Are current policies making it better or worse, and what needs to be done to escape the trap? The ‘middle-income trap’ is an empirical generalisation based mainly on East and Southeast Asian experience: once a country reaches middle-income levels the growth rate often declines and graduation from middle-income to higher-income levels stalls.

During the decade of economic boom ending in 1997 Thailand’s average annual growth rate of real GDP per person was a remarkable 8.4 per cent. Like most booms, this one ended badly. It collapsed with the Asian Financial Crisis of 1997-99. Since 2000 the corresponding growth rate has been 4.1 per cent.

The immediate culprit was a contraction of private investment, which declined as a proportion of GDP from an average of 30 per cent to 18 per cent over the same two periods. The effect of lower investment was twofold: it reduced aggregate demand, lowering income in the short run; and it reduced the rate of capital formation, lowering long-run growth prospects.

Shopping Thailand
Once a country reaches middle-income levels the growth rate often declines and graduation from middle-income to higher-income levels stalls.

A decline in this investment ratio occurred in all of the crisis-affected Asian economies, including Indonesia, Malaysia, the Philippines and South Korea.

The decline in Thailand was one of the largest.

The contraction of investment occurred primarily among Thai-owned, rather than foreign-owned, firms. Put simply, after the crisis Thai firms became less confident about their prospects and hence less inclined to invest. An expectation of this kind is self-fulfilling. It reduces investment, which does indeed ensure that growth will be lower.

Beneath these short-term macroeconomic events lies a deeper and longer-term phenomenon. Between the 1960s and 1990s Thailand achieved the transition from a poor, heavily rural backwater to a middle-income, semi-industrialised and globalised economy.

The transition was primarily market-driven and the central policy imperative was to avoid those policies that impeded absorption of low-cost labour into export-oriented labour-intensive manufacturing and services.

This transition required some elementary market-supporting policy reforms: promoting a stable business environment (not necessarily meaning stable politics); open policies with respect to international trade and foreign investment; and public provision of basic physical infrastructure, including roads, ports, reliable electricity supplies, telecommunications and policing sufficient to protect the physical assets created by business investment.

Peter Warr is John Crawford Professor of Agricultural Economics and Head of the Arndt-Corden Department of Economics in the Crawford School of Economics and Government and Executive Director of theNational Thai Studies Centre at ANU.

This article appeared in the most recent edition of the East Asia Forum Quarterly, ‘Where is Thailand headed?

via Thailand, a nation caught in the middle-income trap | East Asia Forum.

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