IMF warns Asia of “Middle Income Trap” and asset bubble

IMF warns Asia of “Middle Income Trap” and asset bubble

May 2nd, 2013

The International Monetary Fund (IMF) has indicated that a number of Asian countries are potentially susceptible to the “middle-income trap” and asset bubble Asian emerging economies need to guard against asset bubbles and they must improve government institutions and liberalize rigid labor and product markets if they wish to reach the level of developed countries.
The warning has come at time when the region looks set to lead a global economic recovery as risks from a meltdown in Europe recede. Although the risks from an acute euro area crisis have diminished, regional risks are coming into clearer focus. These include some ongoing buildup of financial imbalances and rising asset prices.
The IMF has ranked Malaysia and China as the highest-ranked developing Asian countries in a chart measuring ‘institutional strength’ while Indonesia, India and the Philippines were at the bottom.
What is Institutional Strength?

• IMF defined institutional strength as demonstrating higher political stability, better bureaucratic capability, fewer conflicts and less corruption.

What is ‘middle-income trap’?

• An economic development situation where a developing economy after attaining certain income / growth risk stagnation and are unable to continue their growth further and enter into the rank of a Developed economy.
• Here, a developing economy might grow very fast initially and then it stucks at a certain level (middle income level) and is then unable to grow further i.e. its growth plateaus.
• A developing nation gets “trapped” when it reaches a certain, comparatively comfortable level of income but cannot appear to take that next big jump into the true major league of the developed world economy, with per capita wealth to match.
• Typically characteristics of a countries trapped at middle-income level:  (1) low investment ratios;  (2) slow manufacturing growth;  (3) limited industrial diversification; and  (4) poor labor market conditions.

Can a country come out of “Middle Income Trap” ?

• YES, but breaking out of it, however, is extremely difficult.  The reason is that escaping the “trap” requires an entire overhaul of the economic growth model most often used by emerging economies.
• The concept behind the “middle-income trap” is quite simple:  It’s relatively easier to rise from a low-income to a middle-income economy than it is to jump from a middle-income to a high-income economy.
• The one very famous example is that of the Republic of Korea (South Korea). South Korea has proved to the world that by building a high-quality education system which promotes creativity and innovation in science and technology and private companies supported by the financial sector and the government, a nation can escape the “Middle Income Trap”.

How can a “Middle Income Trap” be avoided:
Some key suggestions to avoid Middle Income Trap include:

• Identifying strategies to introduce new processes and find new markets to maintain export growth.
• Ramping up domestic demand
• Shifting from resource-driven growth (i.e. dependent on cheap labor and capital) to growth based on high productivity and innovation
• Investments in infrastructure and education.