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Arrested development
Saturday, 05 September 2009 07:14

In life, not everyone makes it to the top.  Same goes for countries, not all countries realize their developmental potential.  There is less excuse for countries, however, than for people.  With good policies, most countries could make it near the top.


One manifestation of this is what is called the ‘middle income trap’, something in which many East Asian countries may now be caught.  East Asia has fast become a middle income region – about 9 out of 10 East Asians live in middle income countries.  However, history shows that while many countries have been able to make it from low income to middle income, relatively few have carried on to high income.  Many economies in Latin America and the Middle East have remained at middle income levels for decades.





To make the high-income transition, countries have to specialize more in selected areas where they can achieve economies of scale and technological leadership.  The policy and institutional changes needed are more complex and challenging technically, politically and socially.  But this is hard to do when countries find themselves squeezed between low wage competitors in poor countries and cutting edge innovators in rich countries.  A lot of complex challenges have to be met, from raising the skills and innovativeness of the labor force, to creating sophisticated financial systems, to maintaining social cohesion, to greatly reducing corruption. Without these sorts of tough policy and institutional changes, countries stay where they are, unable to bust out of middle income.


Already within the East Asian region, the experience of Japan, Singapore, Taiwan, Korea and Hong Kong shows what is possible in terms of moving to higher income levels. But the task is not simple.


Now China faces its own middle-income challenges, many of them related to environmental pressure. For example, China is home to 20 of the world’s 30 most polluted cities due largely to high use of coal for energy. Serious soil erosion, acid rain and polluted waterways also affect the lives of millions. The national economy is dominated by manufacturing rather than services, which adds to environmental pressure.  To address these and other problems, the government is developing policies aimed at ‘rebalancing the economy’ and ‘striving for a harmonious society’.


The challenges are somewhat different in other parts of East Asia.   Several middle- and high-income economies in the region are growing at about 2 percentage points less than before the 1997 crisis.  Investment has been weak in these economies and their share of world trade has been under pressure as they adjust to the rapid emergence of China. While China’s emergence is generating tremendous welfare gains for consumers around the world, it is creating intense competitive pressures for other East Asian economies in global markets.


Another big issue for middle-income economies is ensuring that the benefits of greater wealth in the region are shared equitably among the people. While poverty continues to fall, income inequality has also risen -- in some cases sharply.   Research suggests that many of the same forces that are contributing to rapid growth and more regional and global integration are also the forces shaping unevenness in growth and creating inequality in incomes. For example, increased technological change and globalization has increased relative demand for skilled workers, pushing up wages for people with education and skills. Then, the rural-urban divide plays its part by rewarding workers in coastal areas and cities where there are good transport links to global markets. Dealing with inequality while encouraging productivity growth and wealth creation, is now one of the biggest policy challenges for East Asia.


Added to these vulnerabilities is the fact that East Asia is undergoing the most rapid urbanization the world has seen, with projections indicating that more than 500 million people will move to cities in the region – almost 2 million people a month – in the next 25 years. This is placing huge strains on already inadequate transport, electricity, water and sanitation systems.


What can East Asia do?  Reforms like the following would help a lot: Reform of its investment climate; Meeting skilled labor shortages; Liberalizing the trade in services; Investing in infrastructure; Deepening and diversifying capital markets; and Building better social protection systems.


But there are other important examples of arrested development.  Since the US became the world’s economic leader more than a century ago, no other major economy has equalled the US, let alone surpass it.  Europe’s post-war economic performance resulted in very substantial catch-up, but this catch-up process stopped in the 1980s.  Euro area GDP per capita has been stuck at about 30 per cent lower than the US level for over a decade.  Structural rigidities in labour, product and capital markets are holding back innovation and dynamic growth.


For its part, Japan also managed an outstanding post-war economic performance until financial crisis hit two decades ago.  Many efforts have been deployed to re-boot the Japanese economy.  But the main effects have been useless and ugly infrastructure dotting the country, public debt that has now risen to 200 per cent of GDP, a construction industry which is hooked on government infrastructure and a political culture based on pork barrel.  Japan’s GDP per capita has slipped back down the OECD ladder, and will continue to do so until it dynamises its services sector and innovation performance by major regulatory reforms.




“10 Years After the Crisis” -- East Asia & Pacific Update, April 2007


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