Sustained Growth of Middle-Income Countries
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1 Sustained Growth of Middle-Income Countries Thammasat University Bangkok, Thailand 18 January 2018 Jong-Wha Lee Korea University
2 Background Many middle-income economies have shown diverse growth performance over the past half century. There is a concern that many emerging economies will never match the advanced economies, in terms of their per capita income, and would be rather trapped in a middle-income status. Some argue the middle-income trap hypothesis, which implies that an economy transitioning from a middle-income to a high-income status is more likely to experience a sharp growth slowdown, thus failing to advance to the high-income status. 2
3 Diverse Growth Performance over : A Sample of 110 Economies Per capita GDP growth rates, Note: PPP(Purchasing Power Parity)-adjusted 2011 constant international price Source: Penn World Table 9.0 (Feenstra et al., 2015). 3
4 Income Convergence and Growth Deceleration: Selected Economies Per capita GDP, Per capita GDP Year US Singapore Korea China Brazil Thailand Mexico D.R. Congo Note: PPP(Purchasing Power Parity)-adjusted 2011 constant international price Source: Penn World Table 9.0 (Feenstra et al., 2015). 4
5 Main Questions What are the factors enabling middle-income economies to achieve rapid convergence to a high-income status? What causes middle-income economies to suffer from significant growth deceleration, thereby being trapped in a middle-income status? Does data support the middle-income trap hypothesis? What are the effective policies for maintaining strong and persistent growth? (A specific case): How can we explain the economic growth and convergence of South Korea? 5
6 Objectives and Methodologies Investigate the sources of sustained long-term growth, with particular reference to experiences of middle-income emerging economies, over the past half-century. Analyze different growth episodes, theoretically and empirically : Convergence successes vs. Non-successes Middle-income trap vs. No middle-income trap Assess the concept and existence of the middle-income trap and the middle-income trap hypothesis Examine empirically the determinants of convergence success and middle-income trap 6
7 References Lee, J.-W., Convergence Success and the Middle-Income Trap, 2017, Working Paper. ( Lee, J.-W., Korea s economic growth and catch-up: implications for China. China & World Economy, 2016, 24(5),
8 I. Concepts of Various Growth Episodes Income Convergence, Growth Deceleration, and Middle-income Trap 8
9 Conditional Convergence Theory The evolution of the per capita income level and growth rates over time can be explained by the conditional convergence theory. A country with a low level of initial per capita income relative to its own steady-state potential has a higher growth rate than a country with a higher level of per capita output. - Greater gaps of its current physical and human capital stock and technology from its potential levels imply higher rates of return to investment and greater benefits of adopting advanced technologies. A growth rate of an economy declines as it approaches its steady state. The steady-state level of per capita output is determined by a group of external environmental and policy variables. The convergence to the steady-state takes a long period of time. 9
10 Determination of Economic Growth During Transition The conditional convergence suggests that during the transition to the steady-state, the economy s per capita income growth rate is determined by three terms: - (1) The rate of technological progress (total factor productivity growth) - (2) The convergence factor: the gap between the economy s current level of per capita output and the U.S. level. - (3) The level of the economy s steady-state income relative to the steady-state level of the U.S. We can analyze growth paths of middle-income economies based on different assumptions on (1), (2) and (3). 10
11 Convergence Paths of a Hypothetical Middle-Income Economy, Relative Level of Per capita GDP Per Capita GDP Growth Rates Per capita GDP relative to U.S Per capita GDP growth rate Year Benckmark Scenario A Scenario B Year Benckmark Scenario A Scenario B The benchmark scenario: An economy is assumed to have 10% of the U.S. per capita GDP in 1960, the convergence speed (ββ) is 0.02 per year, the relative level of the steady-state income ( yy ) = and the technological growth rate (xx)= 1.9% per year. Scenario A: Scenario B: yy yy UUUU yy yy UUUU = and xx= 3%. = and xx= 0.5%. yy UUUU 11
12 Convergence Process with Growth Deceleration Relative Level of Per capita GDP Per capita GDP relative to U.S Year Benckmark Covergence Path Non-Trapped Trapped Convergence: The hypothetical economy in the benchmark scenario converges to a high-income status in the steady-state, following its convergence path. Growth deceleration: an economy changes its growth path downward, experiencing a sharp decline in growth rates over a sustained period. Middle-income trap: a middle-income economy experiences significant growth deceleration, thereby failing to advance to a high-income status. 12
13 II. Identification of Convergence Success, Growth Deceleration and Middle-Income Trap 13
14 Identification of Middle-Income Economies Existing studies adopt the classification of income categories based on the absolute level of per capita income or its relative level to the U.S. - Both absolute and relative income-based approaches are subject to the limitation as they rely on arbitrary thresholds to set the middle-income economy. - We adopt a relative income-based classification for both the theoretical and practical reasons. We divide countries into three income groups low, middle, and high based on PPP per capita GDP relative to the U.S. - Low-income economies less than 5%, middle-income economies between 5% and 40%, and high-income economies above 40% of U.S. PPP GDP per-capita. We identify 75 middle-income economies in 1960 and 51 in
15 Convergence Successes and Non-Successes Per capita GDP relative to the U.S., 1960 and 2014 Note: PPP(Purchasing Power Parity)-adjusted 2011 constant international price Source: Penn World Table 9.0 (Feenstra et al., 2015). 15
16 Identification of Convergence Success We classify middle-income economies into convergence successes and non-successes, based on their speed of transition to the high income status. A convergence success must meet either of the two conditions: - (i) if an economy has ever completed a transition from middle-income to high-income status over the period, , - (ii) if an economy grew at an average annual per-capita GDP growth rate of over 3% during the period of We identify 14 middle-income economies that graduated to high-income and the other 9 economies as convergence successes. - The 14 graduates includes Chile; Cyprus; Greece; Hong Kong, China; Ireland; Japan; Korea; Malaysia; Malta; Portugal; Seychelles; Singapore; Spain; and Taiwan. - According to (ii), China, India, Indonesia, Mauritius, Panama, Romania, Sri Lanka, Thailand, and Tunisia are classified as convergence successes. 16
17 Middle-Income Convergence Successes Economy Real per capita GDP relative to the U.S. in 1960 Real per capita GDP relative to the U.S. in 2014 Year the economy graduated to highincome Average per capita GDP growth rate, during middleincome Average per capita GDP growth rate, Graduated to High-Income Chile Cyprus Greece Hong Kong, China Ireland Japan Korea Malaysia Malta Portugal Seychelles Singapore Spain Taiwan Not Graduated to High-Income China (PRC) India Indonesia Mauritius Panama Romania Sri Lanka Thailand Tunisia
18 Identification of Growth Deceleration and Middle- Income Trap Definition of Growth Deceleration - An incident in which an economy with an average per capita GDP growth rate of 3% or greater over the preceding period (7 years) undergoes a decrease in the average per capita GDP growth rate by 2 % points or more over at least 7 years. - We identify 152 growth decelerations over the period, which corresponds to 14% of the total sample. Definition of Middle-Income Trap - The middle-income trap corresponds to the episodes of growth deceleration in the convergence non-successes. - We identify 89 growth decelerations for middle-income economies, of which 57 episodes took place in convergence non-successes. - The frequency of growth decelerations for the entire group of middleincome economies was 17% in the sample of 5-year periods, and almost the same between middle-income successes and middle-income non-successes. 18
19 Growth Deceleration Episodes of Convergence Successes China Per capita GDP Year South Korea 19
20 Growth Deceleration Episodes of Convergence Non-Successes Brazil Mexico 20
21 Growth Deceleration Episodes of Convergence Successes- Thailand Thailand Per capita GDP Year 21
22 No Support of the Middle-Income Trap Hypothesis There is no clear pattern that the relative frequency of growth deceleration is higher when the relative income approaches to the upper middle-income. 22
23 III. Determinants of Convergence Success and Middle-Income Trap: Empirical Analysis 23
24 Determinants of Convergence Success and Middle- Income Trap Empirical Framework - Identify the major factors that are significantly associated with the probability of an economy being a convergence success or falling into the middle-income trap over the past half century Data Probit specification: a binary variable for convergence success or middle-income trap as a dependent variable Explanatory variables: demographics and human capital; institutions; macroeconomic environment and policies; economic and industry structure; and external shocks Control variables: per capita GDP relative to the U.S. and period dummies - A panel set of cross-country data for 75 countries over 10 five-year periods from Estimation technique - Probit with one explanatory variable or multiple regressors - Estimation with or without instrument variables (IVs) 24
25 Major Factors for Convergence Success: Probit Estimates Variable Demographics and human capital Average years of schooling + *** Fertility rate, total - *** Life expectancy + *** Dependency ratio - *** Institutions and politics Rule of law + *** Regulation + Freedom to trade internationally + *** Democracy indicator + Macroeconomic environment and policies Investment share + *** Price level of investment - *** Log (1+CPI inflation) - *** Public debt/ GDP - *** FDI inflows/gdp + ** Financial liberalization index + Economic and industry structure Industry share in the GDP + *** Services share in the GDP - * Trade openness + * Financial openness index + *** Manufacturing exports/total exports + *** High technology exports/manu exports + ** High technology exports/gdp + *** Patent + *** Note: *p <0.1, **p<0.05, ***p < Coefficient. 25
26 Major Factors for Middle-Income Trap: Probit Estimates Variable Demographics and human capital Average years of schooling + Fertility rate, total + ** Dependency ratio + *** Institutions and politics Rule of law - Regulation (level, t) - Change of regulation (t-1) + ** Democracy indicator - Macroeconomic environment and policies Investment share (level, t) + Change of investment share (t-1) + *** Price level of investment + *** Log (1+CPI inflation) + FDI inflows/ GDP + Financial liberalization index - Economic and industry structure Industry share in the GDP - Services share in the GDP + Trade openness + Financial openness index (level, t) - Change of financial openness (t-1) + * Manufacturing exports/total exports - ** High technology exports/manu exports - ** High technology exports/gdp - ** Patent - Coefficient. 26 Note: *p <0.1, **p<0.05, ***p < 0.01.
27 Major Findings We draw a clear distinction among different growth episodes income convergence process, growth deceleration and middle-income trap episode. We observe no clear pattern that the relative frequency of growth deceleration was higher when the relative income approached the upper middle-income range, thereby refuting the middle-income trap hypothesis. Convergence successes, compared to non-successes, tend to maintain strong human capital, large working-age population ratio, effective rule-of-law, low price of investment goods, and high levels of high-technology exports and patents. The middle-income trap tends to be linked to rapid investment expansion and hasty deregulation, in addition to unfavorable demographic, trade and technological factors. 27
28 IV. Korea s Economic Growth and Convergence 28
29 Korea s Rapid Growth and Convergence Per capita GDP, Per capita GDP Year US Korea Japan Note: PPP(Purchasing Power Parity)-adjusted 2011 constant international price Source: Penn World Table 9.0 (Feenstra et al., 2015). 29
30 Sources of Korean Economic Growth: Lee (2016) The strong growth of Korea over the past half century confirm the conditional convergence effect. Korea has had favorable conditions for rapid growth by maintaining strong investment, low fertility, high trade openness, and macroeconomic stability, and by improving the quality of human resources and institutions continuously. Korea s success was mainly driven by manufacturing- and exportoriented development. Government played an important role in promoting export-oriented industrialization: export-oriented policies, designed to provide incentives to export firms based on their performance, were effective in pushing the pace of change in comparative advantage. After suffering from the Asian Financial crisis, Korea s continued efforts to amend the structural weaknesses and strengthen its policy frameworks helped to maintain stable growth. 30
31 Investment and Trade Openness in Korea Exports, imports and investment, % of GDP Exports/GDP Imports/GDP Investment/GDP Source : World Bank, World Bank national accounts data; Bank of Korea, National Account ( 31
32 Human Capital Accumulation Average years of formal schooling for population aged 15 years and over Source: Barro R.J. and Lee, J.W. "A New Data Set of Educational Attainment in the World, ," Journal of Development Economics, 104,
33 Evolution of Korea s Top 5 Exports 1960s 1970s 1980s 1990s 2000s 2010s 1 Iron Ore Textiles Textiles Electronics Semiconductors Semiconductors 2 Tungsten Ore Plywood Electronics Textiles Computers Vessel, and Ocean Structure 3 Raw Silk Wigs Iron and Steel Products Footwear Automobiles Automobiles 4 Anthracite Iron Ore Footwear Iron and Steel Products Petrochemical Products Flat Display and Sensor 5 Cuttlefish Electronics Ships Ships Ships Articles of Petroleum Source: The Korea International Trade Association(KITA) 33
34 Overcoming Crises and Traps Korea overcame a number of significant political and economic crises. In 2012, Korea became the 7th country with over 50 million population and over US$ 20,000 per capita income. Per capita GDP (nominal US$) 20,000 15,000 OECD member (1996) 13,138 Global Financial Crisis 23,061 18,292 27,539 10,000 5,000 Korean War ( ) Military Coup (1961) Democratization (1987) 1,051 (1977) Source : World Bank, World Development Indicators Note : PPP(Purchasing Power Parity) international dollar Asian Financial Crisis Source: The World Bank 09 34
35 Challenges to Korea s Sustained Growth The swift catch-up process is for the most part attributed to physical and human capital accumulation rather than total factor productivity (TFP) growth. The catching-up speed has slowed down as Korea faced a much smaller gap in physical and human capital stock from their long-run potential levels, and thus the rate of return to investment declined. The slowing pace of Korea s catch-up was attributed mainly to little gain in TFP catch-up during While manufacturing- and export-oriented development served Korea s success well, poor productivity performance in the services sector has hampered overall growth. The widening gap between large and smaller companies is another consequence of South Korea s export-oriented growth strategy. The deceleration of working-age population growth will begin to have significantly negative effects on GDP and per-capita growth rates. 35
36 Concluding Remarks For a smooth transition to a high-income status, a middleincome economy needs to follow strong growth path, while avoiding falling into a low-growth trap. Strong convergence hinges critically on whether it continues to maintain strong demographic factors and sound policies, and successfully improve export competitiveness. To avoid being trapped in a low-growth path, an emerging economy should also carefully manage macroeconomic and financial vulnerabilities. Korea s historical experience of strong convergence and sustained growth is largely attributed to its favorable convergence factors and continued reform efforts. 36
37 Thank You Jong-Wha Lee Tel.:
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