The Middle Income Trap Phenomenon: First in Latin America, now Southeast Asia?

Malaysia’s economic and political reform initiatives can lift the country out of the “middle income” trap and help it join South Korea and Taiwan among the world’s richest nations, providing the plans are implemented effectively, Professor Woo Wing Thye said in the inaugural Sir John Monash Distinguished Public Lecture at Monash University Malaysia.

“The motivation is there (,” he told the audience. “The good news is that there’s agreement on what needs to be done. The question is why we aren’t doing what we said we would do.” Professor Woo, the President of JCI and a Research Professor at Monash University, said reform would be helped by a “generational change” with younger Malaysians more demanding of their government and less willing to accept the way things were done in the past.

He used historic data to show that ever increasing prosperity is by no means guaranteed, noting that while it was relatively easy to become a middle income nation, different development strategies were necessary to create a high income economy. Professor Woo explained how Western European economies had converged over time learning from each other’s policy successes and mistakes. By 2006, their GDP per capita was about 70 percent of the United States’ partly reflecting Europeans longer holidays and the continent’s ageing population.

In Latin America he noted there was also a convergence between the five nations under study (Argentina, Brazil, Chile, Colombia and Mexico) between 1960 and 2006, but years of instability amid bouts of economic nationalism and military rule meant those countries had been unable to close the gap with the U.S., the world’s richest nation. “The Middle Income Trap was invented for countries that have never closed the distance between themselves and the biggest countries in the world,” Professor Woo said. “It’s not that there’s no growth, it’s just that they are not growing any faster than the U.S.”

The JCI President noted that in comparison to Western Europe and Latin America, there’d been little convergence in East Asia. But while Malaysia and Thailand, dubbed “miracle economies” by the World Bank , had made rapid early progress eclipsing India, Indonesia and the Philippines, the two nations had been unable to continue that success. In the 1960s, Professor Woo said, Malaysia was richer than both South Korea and Taiwan, yet the two countries’ had now eclipsed Malaysia and narrowed the gap with the United States.

“It’s a worrisome situation,” he said. In the ten years until the Asian Financial Crisis, Malaysia expanded at roughly 9.4% a year Professor Woo told the audience, but from 2001-2005 the rate slowed to 4.5% and from 2006 – 2010 4.2%. He then highlighted official economic statistics showing that government spending, rather than private investment, kept Malaysia’s economic growing in the years following the crisis, masking both capital flight and an exodus of the country’s most talented people. Malaysia, he said, was a victim both of China’s rise following its decision to join the World Trade Organisation, and its own policy failures. “The 1970 policy framework can no longer work for Malaysia today,” he warned.

“We must recognise that the private market economy is the ultimate engine of growth. We have got to let the market work and sometimes that means fighting vested interests, usually domestic monopolies.” Professor Woo said signing free trade agreements such as the Trans Pacific Partnership, would also strengthen the government’s hand in facing down those who oppose reform. He noted that joining the WTO had given China an opportunity to restructure problematic state-owned enterprises.