The Middle Income Trap: Here’s What We Know

November 1, 2023


A primary goal of most countries is to boost the wealth of their citizens. In communications with the U.N. Development Programme, the Egyptian government said in 2018 that its Egypt Vision 2030 strategy aims to increase GDP per capita from $10,250 in 2015 to $14,270 by 2030.

According to World Bank metrics, that jump would improve Egypt’s classification from middle income, defined as GDP per capita between $1,136 and $13,845, to high income.

Such a transition could prove challenging. “What typically follows [overcoming] poverty and deprivation … is a growth slowdown that, historically, made further progress toward high-income levels exceedingly rare,” Ferid Belhaj, World Bank vice president for MENA, wrote in the Egyptian Research Forum, a think tank,

However, the transition is not impossible. A March 2022 paper by the Tony Blair Institute for Global Change said that to push countries from middle to high-income status, states need to build a “productive partnership with the private sector and scientific community, and [mobilize] the entire society.”

The purpose of such partnerships is to go “beyond industrial upgrading and productivity gains, developing a strategy to leapfrog into new industries,” noted the document. That requires a “firm political conviction and development strategy with economic diversification and building productive capacity at its center.”

Signs of a trap

In 2007, the World Bank concluded countries it classified as “middle income” were unlikely to step up to “high income” status, labeling that phenomenon the “middle-income trap.” Greg Larson, a World Bank consultant, explained, “There is evidence that rapidly growing economies tend to slow down significantly when they reach middle-income levels.”

As economies grow, they improve their GDP per capita, and labor becomes more expensive as wages rise. Additionally, investors require higher-skilled workers to benefit from more advanced technologies and increasingly sophisticated business models to enable further growth.

That is problematic for middle-income countries seeking to improve their classification. “Some growth models suggest the existence of low-productivity equilibria in middle-income countries,” Larson said, “characterized by a low [supply] of capable workers in highly skilled activities.”

That means those middle-income nations lose the low cost of production advantage, and investors can’t find enough qualified employees for projects in the country.

The World Bank said that leads to a “leveling-off of income per capita and a decline or stagnation in an economy’s competitiveness” as an investment destination for locals and foreigners.

The result is that a middle-income country’s transition to high-income status is rare. Based on the World Bank’s classification benchmarks, from 1960 to 2010, 15 out of 101 middle-income nations transitioned to high-income. The list included Japan, Hong Kong, Singapore, South Korea and Taiwan.

That inability to transition is a concern for developing countries. In a 2009 speech, Malaysia’s Prime Minister Najib Razak said, “We have become a successful middle-income economy, but we cannot and will not be caught in the middle-income trap; we need to make a shift to a high-income economy, or we risk losing growth momentum in our economies and vibrancy in our markets.”

Most nations currently unable to upgrade from middle to high income are in “Latin America and the Middle East,” said Larson. They “provide compelling empirical support for the [middle-income trap] phenomenon, as many in both regions have remained at middle-income levels for four or five decades.” 

Real or myth

Despite his affirmation that the Middle Income Trade exists, Larson pointed to several problems with international narratives surrounding the middle-income trap. The first is that a “close examination of countries’ transitions between income levels, for example, finds that per capita incomes have grown steadily in the majority of countries.” That indicates it is a matter of time before they reach and cross the high-income threshold.

“That does not suggest a trap-like pattern and casts doubt on the notion that high growth was a temporary phenomenon of any particular era,” said Larson. “Comparing today’s middle-income stagnators with countries that have reached high-income status suggests that ‘escapees’ have simply always grown faster.”

Larson said that discrepancy is due to “underlying factors, [including] rapid industrial transformation, low inflation, stronger exports, better quality education or reduced inequality.”

The other problem with the middle-income trap concept is it uses World Bank definitions and not a “methodical or definitional consensus,” Larson said. “There is no established definition for what the middle-income trap is or how it should be explored.”

Nevertheless, Larson stressed that the negative economic metrics that middle-income nations report, and the reasons behind them, are undeniable.

Therefore, government officials should watch out for them. “The concept has undeniable power to influence policymakers,” said Larson. “The specter of being mired in a trap can encourage desperate policymaking. When growth wavers, there may be immediate pressure to revise policies.”

Already in MENA

Belhaj believes the middle-income trap is real in MENA and will continue to hinder the region’s elevation to high-income status. “The [region] urgently needs a new social contract focused on economically empowering the hundreds of millions of youth who are expected to join the labor market in the coming decades,” said Belhaj.

He noted MENA oil exporter and net importer countries have “common structural impediments to growth” despite many reporting bursts of high GDP growth rates. “While many of these economies, especially those … dependent on hydrocarbon exports, have experienced periods of strong growth, no durable catch-up [to high-income nations] has occurred.”

The first major problem is they “all suffer from a lack of private sector dynamism, owing to their lack of will or ability to adopt the latest technologies,” said Belhaj. “This has precluded sustained productivity growth, without which it is impossible to sustain an increase in overall living standards.”

The main reason for the low private sector impact on GDP is that most MENA governments protect incumbents, especially in sectors that spill over to the rest of the economy, such as banking and telecom. According to Belhaj, that is evident in “excessive and outdated regulations that deter new actors from entering the market.”

The result is those measures “short-circuit competition, undermine the diffusion of general purpose technology, and block the type of adaptation and evolution that underpins a vibrant private sector.”

Belhaj also pointed to prevailing subsidy programs for citizens and key industries throughout MENA. “De-risking the economic lives of citizens … stifles entrepreneurship and innovation,” Belhaj said. “It also has undermined the delivery of public services while stoking mistrust of government.”

The third factor “trapping” MENA countries in the middle-income category is rising debt levels, which require governments to cut spending and umbrella subsidies to sustain economic health. The first cuts are usually from the state investment budget. Belhaj said that means MENA economies have lost their “main engine of economic growth.”

Those factors make it increasingly difficult for MENA governments to benefit fully from their efforts to improve pre- and post-graduate education. “Improvements to human capital have not translated into faster economic growth,” Belhaj said. “Instead, the MENA region has some of the world’s … largest brain drain, as educated people seek opportunities abroad.”

Sustainable transition

Larson said governments in middle-income nations face significant difficulties in tackling their slow growth rates of GDP and GDP per capita. He noted in his blog, “Transitioning to high-income status … requires different growth strategies than the ones that propel countries out of low-income countries.”

To become a high-income nation, the Tony Blair Institute paper said governments should focus on increasing value, productivity and technological intensity. Kuen Lee, a professor at Seoul National University, told the institute in March 2022 that economies also need to diversify and ensure the success of their industrial transformation. The aim is to create decent productive jobs, technology-intensive exports and spillover effects to various parts of the economy.

That means “R&D, basic and applied sciences and [high-quality education] are essential drivers,” the institute paper said. That “innovation has to be connected to industrial transformation.”

Lee said governments also need to build and promote the development of “technical schools, [and offer] higher education and foundational general education focusing on science, technology engineering, and math.” He stressed the “critical determinant of an education system that could elevate countries from middle-income to high-income status is quality rather than coverage.”

Nations that want to elevate their standing also need to address their “lack of structural transformation and weak industrial policies,” Albert Hirschman, an economist and author of several books on political economy, told the Tony Blair Institute in March 2022. They also need to address the lack of human capital development. Lastly, governments need to stop relying on extractive political-economic models, improve governance, and increase the quality of institutions and government effectiveness.

Export solution

For Egypt and other middle-income nations, increasing exports could be the quick solution to improving GDP per capita to high-income levels by 2030, as the government intends. According to an economic research paper published by the American University in Cairo (AUC) in 2022, it is “a particular area of interest, [determining] the role of exports in the development of middle-income economies.”

The document noted the government could take two approaches to exports. The first is manufacturing and exporting “capital-intensive goods to benefit from technology spillovers and eventually transform [Egypt] into a more industrialized economy.” The other option is to “specialize in [producing and exporting particular] goods … to capitalize on comparative advantages.”

The AUC paper stressed that if the government wants to escape the middle-income trap quickly, it should focus on “exporting more sophisticated goods.” The most effective approach, the research found, is to “promote the import of technologies required for more technologically advanced production.”

According to the Tony Blair Institute paper, knowledge transfer plays a significant role in promoting sophisticated exports: “Economies that focus on building a strong, internationally competitive export sector are likely to benefit and learn from international economies of scale.”

Having an export-oriented strategy also benefits the government’s “import substitution” efforts that reduce the import bill by enticing local investments. Localization of industries also could boost export revenue by selling more locally made products in international markets.

Accordingly, the government would need to lower trade barriers. A report from the Asia Development Bank in 2011 stressed the importance of introducing new exporter-friendly processes and seeking new markets to maintain export growth as a vital factor, fueling the transition to a high-income nation.

Adapting such strategies should ensure a pipeline of exportable new products. That would likely enable the government to allocate more of its budget to increase industrial investments, further increasing the likelihood of escaping the middle-income trap.

However, Larson noted the biggest challenge middle-income nations face is they usually don’t have the necessary human resources. “Improving the quality of education, enhancing regulatory effectiveness may require different capabilities than those that got them to middle-income status in the first place (e.g., macroeconomic management, provision of basic infrastructure),” he said. The key is “to pursue consistently sound but evolving policies to maintain the fundamental drivers of economic growth.