The Middle-­‐Income Trap
Phenomenon: First in Latin America, Now in East Asia too?
Wing Thye Woo (胡永泰)
University of California, Davis
Jeffrey Cheah Institute on Southeast Asia, Kuala Lumpur
Fudan University, Shanghai
wtwoo@ucdavis.edu
Reserve Bank of Australia, Structural Changes in China, 8 March 2016
TRAP? SHOW ME à The Eyeball Test
• Language: “Being in a Trap” has the connotation of being involuntarily confined to a particular location
• Question: Does the definition of “middle-­‐income trap” meet the eyeball test of permitting us to visually see a country being confined to a particular location?
• Answer: YES, you bet you. Analytical Demarcation
• High Income, Middle Income and Low Income –
where you draw the separation line depends on the specific question being asked
• World Bank (WB) income classification scheme determines degree of concession in WB loans
• Our demarcation is to highlight whether a country is converging to the living standard of the global economic leader? Is it catching up?
• Catch Up Index (CUI) = level of a country’s living standard relative to US level = development gap
• Living Standard = GDP per capita at PPP$ (data for 132 countries from Angus Maddison, 2010)
Illustrating the Middle Income Trap: Growth of the Largest Regional Economies
For China, not useful to look only at the very
richest (e.g. Singapore), so our sample:
• 5 largest from Europe: Germany, UK,
France, Italy, Sweden
• 5 largest from Latin America: Brazil,
Mexico, Argentina, Colombia, Chile
• 10 largest from East & South Asia: China,
India, Japan, Indonesia, S-Korea, Thailand,
Taiwan, Pakistan, Philippines, Malaysia
0.0
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The Middle-Income Trap: Latin America, Stuck at CUI=30%
60.0
50.0
40.0
30.0
20.0
10.0
Argentina
Brazil
Chile
Colombia
Mexico
Western Europe: Maintain 70%
GDP per capita (PPP) of Western Europe as % of US Level
90.0
85.0
80.0
75.0
70.0
65.0
60.0
55.0
France
Germany
Italy
Sweden
UK
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50.0
Why is European CUI < 100% ?
(GNP/L) = (GNP/H)*(H/W)*(W/L) where
• GNP = total output
• L = Population Size
• H = Number of hours actually worked
• W = Number of people actually working
• (GNP/H) = output per hour worked is very similar in USA & Europe
• (H/W)*(W/L) in Europe is 75% of USA 1. Club Convergence is when the largest economies in a region become more alike each other over time.
2. Club Convergence in in South America (Middle-­‐Income Club) and in Western Europe (High-­‐
Income Club).
3. Is East Asia exceptional?
Breaking Out of the Pack in Developing Asia: Malaysia and Thailand
are the Miracle Economies according to World Bank (1993)
GDP per capita (PPP) of Asia-­6 as % of US Level
35.0
30.0
25.0
20.0
15.0
10.0
5.0
China
India
Indonesia
Philippines
Thailand
Malaysia
06
20
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62
0.0
Catch-­‐Up in Japan-­‐S.Korea-­‐Taiwan but not in Malaysia-­‐Thailand
90.0
80.0
70.0
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19621964196619681970197219741976197819801982198419861988199019921994199619982000200220042006
Japan
S. Korea
Taiwan
Malaysia
Thailand
Two Lessons from Malaysia that are Relevant for China
Woo, Wing Thye (2011). "Understanding the Middle-­‐
Income Trap in Economic Development: The Case of Malaysia," invited World Economy Lecture delivered at the University of Nottingham, Globalization and Economic Policy (GEP) conference, Globalization Trends and Cycles: The Asian Experiences, Semenyih, Selangor, Malaysia, 13 January 2011; available at http://www.nottingham.ac.uk/gep/documents/lecture
s/world-­‐economy-­‐asia-­‐lectures/world-­‐econ-­‐asia-­‐wing-­‐
thye-­‐woo-­‐2011.pdf
Lesson 1: Policy Exhaustion. Just doing more of the same will not sustain growth There are stage-­‐specific obstacles to moving up the income ladder. During the earliest catch-­‐up stage as in China in 1978, and in Malaysia in 1970:
• general low equality of education and brain drain not barriers to growth because existence of large amount of under-­‐employed agricultural labor allows industrialization via low-­‐tech exports.
• if the country becomes a big enough player to affect global parameters, then its national interests requires dealing with economic-­‐political spillovers
• destruction of natural environment not a high social concern when country is desperately poor Lesson 2: Catch-up momentum is difficult to
maintain unless the various parts of the system are
compatible with each other.
• Leo Tolstoy in opening of Anna Karenina: “Happy
families are all alike; every unhappy family is unhappy
in its own way.”
• Which is the correct translation, where Y = happiness?
(a) Additive? Y = X0 + aX1 + bX2 + cX3
(b) Synergistic? Y = X0 X1a X2b X3c
• Eclectic approach: The additive equation (a) works in
the short-run but long-run growth is determined by the
synergistic equation (b)
• Soviet Union reached middle-income without a private
market economy but the economy finally imploded
Can China Avoid a Malaysia-­‐
Type Malaise? China as a Speeding Car: Types of Potential Crashes (1/2)
• Hardware failure (wheel of car comes off): failure in an
economic mechanism, e.g. banking sector collapse, fiscal
mismanagement. A private market economy is the right
hardware to have, and it should be managed according to
evidence-based
– micro-regulation (e.g. Bela Balassa: non-discriminatory
promotion of manufacturing)
– macro-adjustment (e.g. Max Corden: exchange rate
protection)
• Software failure (a fight inside the car): failure in sociopolitical governance, e.g. corruption. Need to have
governance institutions that are
– administratively responsive and competent
– socially inclusive in operation
China as a Speeding Car: Types of Potential Crashes (2/2)
• Power supply failure (the car ran out of gas or hit
a road block): Avoid running out of gas or meeting
a road block by being
– ecologically sustainable at national & global
level
– consistent with amicable international relations
• A Holistic Approach is required to ensure
Compatibility amongst Hardware (base structure,
economic structure & policy), Software
(superstructure, socio-political institutions) and
Power Supply (the BIG picture).
Limiting this Talk
• Will limit discussion to solving hardware failures and power supply failures
• Will skip discussing software failures even though Hu Jintao’s goal of building a Harmonious Society (Hexie Shehui) reveals that Software Failure is deemed to be the most probable type of failure
The Worst Hardware Problem Today
• Expansion of State Capitalism under Hu-­‐Wen Administration, 2002-­‐2012 = Softening the Budget Constraints of Local Governments and State-­‐Controlled Enterprises, which resulted at
– microeconomic level à TFP growth of -­‐2% in 2007-­‐2012 (Harry Wu, 2016)
– macroeconomic level à NPLs threaten financial system stability and potential fiscal crisis
Emergency Room Medicine in 2009-­‐2010
• 4 trillion yuan fiscal stimulus over 2 years @ 7% of GDP per year • To prevent waste, bring forward investment projects that would be inevitably implemented, (Obama called this “shovel-­‐ready projects”) e.g. – Hard Infrastructure: roads, bridges, ports, high-­‐
speed train, telecommunications
–Industries of tomorrow: develop alternative energy e.g. solar power
– Urbanization: housing to accelerate rural-­‐to-­‐urban migration (lesson of Pudong: build and they will come)
• Masterful Keynesian countercyclical policy?
Woo’s Prediction, 17 Feb 2009, at US Congress
• “China’s growth in 2009 is likely to lie closer to Premier Wen’s 8 % target than to the IMF’s projection of 6.7 % … The state-­‐owned banks (SOBs) will be happy to obey the command to increase lending because they cannot now be held responsible for future nonperforming loans. The local governments and the state-­‐owned enterprises (SOEs) can now satisfy more of their voracious hunger for investment motivated by the soft-­‐budget constraint situation where the profits would be privatized and the losses socialized. The stimulus package will [therefore] work well …. The price … will be paid later by the recapitalization of the SOBs and a more depleted natural environment.”
• GDP growth was 9.2% in 2009 and 10.6% in 2010
Excess Capacity Galore à NPLs
The 2015 Stock Market Debacle
• Question: How to prevent NPLs from appearing?
• Answer: Firms issue new stocks and use proceeds to repay bank loans. • Action: Government talks up the stock market.
• Outcome: Crash was inevitable: “What rate of return could a zombie firm pay on its equities when it cannot even afford the average bank interest rate?” A rate lower than the average interest rate!
• Using stock market to solve NPLs à 2015 bubble
Faster Convergence to a Modern Private Market Economy is Solution to Hardware Problem
• Financial market reform to use market allocation because infrastructure is now not #1 binding growth constraint
– Promote private small-­‐medium banks à loans to SMES & rural firms
• Land policy reform
– privatize rural land (collateral for rural entrepreneurs)
– public housing under principle of future home ownership as in Singapore
• “Hukou” & labor-­‐social protection reform
– promote urbanization process without discrimination against coastal cities
• Greatly reduce the economic role of the state planning agency, local governments and SOEs to eliminate soft-­‐budget constraint
Power Supply Failures: China’s Neglected Vulnerabilities
Some Potential Power Supply Failures
Physical environment
• air: pollution and health; greenhouse gases and climate change
• water: declining rainfall in northern China, and three canals for south-­‐to-­‐north transfer of water. International concern over access to water from Tibetan plateau
International environment. Avoid external sanctions from Mis-­‐Steps in:
• complacency about trade protectionism
• inept foreign relations
Inept Foreign Relation #1: Failure of WTO Doha Rounds negotiations in Potsdam, June 2007 (1/3)
• Key obstacle WTO Doha Rounds started in 2001 is (a) refusal of
developed countries to reduce agricultural subsidies, and (b) refusal of
developing countries to reduce industrial tariffs. June 2007: Leaders of
both sides (G4) – developed countries represented by USA and EU, and
developing countries by Brazil and India – met in Potsdam, Germany.
• USA-EU offered to lower agricultural protection but Brazil-India
refused to lower industrial protection
• “India and Brazil’s fear of growing Chinese imports was behind their
decision to help prompt the collapse on Thursday of the G4 trade talks in
Potsdam, said Susan Schwab, the US trade Representative” (Schwab
surprised by stance of India and Brazil, Financial Times, 22 June 2007)
• “Beijing has taken a back seat in much of the Doha negotiations so far,
despite urgings from the US to take a leading role.” (Negotiators sift
debris, Financial Times, 29 July 2008).
• Why did China not take leadership position of developing countries and
defended its interests against Brazil-India?
Inept Foreign Relation #2: Copenhagen Summit, Dec 2009 (2/3)
• “We did not get an agreement on 50% reductions in
global emissions by 2050 or on 80% reductions by
developed countries. Both were vetoed by China,
despite the support of a coalition of developed and
the vast majority of developing countries” Ed
Milliband, UK secretary for energy and climate
change, in his column, ‘The Road from
Copenhagen’, The Guardian, 20 Dec 2009
• Premier Wen Jiabao was the only head of state
present in Copenhagen who did not show up for the
last summit session and participated in the
discussions via messages relayed by Chinese officials
at the conference site.
China should scale up its efforts to prevent power supply failures
• ensure national and local environmental sustainability: abandon the “man over nature” mentality (as exemplified by the story of “the stupid old man and the mountain”)
• adopt responsible stakeholder stance in diplomatic relations:
– abandon the “free rider practice” -­‐-­‐ as exemplified in the 2007 WTO Doha rounds negotiation and the 2009 Copenhagen Climate Change Summit
– avoid Second Cold War e.g. South China Sea, nuclear proliferation