Magazine article Regional Economist

Trapped: Few Developing Countries Can Climb the Economic Ladder or Stay There

Magazine article Regional Economist

Trapped: Few Developing Countries Can Climb the Economic Ladder or Stay There

Article excerpt

The low- or middle-income trap phenomenon has been widely studied in recent years. Although economic growth during the postwar period has lifted many low-income economies from poverty to a middle-income level and other economies to even higher levels of income, very few countries have been able to catch up with the high per capita income levels of the developed world and stay there. As a result, relative to the U.S. (as a representative of the developed world), most developing countries have remained, or been "trapped," at a constant low- or middle-income level.

Such a phenomenon raises concern about the validity of the neoclassical growth theory, which predicts global economic convergence. Specifically, economics Nobel Prize winner Robert Solow suggested in 1956 that income levels in poor economies would grow relatively faster than income in developed nations and eventually converge with the latter through capital accumulation. He argued that this would happen as technologies in developed nations spread to the poor countries through learning, international trade, foreign direct investment, student exchange programs and other channels.1

But the cases in which low- or middle-income countries have successfully caught up to highincome countries have been few.

Many poor countries today have a per capita income that is 30 to 50 times smaller than that of the U.S. and sometimes even lower (less than $1,000 per year in 2014). For such countries to catch up to U.S. living standards, it may take at least 170 to 200 years, assuming that the former could maintain a growth rate that is constantly 2 percentage points over the U.S. rate (which is about 3 percent per year). This would be difficult, if not impossible. It is even harder to imagine that such countries could reach U.S. living standards within one to two generations (40 to 50 years), similar to how North American and Western European economies caught up to Britain during the 1800s after the Industrial Revolution. To achieve that speed of convergence today, the developing countries would need to grow about 8 percentage points faster than the U.S. (or about 11 percent per year) nonstop for 40 to 50 years. In recent history, only China came close to this; it was able to maintain a 10 percent annual growth rate (7 percentage points above the U.S. rate) for 35 years, but per capita income in China was still only one-seventh of that in the U.S. in 2014.

Hence, the lack of income convergence and the relative income traps appear to be real problems.

In this article, we first define the concept of an income trap and describe evidence that points to the existence of both low- and middle-income traps. Second, we analyze the historical probability of transitioning to higher relative income groups and test the persistence of the traps over time. Finally, we offer some hypotheses on the existence of income traps, as well as their policy implications.

Defining the Income Trap

The economic development literature provides various ways to classify countries by income groups, as well as several definitions of the "poverty trap" and the "middleincome trap." 2 Most researchers have used absolute measures of income levels (such as median income per capita) or growth rates to define what constitutes a low- or middleincome trap, but in doing so, they have ignored the more pervasive phenomenon of the lack of convergence.

Although many so-called middle-income countries have experienced persistent economic growth, their growth rates never surpassed the U.S. growth rate; consequently, these countries have been unable to close their income gaps with the U.S. In other words, these countries remain "trapped" at relatively lower income levels compared to the living standards of the developed countries, contrary to the neoclassical growth theory's predictions that they will converge due to technology spillover and international capital flows.

The lack of relative income convergence implies that income per capita in the U. …

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