Over the long term, the economic performance of countries around the world tends to converge as less developed countries “catch up” to richer ones by adopting existing technologies and attracting capital which is eager to exploit relatively cheap labor. This convergence has been consistent over time, since the industrial revolution in the 19th century, and has flourished in recent decades, led by the extraordinary progress of China. Nevertheless, a significant number of countries have not participated at all in this process. Also, for many countries, convergence has been moderate and for others it has plateaued or even regressed. In particular, a cohort of middle-income countries have stalled in the process of convergence, a phenomenon which as been labelled as the “Middle Income Trap.” It seems that after reaching a certain level of convergence further “catch up” requires new skills, linked to institutions and human capital, which some countries struggle to develop. This means that for many middle-income countries convergence becomes more arduous, and the result is that, over the past 50 years, only a handful of countries – Taiwan, Korea, Singapore, Hong Kong and Israel – have successfully graduated to high- income status.
Below, we look at convergence for the past 50, 30 and 20 years, and follow with a focus on the evidence for the “Middle-Income Trap.”
The Past 50 Years
The table below shows 50-years of convergence based on World Bank data for 92 countries. Convergence is measured by a country’s change in GDP per Capita relative to that of the United States. For example, China’s score of 12.98 indicates that its GDP/Capita relative to the U.S. has gone from 1.1% to 14.2% over the 50-year period. Countries that are significant for emerging markets investors are highlighted in bold.
- The top performers are very diverse, covering every region and population size, though Asian convergence is very strong.
- Only half the countries enjoyed any convergence at all. Significant underperformers generally fall under two categories: 1. Countries which are categorized by the WB as pre-demographic dividend, meaning that they experienced high population growth and increasing dependency ratios; 2. Countries suffering political turmoil (civil strife, wars,etc…) or extreme political dysfunction (Argentina, Venezuela).
- Focusing on those countries that matter for EM investors, eight important EM countries experienced significant convergence (China, Korea, Thailand, Malaysia, India, Indonesia, Turkey and Chile). Taiwan would also qualify but is not included in WB data. Three countries (Colombia, Brazil, Philippines) experienced either slight convergence or slight regression. Six countries experienced significant regression (Mexico, Peru, Argentina, Nigeria, South Africa, Venezuela). About half of the countries that investors follow closely in emerging markets over this long period have not enjoyed significant convergence.
The Past 30 Years
The World Bank data for the past 30 years (1988-2018) covers 150 countries. These years cover the modern period of institutional investment in emerging market stocks, as the widely-used EM indices (MSCI, IFC/S&P, FTSE) were launched in the second half of the 1980s, and many institutional investors began allocating to emerging markets in the early 1990s.
- Once again, the best performers – those countries converging the most with the GDP/Capita of the U.S. – come from a broad variety of geographies and income groups. Asian convergence is exceptional.
- Well over half the countries experienced positive convergence with the U.S.
- Several new impressive convergers appear from emerging Asia (Myanmar, Vietnam, Bhutan Laos) and Africa (Equatorial Guinea,Cabo Verde, Mozambique).
- The performance of significant countries for EM investors diverges greatly over this period. Asian markets all experience rapid convergence (China, India, Korea, Vietnam, Thailand, Indonesia, Malaysia, Hong Kong, Philippines), with the exception of Pakistan, which makes only slight progress. In Latin America, Chile enjoys strong gains and Peru and Colombia achieve significant positive convergence, but Argentina, Mexico and Brazil all lose ground and Venezuela experiences a collapse, moving from middle-income to low-income status. In Africa, Nigeria achieves moderate convergence, while South Africa suffers a severe deterioration.
The Past 20 Years
The past two decades saw a commodity boom and peak globalization characterized by the extensive development of global supply chains by multinational corporations. Most importantly, the incorporation of the formerly “Soviet Bloc” countries had a big impact on the World Bank data for convergence, as these economies have enjoyed rapid progress by attracting capital and integrating into the global economy.
- Nearly 70% of economies experience convergence over this period.
- Once again, the best performers came from a wide variety of geographies and income groups. Formerly Soviet bloc countries dominate the list (Azerbaijan, Turkmenistan, Armenia, Georgia, etc…). In Africa, Ethiopia appears as a top performer, and, in Asia, Cambodia now arrives.
- Looking a the countries of significance to EM investors, Asia performs well across-the-board; In Eastern Europe, the Middle-East and Africa (EMEA), Poland, Russia, Turkey and Nigeria experience strong convergence, while South Africa languishes; in Latin America, Peru and Colombia perform reasonably well, while Brazil and Mexico slip, Argentina slides and Venezuela crashes.
Evidence for the Middle Income Trap
In the table below, we look at the performance of middle-income countries over the past 30 years (1988-2018). We use a broad definition of middle-income, including countries having incomes which vary from 10% to 50% of the per capital income of the United States at the beginning of the period. 40 countries are included, which represents 27% of the WB database.
- Half of the middle-income countries experience at least some convergence. The number of strong convergers is roughly the same as the number of underperformers. On average, convergence is low for this group. There are also about an equal number of big winners and big losers, with Hong Kong, Malta and Korea graduating to upper- income status, and Venezuela, Ukraine and Georgia falling out of middle-income status.
- Neither geography nor relative income seems to determine either winners or losers. Nevertheless, there is a strong contrast between the high conversions of Asian middle-income countries (Korea, Malaysia) and weak performance of Latin American countries. To some extent, we can conclude that the “Middle-Income Trap” is largely a Latin American phenomenon.
Conclusion
The world has experienced significant economic convergence in recent decades, as expected by economic theory.
However, middle-income countries as a whole have had mediocre performance which is not explained by geography or relative income.
What is it that explains the great divergence within middle-income countries? Why have Korea and Chile prospered while Venezuela has collapsed and Brazil has languished? This is a key debate which we will explore in a future post.