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Is it to be blamed or to be taken action…? Middle Income Trap

By Morena SHETA

Popular expectations assume that when things seem to be going well, is the time to be prudent about the future. What triggers the most awful “Time magazine cover curse” scenarios is the fear of being trapped, sometimes for a long time and performing below potentials. BUT… if it would be framed differently, would it change the game?

History has shown that economies might experience some “red-carpet” periods and gradually go through transition fog.

Like it happened with ASEAN countries (Indonesia; Malaysia; the Philippines; and Thailand) and Latin America (Argentina; Brazil; Chile; Colombia; and Mexico) which had already leveled up as a result of a successful transition from low-income to middle-income status, but their past successful growth could not be surely projected forward to high-income status.

Particularly now that striving for sustainable growth is on highlight, it is very difficult to diagnose all the possible constrains and realize what the next move is. Above all, more concerning is the assumption that these middle-income economies have FALLEN….in a TRAP, and will STAGNATE.

… But time has proved that societies in transition struggle and sometime fail in defining. It leaves open the question of how prevalent are the existent economic theories to suggest a well-constructed growth framework for middle-income economies in transition.

To have a better understanding of “transformation trap” process, let’s revert back to the origins of the definition.

Then and Now: Thirteen Years of Hindsight

Might not be the first, but for sure not the last one to write about middle-income trap, taking into consideration that already by 2015 there were over 3,000 articles in Google mentioning the term.

It is seen as more important to understand how it all started back on 2005 when no credible growth strategy was useful for middle income countries and what it was meant to define.

In this environment ASEAN middle-income countries where straddling between a growth labor-intensive exports strategy against China export juggernaut and a considerable interest in transforming to “knowledge economies”.

The concept was introduced back in 2007, describing economies that were being

“squeezed between the low-wage poor country competitors that dominate in mature industries and the rich-country innovators that dominate in industries undergoing rapid technological change” (Gill and Kharas, 2007).

Since then the concept has been used frequently and interpreted in various ways by Asian Development Bank, IMF, African Development Bank, EBRD, UN, government leaders, academics and media.

Thirteen years after, studies clarify some facts that diminish its prevalence:

- It was more of an “ignorance trap” about the nature of growth in middleincome countries, falling between endogenous growth theories useful for high-income economies and the Solow growth model applicable for low-income countries.

- The trap was meant to convey an empirical work to prove that past growth is just not that informative about future growth and its predictive ability is generally even lower over longer horizons.

- It was short-hand for “a trap that can catch middle-income countries”, but not a statement.

What can be concluded and generalized in thirteen years hindsight, the most widelyaccepted proposition is that a “trap” is characterized by a context where growth is below potential, and slow-downs in productivity can occur at all income levels. Following that, all middle-income countries pass through some key transitions.

- The Lewis turning point occurs at middle-income levels, where economies must move away from labor-intensive technologies.

- Technological upgrading, where industrial policy becomes more important in managing the transition to greater technological sophistication.

- The move from authoritarian to democratic regimes, which it requires greater institutional stability and a move to democracy can prove to be beneficial.

Middle-income countries find themselves straddling between both strategies, thus they are so in need for a new growth model.

46 December 2018

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GDP breakdown by sector in WB

Albania BIH Kosovo FYRoMMontenegro Serbia Source: National statistical offices.

Through which transitions is the Western Balkans passing?

The concept of transition has been reviewed taking into consideration the complexity of the process from low to high income status. According to EBRD, under that updated interpretation of transition, a sustainable market economy is regarded as being competitive, well governed, green, inclusive, resilient and integrated.

Others Information & Communication Professional, Sci. & Admin. Services Financial & Insurance Activities Construction Real Estate Activities Agriculture, Forestry & Fishing Public Adm., Defense & Social Security Industry Trade, Transport & Food Services

- Loss due to business environment obstacles: Total annual sales loss counts to 13.2 % on average compared to 9.8% in the EU-11. In Albania competition from informal sector, electricity, corruption and tax administration are the biggest business obstacles.

- Lack of Competitiveness: In market size, labor market efficiency, and weak business sophistication and innovation capacity. Albania is less competitive for market size, infrastructure and labor market efficiency.

Assessment of transition qualities in EBRD countries

GDP per capita (PPP adjusted)

GDP PPP per capita

Current International Dollar

45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000

0EU Western Europe

EU Southern Europe

Source: IMF World Economic Outlook

EU Eastern Europe

Western Balkans

processing are the most undersupplied sectors in Albania.

- Significant resilience: Banking system has demonstrated resilience during recent year’s crisis, but still NPL rates are high. Over more progress towards transportation and implementation of the Third Energy Package. In Albania the NPL rates are still in double-digit levels, albeit on a declining trend in all cases.

Countries in the region are at various stages of progress on three transitions: the transition to market economy, the transition to EU membership, and the transition to high-income status.

2018 Report by EBRD shows that WB-6 are experiencing:

- Living Standards Gap: The WB-6 countries have significant convergence towards EU living standards. GDP per capita is roughly 1/2 of that of Eastern EU countries, 1/3 of southern EU members and a mere quarter of the richest EU members in the Western Europe.

Albania’s economic growth is projected to slow to about 3.5 % by 2019-20 as the increased economic dynamics gradually closes the output gap.

- Labor Productivity Gap: Firm level labor productivity is about 60% of the EU-11, and mostly the gap is driven by the low productivity in manufacturing sector. Albania scores the lowest labor productivity among WB-6 countries, especially in service sector.

Transition scores for six qualities of a sustainable market economy

Albania Bosnia and Herz. FYR Macedonia Kosovo Montenegro Serbia

WB-6 EU-11 EBRD

Competitive

4.4 4.7 5.4 3.4 4.9 4.9

4.6 6.5 4.9

Wellgoverned

4.4 4.7 5.4 3.4 4.9 4.9

4.6 6.5 4.9

Green Inclusive Resilient Integrated Average

4.4 4.7 5.4 3.4 4.9 4.9

4.6 6.5 4.9

- Public Governance lags behind: Progress has been made on political stability, but control on corruption still remains concerning. Especially in Albania political connections as more important than either effort and hard work, or intelligence and skills, as the key to success in life

- Environmental- green challenges: Air pollution is a serious problem and level of carbon intensity is very high. In Albania 10% of renewable energy comes from hydropower plants and 40% from biofuels/waste.

- Less inclusive growth: Inadequately educated labor force remains the main obstacles. Shortcomings in VET, preparational training, startup financing are not meeting the market needs. Agriculture, forestry, hospitality and food

4.4 4.7 5.4 3.4 4.9 4.9

4.6 6.5 4.9

4.4 4.7 5.4 3.4 4.9 4.9

4.6 6.5 4.9

4.4 4.7 5.4 3.4 4.9 4.9

4.6 6.5 4.9

4.4 4.7 5.4 3.4 4.9 4.9

4.6 6.5 4.9

- Challenging cross boarder integration: due to poor quality of transport infrastructure which makes trade more costly and time consuming. The average cost to export in the EU-11 is at US$ 34 per unit compared with US$ 65 in Albania.

- EU Membership: which is the key driver of political, economic and institutional reforms. Albania is facing challenges to cope with competitive pressure within the EU.

Albania’s GDP Growth

14 12 10 8 6 4 2 0 -2 -4 -6

Albania’s GDP growth

Comparator

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Source: IMF

Economies are really moving slowly, but they are making more progress in the headway than they realize. The key is to focus at the headway, not how far they had yet to go. Forewarned, policy makers can make adjustments so that passage through transitions becomes an opportunity for continued rapid growth.

It is time to frame uncertainties and “now what?” into opportunities and “why not!”

Source: EBRD.

December 201847

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