As wages rise, manufacturers often find themselves unable to compete in export markets with lower-cost producers elsewhere. Yet, they still find themselves behind the advanced economies in higher-value products (the lack of advanced technology). This is the middle-income trap which saw, for example, South Africa and Brazil languish for decades in what the World Bank call the “middle income” range (about $1,000 to $12,000 gross national income per person measured in 2010 money). Typically, countries trapped at middle-income level have: (1) low investment ratios; (2) slow manufacturing growth; (3) limited industrial diversification; and (4) poor labor market conditions.
How to avoid the middle income trap?
The Middle Income Trap occurs when a country's growth plateaus and eventually stagnates after reaching middle income levels. The problem usually arises when developing economies find themselves stuck in the middle, with rising wages and declining cost competitiveness, unable to compete with advanced economies in high-skill innovations, or with low income, low wage economies in the cheap production of manufactured goods.Avoiding the Middle Income Trap entails identifying strategies to introduce new processes and find new markets to maintain export growth. Ramping up domestic demand is also important—an expanding middle class can use its increasing purchasing power to buy high-quality, innovative products and help drive growth.
The biggest challenge is moving from resource-driven growth that is dependent on cheap labor and capital to growth based on high productivity and innovation. This requires investments in infrastructure and education. As the Republic of Korea has proven, building a high-quality education system which encourages creativity and supports breakthroughs in science and technology is key.
Clearly the government plays an important role to escape the middle income trap. When the government reduces spending, taxes can be reduced. It reduces business costs, enabling technology investments. So, companies now have a more competitive product , jobs are created, and the country enters the virtuous cycle of the economy. This cycle produces wealth and country escapes the trap of middle income, making it a high-income country.
