and a poor business and governance environment. In this sense, the following changes are required:

Innovation for competitiveness: Support research and development and promote collaboration between the private sector and academic institutions to stimulate global competitiveness. Remembering that the ability to innovate determines the long-term competitiveness of an economy in the global market

Future-oriented education: Invest in quality education and technical training aligned with the needs of the international labor market and technological trends. Although there have been improvements in enrollment rates, the quality of education and the development of advanced skills still lag behind high-income economies.

Better infrastructure: Prioritize infrastructure development to increase efficiency and attract investment. Guaranteeing good functioning and resilience to natural disasters.

Social inclusion: Implement policies that address inequality and promote equitable distribution of income and opportunities. Urban-rural inequalities and between different social groups perpetuate poverty and limit internal demand, which is essential to sustain growth.

Better institutions: Simplify bureaucratic processes and strengthen law and order to improve the business environment and attract investment; that is, guarantee certainty. Excessive bureaucracy, corruption and political instability deter foreign direct investment and weaken confidence in the local business environment.

Have clear goals

Of course, escaping the middle-income trap is not a simple task; there are social, technological, economic and institutional issues that have to be addressed. This means having a sustained commitment to clear and coherent policies that address the roots of economic inertia. And furthermore, doing so in an uncertain, vulnerable, risky, and ambiguous global context further complicates the scenario. But at the same time it is clear that inaction or complacent incremental progress are not viable options; A dynamic and comprehensive strategy is required that addresses these challenges with the urgency and seriousness they deserve. Achieving a region with greater income and social progress in the coming years will depend on us truly understanding that it is urgent to change and accelerate to prosper.