Author: Homi Kharas, Brookings Institution

Developing Asia’s share of global GDP has risen inexorably over the last 30 years: 7.5 per cent in 1980, 10.5 per cent in 1990, 14.5 per cent in 2000 and 26 per cent projected for this year.

This has happened despite a major regional financial crisis in 1997–98 and a number of global crises in food, fuel and energy, as well as the longest-lasting and deepest recession in history in Asia’s major trading partners in the advanced world. The strength and resilience of developing Asia’s growth over such a long period of time invites speculation as to what the future may bring. Simple extrapolation of past trends coupled with the fact that Asia has a large and fast-growing middle-class population produces forecasts of an inevitable Asian century.

Asian policymakers should beware of complacency and pay heed to the example of Latin America. Developing Asian economies are large (US$23 trillion in 2013) but not rich. The average income per capita of someone in developing Asia is still less than US$7000 per year. That is about half the income level of a Latin American and is approaching the income level reached by Latin America when it became trapped and stagnated. Latin America’s post-World War II growth strategies based on urbanisation and credit-fuelled public sectors were unsustainable and real incomes in Latin American have consequently grown by only 1 per cent in real capita terms per annum for the last 30 years.

Could East Asian countries suffer the same fate? Might the strategies that allowed them to grow from poor- to middle-income countries now fail them as they strive to become advanced economies? This is the question preoccupying policymakers across the region.

Asian countries could get trapped in middle-income status, unable to compete with low-wage competitors in standardised manufactured exports or with advanced economies growing on the basis of innovations and advanced technology. Take the case of Malaysia, a highly successful exporter that has also attracted large amounts of FDI and is ranked as number 25 in the world in competitiveness. Since the Asian financial crisis — and since it reached an income level similar to that of Latin American nations at US$10,000 per annum — its growth rate has fallen by one-half.

Or look at China, which is also slowing down and showing signs of weakness in the housing and local-government development projects that have kept its economy booming at double-digit rates for over 20 years. Both need new strategies to keep growth high.

In Malaysia the strategies include moves to stop the outflow of the talent and capital of its dynamic ethnic Chinese business community. For China, new strategies may include rebalancing towards domestic demand and levelling the playing field for the domestic private sector. Both countries face the challenge of altering course to reflect their shifting comparative advantage in the face of resistance from vested interests that have grown rich and powerful from the status quo.

There is no uniform policy prescription for avoiding the middle-income trap. It is not a destiny but an obstacle to be overcome. South Korea, Taiwan, Hong Kong and Singapore have made the transition to advanced economies. In each case, strong domestic political and bureaucratic forces had to be overcome to unleash a new wave of dynamism before these countries could move ahead. Their paths were different but they shared a willingness and ability to change course.

Most Asian countries are unlikely to face immediate economic danger. Indeed, the Asian Development Bank is forecasting a very respectable 6–7 per cent growth in the near-term. But middle-income traps build slowly over time. They strangle economies by absorbing resources that could otherwise be put to more effective use and by constraining policy space. For example, resources can get tied up in inefficient public enterprises, low value-added exporters, risky bank credits or speculative asset booms. Policy space can be reduced when public spending has to deal with pressing problems of social assistance, health care or environmental clean up that could have been avoided if more inclusive and sustainable growth strategies had been pursued from the start.

At its heart, the middle-income trap is a governance failure: an inability to take a long-term view of the best way forward for society as a whole. Avoiding the trap can take careful preparation and implementation over a decade or more. Building top-tier universities, forming fair, transparent and accountable public institutions, building a culture of prudent risk-taking and a mindset of environmental sustainability are not processes that happen overnight. Politically, the shift from the ‘rule of man’, where an enlightened leader can be relied upon to make the right choices, to a ‘rule of law’, with institutional structures that produce predictable and sound decisions, is hard to accomplish. But unless middle-income Asian countries take the long view and change course they could fall, like many Latin American countries, into middle-income traps of their own making.

Homi Kharas is a senior fellow and deputy director of the Global Economy and Development, Development Assistance and Governance Initiative at the Brookings Institution. He is co-author of ‘An East Asian Renaissance: Ideas for Economic Growth’.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Coming to terms with Asia’.

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Developing Asia and the middle-income trap