“BRICS or Bust? Escaping the Middle-Income Trap” by Hartmut Elsenhans and Salvatore Babones: an excerpt

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The rise and fall of Brazil, Russia, India, and China, the so-called BRIC nations, is the great geo-economic story of the twenty-first century. In the early 2000s, these countries were tipped to redraw the economic map of the world. With a combined population of nearly 3 billion, they constituted roughly 40 percent of the world’s people. Throughout the first decade of the new millennium, they were among the fastest-growing countries in the world, sailing through the 2008-2009 global financial crisis in a way that made them the envy of the world. When the long-standing G-7 group of developed countries proved unable to meet the challenges posed by the crisis, the wider G-20—including all four BRICs economies—rose to the occasion. At a time when developed countries were talking austerity, the BRICs countries opened the taps on government spending. The crisis did not turn into the second Great Depression (though it looked as though it might in early 2009). For this, surely some of the credit goes to the swift action taken by the BRICs to stimulate domestic demand.

Fast forward a few years and the BRICs seem a spent force. Brazil is facing a political crisis of momentous proportions as it deals with its second year of recession. Russia’s economy is also stagnating under the combined pressures of low oil prices, Western sanctions, and incessant military action. India, much poorer than the other BRICs, is the lone economic bright spot—but clouds are gathering and even the Reserve Bank of India believes that its growth is unsustainable. And then there’s China. In theory, China is the engine of the global economy, continuing to grow at more than six percent per year despite the fact that it is now a middle income country and the world’s second-largest economy. In practice, there are grave doubts about the veracity of China’s economic statistics. In late January, 2016, after a run of bad economic news, China removed the director of its National Bureau of Statistics for “violating party discipline.” China’s economic statistics improved dramatically immediately following the appointment of a new director in early March.

BRICS or Bust? Escaping the Middle-Income Trap, Hartmut Elsenhans, Salvatore Babones (Stanford University Press, 2017)
BRICS or Bust? Escaping the Middle-Income Trap, Hartmut Elsenhans, Salvatore Babones (Stanford University Press, 2017)

The role of the BRICs countries in the global economy may at times be overstated, but there is no denying their importance—both as economies and as examples. In the popular imagination, the BRICs have made the transition from acronym to model. China in particular has become the articulation of the global economy: neither the consumer nor the producer of last resort but the place where demand and supply meet to cater to the world’s needs and desires. China is the great crossroads, the focal point of the world’s manufacturing supply chains, a position it occupied before Europe’s industrial revolution and has come to occupy again. Brazil and Russia have long been middle income countries and have experienced many episodes of rising hopes followed by long-term stagnation. Besides, both are primarily resource-based economies, not models of industrial upgrading. India is growing rapidly but is still a very poor country, more a BRIC of the future than a BRIC of today.

If the BRICs do not provide a single, exportable growth model that can be copied by other developing countries, their experiences can at least teach lessons that can be learned, point to pitfalls that can be avoided, and offer hope that better economies (and better societies) are within reach for countries that are sufficiently well-governed to pursue them. In a recent book review in Foreign Affairs, political scientist Nicolas van de Walle wrote of a particular country that “Greedy national elites have always preferred to appropriate public resources for their private use rather than grow the national economy or govern effectively.” No economic policy can solve the problem of greedy national elites. But even development-minded elites lack disinterested guidance as to what specific policies could help their countries rise out of the middle income levels of the global economy. If national elites are to be expected to make real personal sacrifices today for the future good of their countries, they should at least be given good reasons to believe that their sacrifices will not be in vain. The BRICs examples are not promising in this regard. But their experiences do light some paths forward.

Economists and other social scientists have assembled quite a lot of evidence about how poor countries can reach middle income status. Most of the required interventions involve the removal of supply-side bottlenecks: a modern economy requires a literate workforce, the liberation of women, basic transportation networks, decent public health, and the provision of a minimum level of law and order. As first China and now India have demonstrated, the introduction of market forces can liberate economies that were previously held down by bad central planning, but as Russia and Brazil have demonstrated, market forces do not necessarily produce better outcomes than can be achieved even by mediocre central planning. Supply-side good governance is surely a good thing in itself, but it takes only moderately competent levels of public administration to raise an economy from poor to middle income levels of productivity. Just look at Mexico, which has been stuck in the middle of the middle income range for as long as economic statistics have been kept.

There is much less evidence about how middle income countries can attain high income levels. Evidence is hard to come by in part because only one large country has ever unequivocally accomplished this feat. In the 1930s, Japan was a middle income country that was economically and socially similar in many ways to the rapidly industrializing countries of central and eastern Europe. Its brutal military expansionism was remarkable, but not its economic productivity. Then between 1950 and 1990, Japan rose to become one of the richest countries in the world. This required—or at least was accompanied by—massive demand-side changes in the structure of the Japanese economy: much higher levels of domestic consumption, much higher levels of government spending, the democratization of income and wealth, policies to promote full employment, and (fundamentally) the redirection of the benefits of economic growth away from national elites in favor of ordinary consumers.

Not coincidentally, these are all structural changes that the leading economies of the West experienced a generation or two earlier. As a late developer, Japan employed different strategies to achieve these objectives, but it ended up with an economy that is very similar to those of the developed West. Like Japan, today’s middle income countries will also formulate their own distinctive strategies for development, but as with Japan the structural impacts of those strategies will have to involve the expansion of mass consumption. Japan may have experienced more than two decades of economic malaise since the early 1990s, but its people still enjoy one of the highest living standards in the world. Leading Western economists like Larry Summers correctly identify a lack of consumer demand as the root cause of the stagnation that currently afflicts nearly all of the world’s high income countries outside North America. In other words, today’s high income countries are slowly drifting toward middle income status because people are not buying enough to continue to propel them ahead. It takes only a slight shift in vantage point to reveal that a lack of demand is also what keeps middle income countries from rising toward high income status.

 

Aging tiger, flying goose

The way that the BRIC nations came together as a cohort is now well-known. In a 2001 investment research report, industry economist Jim O’Neill coined the term “BRIC” to describe the four large emerging market economies of Brazil, Russia, India, and China. These BRIC countries began meeting as a in the mid-2000s to coordinate economic policies and lobby for greater representation in intergovernmental organizations. After an intense bout of lobbying, the BRICs became the “BRICS” with the admission of South Africa into the formal summit system among these countries in 2010. Though South Africa is much smaller than the other BRICS in the overall size of its population and economy, it is similar to them in national income per capita and overall economic structure. Like Russia and Brazil its economy is highly dependent on natural resources and, like all of the BRICs, it has extraordinarily high levels of income inequality. It also gives the BRICS an outpost in Africa, making the group more globally representative.

In 2011 O’Neill began to promote the “next eleven” emerging market economies, from which he later carved out the MINTs (Mexico, Indonesia, Nigeria, Turkey). Acronym groupings like the BRICs, BRICS, and MINTs that pull together the largest emerging market economies are mainly of interest to businesses and investors, people for whom market size matters. They are less useful for driving policies to promote growth, since sheer size tends to be uncorrelated with economic, political, and social indicators that policymakers care about. Still, they do serve to focus attention—and they do have the potential to promote global policy change.

There has been much talk of a new BRICS economic model of state-led development, but there is little that is new in that. Careful followers of development debates may remember a previous era’s acronym, the NICs (newly industrialized countries). The original NICs were the four “Asian tigers” of Hong Kong, Singapore, South Korea, and Taiwan, though the term later came to be applied more expansively. Just like today’s BRICS, all four NICs had (and have) very large state sectors. Thus one obvious lesson that can be learned from the NICs is that a large state sector is no barrier to development; after all, much of Singapore’s domestic economy is state-owned. Many other lessons can be learned as well. Perhaps the biggest is that development can spill over from country to country as foreign investment and domestic pro-growth policies spread across borders (or in the case of east Asia, oceans). The spread of industrialization from Japan to the NICs and finally to China is known as the “flying geese” model of development. The biggest foreign investors in China today are not from western countries. They are from the NICs.

The NICs may have been enormously successful, but they do not provide full-scale development models that can be copied by the BRICs. To begin with, Singapore and Hong Hong are central cities that are (statistically) separated from their respective geographical hinterlands. Taiwan benefited enormously from a massive influx of (relatively) skilled refugees after the end of China’s civil war in 1949. The economies of Hong Kong and Singapore were similarly boosted by very large influxes of skilled refugees from China and Indonesia. South Korea, the one remaining Asian tiger NIC, also exhibits some unique qualities. Its geography and its history place it between the historical success of Japan and a (now) rapidly rising China. South Korea’s success has depended as much on its lucky geographical location as on any policies of its own. Korea’s historical misfortune (to be caught between the two Asian giants of China and Taiwan) has turned out to be its modern economic salvation.

China is the only one of the BRICS countries that has benefited from “flying geese” style economic growth, and even in China this has been mostly limited to the coastal provinces that surround Hong Kong and Shanghai: the Pearl River Delta and the Yangtze River Delta. The rest of China has been left to develop by its own devices, and has been much less successful. The northeastern Dongbei region and the interior western provinces of China are depopulating as hundreds of millions of migrant workers head toward the coast. As China’s growth slows to a crawl in the mid-2010s it is pulling the other Asian tigers down with it. It’s as if the flying geese have all turned around to fly home.

China is at least closely tied into global economic networks through its integration into the east Asian economic sphere. The other BRICS countries, by contrast, are must more isolated from the larger global economy. Their companies are not closely integrated into global production networks and thus their people have few opportunities to upgrade their positions in global value chains. And like China, the other three original BRICs are too large to be pulled out of middle income status by big wins in particular industries. The four small NIC economies could be completely transformed by the success of important export industries, like shipbuilding (Korea) or semiconductors (Taiwan). The BRICs are too big for that. They need domestic development, not just export success.

 

The middle income “trap”

The economist James Heckman has written that policy questions fall into three types: problems of internal validity, problems of external validity, and … more difficult problems. Internal validation problems require only an evaluation of whether or not a specific policy worked at a specific time in a specific place. Did China’s massive infrastructure spending in 2009 stimulate growth? Yes, certainly. External validation problems call for a forecast of the effects of a specific policy in a new environment. Would a China-2009 style infrastructure stimulus have boosted growth in 2015 Russia? Maybe. But most policy questions fall into a third category of anticipating the effects of policies that have never actually been tried before in quite the same form. Building mass transit systems provided a short term boost in China in 2009, so would building housing provide a long term boost in Russia in 2020? That is an altogether more difficult question.

The only way to answer (or make a good-faith attempt to answer) these kinds of challenging economic policy questions is to use economic theory to unpack the available evidence drawn from policies that have been tried in the past and reassemble it in ways that make sense for the formulation of policies for the future. The BRICS countries offer ample scope for this. They may have massive problems, but they have also scored massive successes. They may not have reached high income status, but they have at least overcome most of the supply-side challenges that keep other countries stuck at low income levels. And they seem to have the administrative capacity to undertake ambitious reform programs once an elite consensus is reached on the right direction forward. When it comes to breaking out of the middle income trap, they may yet surprise. But will the succeed?

The economics of growth and development is chock-full of traps of all kinds and descriptions.  At its most straightforward, the idea of the middle income trap is based on a simple observation: many countries have moved back and forth between the lower and middle income tiers of the global economy, but relatively few countries have moved back and forth between the middle and upper tiers.  It is more a barrier than a trap: it is true that middle income countries rarely move up, but it is equally true that high income countries rarely move down.  In a nutshell, the thesis presented in this book is that the ceiling for middle income countries is caused by the inequalities that are typically generated early in the development process itself. An insufficient expansion of mass consumption shifts middle income economies toward an emphasis on luxury goods, while profits are disproportionately captured by elites.  High income countries with strong civil societies are prevented from falling down the global income hierarchy by politics that favor mass consumption, but middle income countries with weak civil societies have trouble getting over the political hurdles to continued growth in mass incomes.

Leaving aside exceptional cases like Japan and the NICs, few countries have ever risen from middle to high income status. Some countries have temporarily become rich due to massive natural resource endowments (e.g., Kuwait) but in an essential sense they are not really high income countries. That is to say, they do not possess economic systems that generate high income levels for the participants in them. They are merely rentier states, prone to economic collapse if the world ever loses interest in their one product. The most extreme example of this is the Pacific island state of Nauru. Once the guano capital of the world, it was put out of business by the Haber-Bosch process for the production of artificial nitrogen fertilizers. Another famous example is 1920s Argentina. Briefly one of the “richest” countries in the world — on a par with France and Germany — the 1930s collapse in global demand for beef. A true high income country, the kind of country that people in other countries aspire to emulate, is one that has a productive, stable, diversified economy that supports a high level of well-being for the broad majority of the population.

In real high income countries, in the kinds of successful countries that others want to emulate, most people have high incomes (by global standards), even relatively poor people. Such countries are the exception in the world, not the rule. No more than thirty or forty countries (out of some 200) fall into this category, many of them quite small. They are nearly all concentrated in or near northwestern Europe or are descended from the settler colonies of the United Kingdom. Provocatively, nearly all of today’s high income countries were already the world’s high income countries in the 1810s. Two hundred years of economic growth have not overturned this basic hierarchy in the global economy, and although a few countries have caught up none of the historically successful countries have fallen behind. It is an amazing fact that since the beginning of the industrial revolution not a single country has ever declined from high income status to middle or low income status.

The robustness of high income countries, the fact that they remain high income countries through civil wars, world wars, political gridlock, political revolutions, financial crises, recessions, depressions, and recoveries, suggests that there is something more to it than just getting the policies right. Much more remarkable than the fact that so few middle income countries have pursued sufficiently good policies to join the high income club is the fact that not a single high income country has pursued sufficiently bad policies to fall out of it. The so-called middle income trap may not be a trap at all. It may be that the high income countries are the ones trapped—pleasantly and fortuitously—in economic systems that perform well no matter what policies they pursue. The challenge for middle income countries is to “fall up” into that same trap. Middle income countries seem to experience high levels of economic mobility (just look at China and India) and high levels of policy responsiveness (viz. Russia after Communism; South Africa after Apartheid). They can hardly be called trapped. Capped is more like it.

High income status is an all-pervasive quality of a country’s economy, polity, and society. Clearly the BRICS don’t have it—yet. But all countries have the potential for positive social change, and the BRICS have shown greater adaptability than most. What they lack most of all is appropriate guidance. No one policy reform will transform a middle income country into a high income country, just as no one policy failure (or even suite of failures) has been enough to transform a high income country into a middle income country. But a broad set of guidelines for large-scale economic, political and social change can be assembled out of past experiences viewed through appropriate theoretical lenses. Get the governance right, get the demand side right, get the supply side right, and get the international linkages right and the market will take care of the rest.

Obviously all of that is much easier said than done. But saying it is the first step. This book links the theory and practice of development economics to present a roadmap for escaping the middle income trap. It starts from a thorough statistical analysis of the economic trajectories of the BRICS countries and proceeds by using these to illustrate what works and what might work for middle income countries of all acronyms.

Published with the permission of Stanford University Press.

Hartmut Elsenhans is Professor Emeritus of International Relations at Leipzig University. Salvatore Babones is Associate Professor of Sociology at the University of Sydney.