Middle income trap refers to failing to transition to high-income status due to rising labor costs and declining competitiveness. As conventional means such as investment in infrastructure and education fail to find a way out, escaping the middle income trap has become a burning issue. Hence, there has been a suggestion to innovate or perish in the Death Valley of middle-income trap. But how to innovate is a big issue. As Innovation is often termed as the act of creative genius of generating sudden sparks and the heroic art of rolling out as a profitable business, crafting a pathway of escaping the middle income trap out of innovation remains elusive.
Furthermore, suggestions for democratizing creativity and promoting grassroots innovation do not end up finding scalable growth paths. Hence, despite desperateness and suggestions for innovations, all developing countries are caught in the middle income trap.
There have been exceptions too. For example, Japan, South Korea, and Taiwan succeeded to keep growing and reaching high-income status without getting caught in the middle income trap.
Their success remains unexplained to development professionals as World Bank’s growth commission could not find a repeatable pattern for sustaining growth reaching high income status. On the other hand, due to the perceived importance of innovation in driving growth, economist Dani Rodrik mentioned that “Innovation is too important to leave to innovators alone.” He argues that policymakers should play a much more significant role in democratizing innovation so that it does not remain caught in the hands of a few firms and selected countries.
But how to make it happen? Portraying correlations of conventional indicators like STEM graduates, R&D funding as a percentage of GDP, patent filling, and the economic status of a few countries does not offer a clue of how to make innovation a growth engine.
Economic theories in favor of innovation for escaping middle income traps
In economic growth theories, Economists have articulated ideas or innovations’ role in total factor productivity (TFP). In producing economic value, the role of knowledge, ideas, and innovation are presented as TFP, an exogenous factor. As TFP distills from knowledge, hence there has been growing importance on human capital and R&D funding. To increase the role of human capital in development policies, economic outputs have been articulated as Y=F(K,L,H) (K: capital, L: labor, and H: human capital). But the growing unemployment of college graduates in Bangladesh, India, and many other developing countries has raised a question about the acceptability of correlation between human capital and economic growth. Hence, the efficacy of such economic theories in favor of policy interventions of expanding higher education to escape the middle income trap is questionable.
In recent reports of development lenders like ADB, World Bank, bilateral agencies, and Think Tanks, innovation has been cited for escaping the middle income trap. They have given high priority to creation stating that either innovate or perish. The suggestion has been that middle-income countries need to embrace a strategy focused on the capability to advance innovation. It’s a must to move up the value chain and create decent jobs to escape the middle income trap. But such reports fall short of prescribing how to systematically design and implement interventions to make progress in embracing innovation. By the way, how to move up the value chain and create decent jobs are not clear either.
To further emphasize the role of innovation in endless or sustained growth, Paul Romer developed the theory of ideas and objects. But due to a lack of clarity in explaining unfolding realities, such suggestions and theories do not help much. Ironically, often, they misguide policy-making circles.
Endogenous growth theory for escaping middle income trap
It is not challenging to realize that ideas or recipes are vital in creating economic value by mixing ingredients. And by improving ideas, we can derive more economic value, measured as consumer and producer surpluses. And same ideas could be by multiple people simultaneously in creating economic value. Hence, unlike materials and labor, ideas are non-rivalry. Furthermore, as ideas play critical roles in creating economic value from labor, capital, and ingredients, they form endogenous factors. Hence, for an apparent reason, Paul Romer came up with his Nobel Prize-winning economic theory of ideas (A) and objects (X): Y=F(A, X).
To meet our urgency, we feed knowledge into our creative process to produce better ideas or recipes for deriving more value from the inputs. For example, microchips have been driving economic growth due to the continued success of making transistors increasingly better and cheaper through better silicon processing and component design ideas. As humans face no limit in generating knowledge, the creative process should keep producing better ideas. Hence, every nation is supposed to keep growing by leveraging ideas in the form of product and Process innovation. But, why are we observing that a growing number of countries have been failing to escape the middle income trap? Over the last 70 years, why have only three countries succeeded in escaping it and reaching high-income status by leveraging innovation or building an idea economy?
Failure of import substitution and export-oriented manufacturing to escape the middle income trap
Import substitution is a preferred option among development planners to drive economic growth. Due to the local value addition scope out of mostly labor, it has merit. But as the labor content at the final stage has been falling, the scaling-up opportunity has been shrinking. Furthermore, as replication-based import substitution does not keep improving the quality and reducing the cost, the protection for import substitution faces the limit of diffusion and growth. On the other hand, protection for import substitution does not encourage firms to pursue risk taking path of innovation. Hence, upon succeeding in attaining the capability of making many products through import substitution measures, India and many developing countries stagnated and failed to graduate as high-income economies.
Export-oriented manufacturing also does not offer a sustained growth path. First of all, the primary means of value addition is labor. Due to wage increases, competitiveness suffers, resulting in slow growth. Consequentially, despite being the factory of the world, development progression ends up getting caught in the middle income trap.
Grassroots innovations do not scale up—failing to escape middle income trap
Of course, people in the country, including all least developed and developing countries, are creative. They have been after generating ideas and turning them into innovations to get their jobs done better. Due to the urgence to address livelihood better, people in developing countries are after ideas of reorganizing whatever ingredients they have to innovate better. There have been many examples, from water sprinklers from discarded plastic bottles to connecting motors and batteries to rickshaws. These are grassroots innovations.
Yes, grassroots innovations contribute to economic growth out of ideas. But they are not scalable. Hence, they do not keep improving and diffusing, creating quality jobs—let alone helping host countries attain high-income status.
But many grassroots innovations in developed countries succeeded in scaling and turning their country’s advanced economies. It happened due to the systematic Flow of Ideas and their integration. It happens that less developed countries have been failing to do so. The failure to scale grassroots innovation through a systematic flow of ideas out of science and engineering has been one of the barriers to benefiting from innovation.
Inefficacy of linear model of innovation in developing countries to leverage innovation
Some experts have been offering a prescription for scientists in less developed countries to embark on basic research. Hence, Government should increase research funding. In reality, many developing countries have been doing so, growing publications. The argument is that knowledge discovery will lead to inventions and innovations driving economic growth. Countries like the USA and Germany have many examples to show. By following that linear model, developing countries will keep progressing to high-income status by leveraging innovation.
Undoubtedly, knowledge is a primary ingredient to invention and innovation. But basic research leads to inventions that take a long gestation period to grow as commercially viable innovations. Furthermore, due to global competition, they face increasing substitution pressure. Hence, research establishments comprising national laboratories in India, Bangladesh, Pakistan, and many other developing countries have failed to reach the growth path in making their host countries high-income ones.
Misleading innovation index and university ranking to benefit from innovation and human capital
Based on conventional indicators like STEM graduates, publications, patents, and many others, the innovation capabilities of different countries are being ranked. Yes, those indicators are relevant for innovations. But they are not sufficient to help nations to drive economic growth. Hence, it’s misleading. Ironically, instead of looking into what it takes to succeed with innovation, developing countries have been investing in improving relevant indicators for enhancing ranking. Similarly, despite having no visible progress in leveraging human resources to drive economic growth, universities of many developing countries have been in the race for university ranking.
Lessons from Japan, Taiwan, and South Korea
The growth of Japan from WWII ash to high-income status is remarkable indeed. What are the underlying reasons? Is it due to labor, infrastructure, and trade negotiations? Yes, they matter; but they are not sufficient. Similarly, why have Taiwan and South Korea reached high-income status?
On the other hand, despite being more prosperous and naturally more resourceful, why has Malaysia failed to escape the middle income trap? These three countries understood the limitations of economic value creation from natural resources, labor, knowledge, and ideas. They carefully made decisions to make timely migration from natural resources and labor to ideas. Notably, all the three took advantage of emerging semiconductor technology core. They turned semiconductors into idea beds to fuel economic growth— taking them to high-income status.
Focus on understanding innovation dynamics and rational decisions for leveraging a flow of ideas for improving the quality and reducing the cost
Creating economic value out of innovation in a globally connected competitive market does not happen in isolation. To succeed, the global competition must be won. Hence, the focus should be on understanding unfolding dynamics and making a conscious decision.
For creating a flow of ideas, we need a suitable technology core. Hence, target and assimilate emerging technology core. Both process and product innovations through incremental advancement should be leveraged. Upon doing so, the mission should be on Creative Destruction and Disruptive innovation. It’s worth noting that Japan is an economic success story out of all of them. Japan’s success in creative destruction also unleashed disruptive innovation effects on American and European firms. And in doing so, developing countries should pursue product and process-centric R&D through refinement and fusion of emerging technologies. Hence, escaping the middle income trap demands understanding globally unfolding innovation dynamics and to make conscious decisions to penetrate and scale up out of a flow of ideas.
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Related articles:
Middle Income Trap–how to escape?
Uprising of Japan’s Tinkerers to Innovators– lesson to be drawn for entering into the idea economy
Grassroots Innovations — why and how to scale up
Innovation Decision–fraught with pervasive uncertainties
Incremental innovation Examples — creating big bang
Creative Destruction – creation from Reinvention
