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The Middle Income Trap

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Author:
Jurij Bajec
Professor of Economics at University of Belgrade and a special advisor to the Institute of Economics in Belgrade

Jurij Bajec

 

It is a misconception to expect that accelerated economic growth can “automatically” achieve key development goals. This is, admittedly, the way Serbia was able to reach a relatively solid GDP growth rate of over 5% annually from 2001 to 2008. However, it simultaneously failed to increase employment, reduce poverty and result in necessary measures for diminishing growing disparities in income and wealth distribution. It aggravated the structure of industry and its export sustainability, while doing little to create sustainable infrastructure in education, environmental and other systems of vital importance for future development. To a large extent, Serbia was unsuccessful in implementing economic, social and political reforms as well as in creating an institutional framework that would enable the Serbian economy to reorient itself on growth factors that required higher levels of development. In short, there has been economic growth but no development. “Defective” progress was achieved, thus nudging Serbia into the “middle income trap.” The impact of the global economic crisis is only partially to be blamed for such turn of events.

 

Serbia is not the only country to have found itself in this situation. This year’s EBRD Report entitled Stuck in Transition (2014) warned of a stalling of undergoing processes in the transition countries. This began in 2005 and intensified since the beginning of the global economic crisis in 2008. Should economic, social and political reforms continue contributing to the existing stalemate, transition countries, with the exception of the Baltic States and the Central European countries, could not expect major economic progress for quite some time, much less count on achieving convergence with developed European countries.

 

What are the reasons for transitional and overall development processes being stalled? It turns out that a number of countries have found themselves in a specific “middle income trap.” A country reaches a certain level of development (3000-9000 $ per capita), and soon stops being able to continue pursuing its development path for quite some time.

 

The explanation is that it is not possible to achieve higher level of development simply by relying on low labor costs and extensive use of natural resources. While such an approach remains typical for achieving lower levels of development, advanced progress depends more on greater efficiency of human, material and natural resources, as well as on an increase of total national productivity and competitiveness. It has been determined that in many middle-income developing countries, the poor functioning of economic, social and political institutions and the lack of adequate coordination between the main stakeholders represented key obstacles in generating conditions typical for developed economies. Such conditions include creating original solutions and innovations in production, absorbing and applying modern technologies, and eliminating large distribution inequalities detrimental to development.

 

How to get out of the middle income trap and restart the quest for dynamic economic growth and development? The EBRD Report insists on building political institutions that strengthen the democratization processes; effective functioning of economic institutions and reforms in order to provide better business conditions; education reforms; greater social inclusion and the provision of equal opportunities in education and employment for young people.

 

It is about instituting changes that market mechanisms cannot make by themselves. The market is not the one to create institutions, but the other way around; institutions enable the efficient operation of markets. What is required is an active of the state and a well-thought out national development strategy designed to encourage faster economic growth, whilst actively encouraging the achievement of fundamental development goals.

 

Consequently, a narrow economic approach should be avoided when defining the new national development strategy. Rather, a broader concept that includes the priorities set out in the EU’s “Europe 2020” strategy must be set forth. The primary pillars of this strategy include knowledge and innovation, the efficient use of resources, greater competitiveness, greater concern for the natural environment, a high level of employment and greater social and territorial cohesion. Similarly, the United Nations have too adopted such an approach when defining the Millennium Development Goals, and will likely do so again next year when the Sustainable Development Goals are laid out, which will chart a course for holistic global development for the decades to come.

 

Prof. Dr. Jurij Bajec is a Professor of Economics at University of Belgrade and a special advisor to the Institute of Economics in Belgrade

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