Bernardo M. Villegas
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The Middle Income Trap

          The Asian Development Bank (ADB) just published an extremely valuable document entitled Asia 2050:  Realizing the Asian Century.  From a first reading of this very well researched study, I came out with two major conclusions.  First, that Asia is not predestined to inherit the twenty first century.  Asian leaders and societies can still make terrible mistakes in political and economic strategies and fall into what is called the "middle-income" trap, failing to capitalize on their great potentials for joining the advanced countries in the next forty years.  Second, among the Asian countries in greatest danger of falling into the middle-income trap is the Philippines, having already done so in the last thirty years.

          Just by coincidence, I was deep into poring over the 127-page document, when the National Statistics Office announced that the GDP growth rate in 2010 was being upgraded from 7.3% to 7.6%.  Despite a series of economic forecasts coming from various sources predicting much lower growth rates for 2011 (4.5 to 5.0%), I continue to maintain that Philippine GDP will grow by at least 7.0% in 2011 on the basis of hefty increases in private investments and local government expenditures on infrastructures and social services.  The Philippines was systematically excluded in the listing of Asia 2050 of the most promising Asian economies (which always included Indonesia and the Vietnam) because of the lack-lustre growth that we have been demonstrating over the last ten years or so.  Vietnam, despite certain imperfections in financial institutions, governance and infrastructures, has been growing at more than 7% for almost a decade now.  Indonesia has made significant strides in good governance.  If the Philippines starts growing at 7% or more over the next five to ten years, is its long-term ascent to the state of an advanced economy already guaranteed?  Absolutely not, Asia 2050 responds.

          To understand the grave risk that the Philippines faces in falling into the Middle Income Trap, let us see how the term is defined in Asia 2050 (Page 8).  The Middle Income Trap refers to countries stagnating and not growing to advanced country levels.  In a very graphic manner, this concept is illustrated in Asia 2050 with the example of three countries that were already in the middle-income category in the mid-1970s:  South Korea, South Africa and Brazil.  Their per capita incomes then ranged from about $2,000 to $6,000.  In the last thirty years, South Korea's per capita income zoomed to over $20,000 making it join the advanced economies as a First World country.  Brazil and South Africa stagnated during the same period, unable to break through the $6,000 level.  As explained in Asia 2050, "In a steadily growing economy, the per capita GDP would rise continuously over time, towards higher incomes.  That is the experience of the Republic of Korea.  But many middle income countries do not follow this pattern.  Instead, they have short periods of growth, followed by periods of stagnation or even declines, or are stuck at low growth rates."

          The Philippines was very much middle income in the circle of developing nations in Asia by the early 1970s.  In fact, we were "predestined", according to some international economists (together with Burma) to be the most promising Asian countries to follow Japan in becoming a modern economy.  Well, the rest is history.  Together with many other Asian and Latin American countries (not to mention African), we were "caught in the Middle Income Trap--unable to compete with low income, low wage economies in manufacturing exports and unable to compete with advanced economies in high skill innovations. Put another way, (we) could not make a timely transition from resource-driven growth, with low cost labor and capital, to productivity-driven growth."  It would be very tragic if we commit the same mistakes during the next thirty years.

          How did South Korea avoid the Middle Income trap over the last thirty years.  I venture to give some of the answers.  Despite the failure to stamp out corruption during and after the Park Chung Hee regime, the leaders of South Korean society--building on a strong patriotic spirit and work ethic that came as a response to the ever present threat from North Korea--followed an economic strategy that improved productivity on all fronts of the Korean economy.  Despite their poor natural resources, there was a determined effort to improve the productivity of the small farmers through investments in rural infrastructures and the education and training of rural workers (especially through a program called Semaeul Undung).  Through an industrial policy relatively free of crony capitalism (in stark contrast with what transpired during the Marcos regime in the Philippines), the chaebols (large private conglomerates like Samsung, Hyundai, and Lucky Gold Star) were encouraged to compete in the world market through a combination of subsidies, export-oriented foreign currency and interest rate policies, and an accent on the development of small and medium-scale enterprises that served as the supplier base of the chaebols.  Finally, there was very heavy investment in the training of scientists and engineers (many of them sent to the U.S. and other advanced countries for post-graduate education) and in research and development.  These favorable policies were strong enough to counteract the economic and social costs of corruption, weak financial institutions, and extreme protectionism in the agricultural sector till late into the 1990s.    Today, the facts speak for themselves.  South Korea is the only country that straddles being still an emerging market (with such countries as China, India, and Indonesia) and already an advanced economy (like the U.S. and Japan).

          For the Philippines to avoid falling once more into the Middle Income Trap between now and 2050, we have to follow the example of South Korea in improving productivity on all fronts, starting with our still backward agriculture sector.  We must have macroeconomic policies that encourage export-oriented industrialization, trying our best to keep our peso as undervalued as possible, like China. We must welcome foreign investments in such strategic sectors as energy, infrastructure, mining, large-scale agribusiness, tourism, education, telecommunications and IT, and health care.  All these will just address our catching up with such countries as China, India, Indonesia and Vietnam (that already allows foreign ownership of land).  Considering the circumstances unique to the next thirty years, we must follow the advice contained in Asia 2050 about the four overriding non-tangibles which will ultimately determine Asia's long-term destiny.

          First is the ability of our leaders to persevere during the inevitable ups and downs and to focus on the long-term.  It is very important that those of us who were products of the lost generation of the last thirty years should do our best to contribute to the nurturing of leaders who are now in their thirties and forties so that they will exercise "mature, far-sighted and enlightened leadership."  These leaders will be needed to maintain the current momentum for another 40 years, which will require continual adjustments in strategy and policies to respond to changing circumstances and shifting comparative advantages.  We will expect these leaders to emulate the success of East Asia to adopt a pragmatic rather than ideological approach to policy formulation and to keep a laser like focus on results.  They must also be sufficiently international in their outlook so that they will actively participate in building much greater mutual trust and confidence between the major economies within and outside the Asian region, vital for effective regional cooperation and collaboration.  And finally, our leaders should be committed to modernize governance and retool institutions, while enhancing transparency and accountability.

          The message of Asia 2050 is loud and clear.  The ability of the Philippines to avoid falling once again into the Middle Income Trap will depend on strong and enlightened leadership.  The failure of the past was a failure of leadership.  We cannot afford to fail again in this regard.  All our institutions--the family, schools, business enterprises, civil society, religious communities, voluntary organizations, NGOs, etc.--must be committed to producing leaders that will guarantee that by 2050, the Philippines will be counted among the advanced economies of the world, as South Korea today is already an advanced economy.  Even if I live as long as my mother (who is now 102 and still enjoying the best of mental health), I will not be around anymore in 2050.  But I promise to spend the rest of my life contributing to the intellectual and spiritual formation of the next generation of leaders.  Our future as a progressive and just society critically hinges on these enlightened leaders.  For comments, my email address is bvillegas@uap.uap.edu.