Escaping the Middle Income Trap: Exploring the international dimension of successful countries [1]

Escaping the Middle-Income Country Trap EMIT Working Paper Series No. 216rsm4 Escaping the Middle Income Trap: Exploring the international dimension of successful countries [1] Jan Anton van Zanten, Rob van Tulder and Annette Pelkmans-Balaoing - draft, not for citation Abstract In a general position paper (Van Zanten et al, 216a) we identified the need as well as the potential for an international multi-level lense through which the experience of countries that successfully developed beyond a middle income position can be assessed. This paper is a first effort in exploring these insights. It first selects the sample of thirteen countries which have been successfully moving beyond middle income status in the post-war period. We specify subgroups that share comparable histories and explore in particular the international dimension of them at the macro (national and regional) level of analysis. This includes a number of key characteristics of these countries over a longer period of time in which they moved through various income positions related to: (1) trade (exports and imports), (2) inward and outward foreign direct investment, as well as (3) changes in competitiveness and (4) inclusiveness over time. We will apply a number of the theoretical lenses as presented in the general position paper that are particularly relevant for the macro-economic analysis: (a) trade position in general and in the region in specific, (b) investment development path (net effect between outward and inward foreign direct investment) and (c) competitiveness-inclusiveness pathway. The First two dimensions relate to what we can dub the Economic Openness Development Path, the last dimension relate to what we can dub the Inclusive Growth Development Path. Along these same dimensions we will also analyse the two countries that are still facing the middle income trap and which are the prime topic of the EMIT research project the Philippines and Thailand. In follow-up contributions we will zoom in more specifically (a) at the characteristics of these clusters of countries at the meso (global value chain) level of analysis and (b) present the first results of an exploratory study of three exemplary countries at the micro level of analysis. 1

1. IDENTIFYING POST MIDDLE-INCOME COUNTRIES Out of 11 middle-income countries in the 196s, only thirteen have developed to become high-income countries by 28 (Worldbank, 212). This shows that many countries struggle, over prolongued periods of time, to to move out of the middle-income position and pass the tipping point of becoming a high-income country. Countries that are seen to be stuck in the middle-income trap include many economies in Latin America and the Middle-East and nations in South-East Asia, such as Thailand, the Philippines and Malaysia (World Bank, 212). This paper considers the experience of the thirteen countries that successfully developed beyond a middle income position since the 196s and compares them with a two country benchmark in the Asean region: The Philippines and Thailand. To identify the countries that have moved past the middle-income segment, the Gross National Income construct as used by the World Bank can best be applied.. Based on 212 GNI per capita, countries can be classified as low-income ($1,35 or less), lower middle-income ($ 1,36 - $ 4,85), upper middle-income ($ 4,66 - $ 12,615), or high income ($ 12,615 or more). The World Bank provides its GNI per capita data only from 198 onwards. Because many countries entered the middle-income classification already before 198, and because the middle-income trap is by definition a longitudinal concept, having a more historical perspective is important. For that reason, recent work by Van Heuvelen (213) has set out to convert Madisson s GDP per capita dataset (Bold & van Zanden, 213), that provides longitudinal GDP per capita data, and align it with the World Bank s GNI per capita data (based on the Atlas method) and the related income classifications. The conversion of Madisson s GDP per capita data (Bold & van Zanden, 213) to the World Bank GNI per capita data results in the following new income categories: low-income ($ 2,2 or less), lower middleincome ($2,21 - $ 6,3), upper middle-income ($ 6,31 - $ 11,15) and high income ($ 11,151 or more) (van Heuvelen, 213). Subsequently, retrieving the Madisson GDP data (Bolt & van Zanden, 213) for the 195 21 period allows for the classification of countries into the different income categories over this timeframe. This provides a historical perspective on economic development and reveals the tipping points related to entrance in specific income categories. This research has analyzed the development of 166 countries and their related income category tipping points. On the basis of this, a selection of countries can be made that will be analyzed in this study. The main selection criterion taken into account is whether or not the countries progress through the middleincome category was recent. There are two reasons for adopting this criterion. First of all, over the past decades globalization has caused trade, FDI, and regional integration to have had major impact on development. These topics are highly time sensitive and were seen to have rapidly increased over the past decades. Analyzing countries that relatively recently developed past the middle-income positions is therefore more likely to result in representative findings which can be used as foundations for constructing future theory. The second reason is of a more practical nature and stems from the fact that most databases 2

195 1953 1956 1959 1962 1965 1968 1971 1974 1977 198 1983 1986 1989 1992 1995 1998 21 24 27 21 Real GDP per capita, Constrant 25 PPP US$ on GDP and trade commence in the 195s and 196s, and databases on FDI tend to commence in 198. Selecting those countries which developed through the middle-income categories in the years in which these types of data are available is therefore more practical. Doing so, this paper has identified 13 countries that successfully developed beyond the middle-income segments. These countries are: Japan, Taiwan, South Korea, Hong Kong, Singapore, Portugal, Greece, Ireland, Chile, Uruguay, Estonia, Latvia and Lithuania. In addition, two countries have been included that are still in the middle-income category. These serve as control countries and are the Philippines, which is currently in the lower middle-incomesegment, and Thailand, which is in the upper middle-incomesegment. Figure 1 shows the 13 successful countries (+2 benchmark countries) that were selected for this study. In the 195s, interestingly, all these countries were at relatively similar levels of development. However, while various countries achieved rapid economic development over the course of the 196s, such as Japan, Hong Kong, Ireland, Portugal and Singapore, other countries accelerated economic growth at later times. For example, Taiwan and South Korea saw their economies increase rapidly from the 197s onwards. Additionally, countries such as Chile and Uruguay grew at a slow, but stable pace. Since 1983, Thailand and in particular the Philippines in particular, fail to achieve consistent economic growth needed to get them beyond the middle-income level. Figure 1 - GDP per capita (195-21) 6 Chile 5 4 3 2 1 Estonia Greece Hong Kong Ireland Japan Korea Latvia Lithuania Philippines Portugal Singapore Taiwan Thailand 3

The 13 successful countries entered the lower-middle, upper-middle and high-income classifications at different points in time (Table 1). Table 1 - Entrance into different income segments by year Country Income category Lower- middle Upper- middle High Japan 1952 1966 1973 Hong Kong 195* 1972 1981 Singapore 195* 1974 1987 Ireland 1921 1972 199 Portugal 1951 1973 1991 Taiwan 1968 1984 1992 South Korea 197 1986 1994 Greece 1953 1971 1998 Estonia n/a** 199* 1998 Chile 191 1991 24 Latvia n/a** 199* 25 Lithuania n/a** 199* 26 Uruguay 1891 1991 21 * Most recent data available ** Most recent data for the Baltic States is available as of 199, due to their previously being under Soviet rule Chile and Uruguay entered the lower middle-income category more than a century ago, while Ireland obtained this status in 1921. Hong Kong and Singapore were also in this category in the first half of the 2 th century (most recent data for these countries is available as of 195). Other countries, such as Taiwan and South Korea, entered the lower middle-income category as late as 1968 and 197. The upper middle-income category was reached first by Japan in 1966, while Chile and Uruguay were the last countries to leave the lower middle-income category in 1991. Japan was also the first country to reach high income status, in 1973, while Uruguay only reached this status in 21. 4

It becomes clear that the development paths of these countries over time are highly dissimilar. Figure 2 depicts the time it took these countries to transition from the lower middle-income category (LM) to the upper middle-income category (UM), and from the upper middle-income category to high income. Figure 2 - Number of years required to pass the middle-income categories Japan 14 7 Taiwan 16 8 South Korea 16 8 Hong Kong* 22 9 Singapore* 24 13 Portugal 22 18 Greece 18 27 Ireland 51 18 Chile 9 13 Uruguay 1 19 2 4 6 8 1 12 Time (years) LM - UM income UM - High income *Most recent data for Hong Kong and Singapore is available as of 195. The total number of years the countries required to pass the lower middle-incomecategory might therefore be understated in this graph. The rapid development experienced by the Asian countries, Japan, Taiwan, South Korea, Hong Kong and Singapore, is evident and stands in stark contrast to some of the other countries. Whereas Japan, Taiwan and South Korea required 21 and 24 years respectively to move out of the middle-income position, Chile needed 13 years and Uruguay required 119 years. This supports the position of Van Heuvelen (213) that the middle-income trap is a notion that requires further defining. On the one hand, successfully developing countries, such as the Asian ones in this sample, maneuver through the middle-income categories rapidly 5

and can for that reason not be considered to have been stuck in a middle-income trap. On the other hand, Chile and Uruguay were in the middle-income position for more than a century and can therefore be argued to have been trapped in this position. However, countries such as Portugal and Greece needed 4 and 45 years respectively to reach high income status and it remains unclear whether this constituted a middleincome trap (for a recent discussion and analysis of the definitions of the middle-income trap see van Heuvelen, 213). In addition, it can be seen that almost all countries have been in the lower middle-income category for a longer period of time than the upper middle-income category. Exceptions to this are Greece, which has been in the upper middle-income category for 27 years while only having been in the lower income category for 18 years. This is in line with van Tulder (214) and van Heuvelen s (213) distinction between a lower middle-income trap and an upper middle-income trap. On the basis of the previous general overview of the countries development, different clusters of countries can be identified. First, Japan should be treated separately due to its very rapid development and its very early obtainment of high-income status. The second cluster includes the city states Hong Kong and Singapore. The third cluster consists of the two other Asian Tigers, namely Taiwan and South Korea. The fourth cluster includes the European countries: Ireland, Portugal and Greece. Fifth, Estonia, Latvia and Lithuania constitute a cluster of Baltic States. The sixth cluster is Latin American and includes Chile and Uruguay. And seventh, Thailand and the Philippines are currently in a middle-income position and therefore make up a control group. The following sections analyze these clusters development paths in terms of trade, trade openness, and FDI and the IDP. It focuses on the 195 212 period. However, FDI data is available for the period between 198 and 212. Because many countries were already in the upper middle-income category in 198, this period does not cover all countries entrance into sequential income categories. Nevertheless, the FDI positions of the countries that either already were in the upper middle-income position in 198 (Ireland, Portugal, Greece and Singapore), obtained this position after 198 (Taiwan, South Korea, Chile and Uruguay), or the countries of which data became available after 199 (Estonia, Latvia and Lithuania) can be examined. Similarly, Thailand and the Philippines can be analyzed, even though they still are regarded as middle-income countries. 2. METHODOLOGY FOR FURTHER ANALYSIS For the macro-economic data gathering over the years of the four key variables, a large number of relatively reliable sources are available. Regarding trade, UNCTAD s statistical database provides trade data (volumes) for the 195 212 period. This data has been downloaded and analyzed. Furthermore, this data was combined with nominal GDP data, allowing for the calculation of a country s ratio of trade to GDP by 6

dividing the sum of exports and imports by nominal GDP. The World Bank s database has been used to retrieve GDP data rather than UNCTAD s because the former provides data starting in 196, while the latter provides data starting in 197. This ratio of trade to GDP is, among various other diverse indicators (see Pak Hung, 21; Winters, 24), commonly used to measure trade openness (e.g. Liu, Song & Romilly, 1997; Siong, 29; Chen & Emile, 213; Dritsaki & Dritsaki, 213). Along these lines, the most inclusive source for FDI data is UNCTAD s statistical database. This source contains inward as well as outward FDI starting for most countries in 198. Using FDI stock data, which reflects accumulated FDI, rather than flows, which reflects annually changing streams of FDI, results in an overview of FDI development over the 198 212 period. Net outward FDI is calculated by subtracting inward FDI from outward FDI. This allows for an analysis of the countries IDP. Moreover, the obtained FDI data is compared to the respective country s nominal GDP level. National competitiveness can be analyzed through the World Economic Forum s annual Global Competitiveness Report in which countries are ranked based on their Global Competitiveness Index (World Economic Forum, 213). This index is a tool that measures the microeconomic and macroeconomic foundations of national competitiveness (World Economic Forum, 213), where national competitiveness is defined as the set of institutions, policies, and factors that determine the level of productivity of a country (World Economic Forum, 213:4). In turn, the level of productivity of a country sets the level of prosperity that can be reached by an economy (World Economic Forum, 213). The index is published since 25. It is acknowledged that it would be more preferable to measure competitiveness over a longer time span. However, alternatives or substitutes for measuring competitiveness are also not available for a longer period of time. Nevertheless, through deductive reasoning this data provides an insight into the way the countries developed over time. To measure inclusiveness (i.e. how a country s income is distributed among its inhabitants) the country s Gini index can beused. This index measures the extent to which a country s income distribution deviates from a perfectly equal distribution (Worldbank, 214). The cumulative percentages of total income received are plotted in a Lorenz curve against the cumulative number of recipients, starting with the poorest individual or household. The Gini index measures the area between the Lorenz curve and a hypothetical line of absolute equality. This is expressed as a percentage of the maximum area under the line. As such, a Gini index of implies perfect equality, whereas an index of 1 implies perfect inequality (World Bank, 214). Gini indices are retrieved through the World Bank database. 7

3. OPEN ECONOMICS DEVELOPMENT PATHWAYS: CLUSTERING SUCCESSFUL COUNTRIES 3.1 First Mover: Japan Having developed from lower middle-income to high income in just 21 years, between 1952 and 1973, Japan is the most successful country in this sample. During its lower middle-income period (1952-1966) average annual growth rates (AAGR) of exports and imports were 16 per cent and 12 per cent, respectively. These were higher during the country s upper middle-income period (1966-1973) and amounted to 23 per cent and 21 per cent. At the end of Japan s lower middle-income period, the absolute value of its exports first exceeded the absolute value of its imports. Notwithstanding multiple years in which imports exceeded exports, this remained so during most of its years as an upper middle-income country. Hence, particularly since the end of Japan s lower middle-income period exports became an increasingly important focus of economic activity. Nevertheless, Japan can be characterized as a relatively closed economy. In both its lower and the upper middle-income period the country s average ratio of trade to GDP was 18 per cent. This was also the country s degree of trade openness at the income classification tipping points. An explanation for this can be found first of all in Japan s reconstruction after World War II. Japan had to focus on domestic policies to reshape its economy and enhance development. As such it had an inward looking perspective. A second explanation for its low degree of trade openness is found in the relative scarcity of regional integration initiatives and free trade agreements between countries in this period. These initiatives have particularly gained popularity starting in the 198s. Hence, this is well after Japan gained high-income status. Examples of such initiatives Japan is part of include the country s membership of APEC in 1989, its WTO accession in 1995 and its part in the initiation of ASEAN Plus Three (APT) in 1997. Unfortunately the country s FDI positions over the course of its middle-income period cannot be assessed due to the fact that FDI data only became available in 198. Nevertheless, analyzing the development of FDI after this period yields important insights into the country s development path. It is found that while inward FDI only increases moderately, particularty since the end of the 199s, outward FDI experiences very strong growth. In combination with the country s strong export position this leads to the conclusion that by the 198s Japan had a very strong domestic industry, capable of effectively competing in foreign markets. Its low degree of trade openness and its relatively small inward FDI positions further imply that Japan s development path can be typified as endogenous. Its development path is displayed in figure 3 below. 8

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ Figure 3 - Japan's development path (195-212) 25 2 15 1 5 Global Financial Crisis Dot-com bubble Asia Crisis APT Initiated WTO Accession APEC Membership 12 1 8 6 4 2 3.2 Asian Tigers: Taiwan and South Korea Taiwan and South Korea both required 24 years to move from a lower middle-income position to a highincome position and they passed this threshold in a similar timeframe. In terms of trade, both countries were relatively open over the course of this period. Taiwan s degree of trade openness remained stable during both its lower middle-income and upper middle-income periods, at an average rate of about 8 per cent. South Korea s trade openness increased from 32 per cent when reaching the lower middle-income tipping point in 197, to 6 per cent while reaching the upper middle-income tipping point in 1986. Its reaching the high-income threshold in 1994 was characterized by a 47 per cent degree of trade openness. Overall, South Korea s trade openness during its middle-income period averaged 54 per cent. To add to this, Taiwan and South Korea both experienced strong and similar growth of trade. This is seen to particularly take off during the countries lower middle-income period. During their lower middleincome periods Taiwan s and South Korea s exports were characterized by AAGR s of 24 per cent and 26 per cent, while imports increased respectively on average with 2 per cent and 19 per cent annually. In their upper middle-income periods Taiwan s and South Korea s exports increased on average by 13 and 14 per cent annually, while imports increased by 16 per cent for both countries. Taiwan s exports, in absolute volume, first exceeded its imports in the second half of its lower income period. The country maintained this net exporting position ever since. South Korea was also a net importer for most of its lower middle- 9

income period. After that, its characterization as a net importer or exporter is seen to fluctuate. Both countries high trade openness and strong growth of exports and imports allow for the conclusion that engaging in international trade has been important for the countries in reaching high-income status. During their upper middle-income periods, Taiwan s ratio of inward FDI to GDP averaged around five per cent, compared to two per cent for South Korea. Outward FDI stands in contrast. Whereas Taiwanese outward investment compared to GDP amounted to 22 per cent in 1984 (its upper middle-income tipping point) and 16 per cent in 1992 (its high-income tipping point), South Korea s outward investment increased from 1 per cent in 1986 to 2 per cent in 1994. Hence, even though the countries are relatively similar concerning inward FDI, outward FDI plays a prominent role during Taiwan s transition to high-income status, while it is largely insignificant in South Korea s development. In terms of the IDP, South Korea was a net inward investor with slowly increasing inward and outward FDI. Taiwan was a net outward investor over the course of its whole upper middle-income period. This can be explained by Taiwan s close, although not always positive, relation with China. When the Communist Party of China founded the People s Republic of China (PRC) following the Chinese civil war in 1949, many mainland Chinese moved to the Republic of China (ROC), or Taiwan. As a consequence of these ethnic relations many Taiwanese companies invest in mainland China. In terms of regional cooperation Taiwan is a special case. In 1971 the PRC claimed China s seat at the United Nations (UN). The ROC was consequently derecognized by most UN member states which made the establishment of regional cooperation and trade agreements a difficult task. Nevertheless, in 1991 it became an APEC member and in 22 it joined the WTO. Moreover, in 21 the PRC and ROC signed the Economic Cooperation Framework Agreement, which is a preferential trade agreement between Taiwan and mainland China. South Korea became a member of APEC in 1989 and acceded to the WTO in 1995. Furthermore, in 1997 it also was part of the initiation of APT. The Asian Tiger s strong trade positions while maneuvering through the middle-income categories and their low inward FDI positions are similar to Japan s development path and therefore indicate a endogenous development path. Taiwan s high outward investment positions further relate to Japan and reflect the high competitiveness of local Taiwanese firms. South Korea s outward investment is seen to catch up when it reached high-income status. The countries development paths are displayed in figures 4 (Taiwan) and 5 (South Korea). 1

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ 195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ Figure 4 - Taiwan's development path (195-212) 25, 2, 15, 1, Dot-com bubble ECFA Financial Crisis Asia Crisis WTO Accession APEC Membership 35 3 25 2 15 5, UN derecognition 1 5 Figure 5 - South Korea's development path (195 212) 25, 2, 15, 1, 5, APEC Membership Asia Crisis APT+3 Initiated Global Financial Crisis Dot-com bubble WTO Accession 6 5 4 3 2 1-1 11

3.4 City States: Hong Kong and Singapore Hong Kong and Singapore are, together with Taiwan and South Korea, part of the Asian Tigers. Of these four, Hong Kong and Singapore are city states. They reached the high income threshold in 1981 and 1987, respectively. Both city states serve as important trade and financial hubs in the region. Therefore, both countries, but Singapore in particular, were characterized by very high trade openness during their middleincome periods. At Hong Kong and Singapore s upper middle-income tipping points in 1972 and 1974 trade openness amounted to 128 per cent and 272 per cent. At their high income tipping points in 1981 and 1987 trade openness increased to 154 per cent and 294 per cent, respectively. During their lower middle-income periods Hong Kong s exports and imports both increased on average by 1 per cent annually, while Singapore s exports increased by 8 per cent and its imports by 9 per cent on average annually. Additionally, Hong Kong s growth of exports and imports was substantially higher after it passed the upper middle-income segment as these reflect AAGRs of 23 and 24 per cent, respectively. Singapore s growth of exports and imports was more similar during both periods as the AAGRs thereof amounted to 13 and 11 per cent. Hence, trade played an important role in the countries paths to high-income status. For both countries, in absolute terms imports were larger than exports during the middle-income period, even though the difference between the two is small. This makes Hong Kong and Singapore net importers. Due to the fact that FDI data became available one year prior to Hong Kong s passing of the high income threshold, only Singapore can be analyzed during its middle-income period on this indicator. It can be seen that inward FDI stock averaged 51 per cent of GDP during the last seven years of the country being in the upper middle-income segment, while outward FDI averaged six per cent. Both variables recorded double digit average annual growth rates during these years. For that reason, inward FDI in particular can be hypothesized to have played an important role in Singapore s path to high income status. In terms of the IDP, both countries are negative net outward investors. Hong Kong s inward and outward FDI increased rapidly and in tandem since the mid-199s. This can be explained by the transfer of sovereignty over Hong Kong from the United Kingdom to China in 1997. Singapore increasingly received inward investments in the years prior to its high-income tipping point. Outward FDI started to increase rapidly after becoming a high-income country but is still lower than inward FDI. These increases in FDI are surrounded by various international cooperation agreements the countries signed. For example, Singapore was among the Association of South East Asian Nation s (ASEAN) founding members in 1967 and joined APEC in 1989, while Hong Kong joined APEC in 1991. Moreover, in 1995 both countries joined the WTO and Singapore was involved in the initiation of APT in 1997. Furthermore, in 23 Hong Kong signed the Closer Economic Partnership Arrangement (CEPA) with mainland China, while Singapore signed a free trade agreement with China in 28. Lastly, 21 marked Hong Kong and Singapore s 12

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ engagement in the Chiang Mai initiative which is a multilateral currency swap arrangement among the ASEAN members, China, Hong Kong, Japan and South Korea. Due to their function as a regional hub, trade and FDI are important in Hong Kong and Singapore s development paths, which can therefore be described as transit. They are displayed in figures 6 (Hong Kong) and 7 (Singapore). Figure 6 - Hong Kong's development path (195 212) 35, 3, 25, 2, 15, 1, 5, Asia Crisis Sovereignty transfer UK - PRC CEPA - China, P.R.C. Dot-com bubble WTO Accession APEC Membership Chiang Mai Initiative Global Financial Crisis 16 14 12 1 8 6 4 2-2 -4 13

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ Figure 17 - Singapore's development path (195-212) 35, 3, 25, 2, 15, 1, 5, Chiang Mai Initiative China - Singapore FTA Global Financial Crisis Dot-com bubble Asia Crisis APT Initiated AFTA Signed WTO Accession APEC Membership 8 6 4 2-2 -4 3.5 The effect of early European integration: Ireland, Portugal and Greece Greece, Portugal and Ireland differ substantially regarding the time in which they passed the lower middleincome threshold. However, they transgressed the upper income segment in a comparable timeframe. Like Hong Kong and Singapore, Ireland serves as a regional trade hub. As such, it is characterized as a very open economy. Its degree of trade openness reached 6 per cent at its upper middle-income tipping point and 92 per cent at its high-income tipping point. Ireland s exports and imports increased at a moderate pace while passing the upper middle-income threshold. During Ireland s lower middle-income period, exports and imports increased on average by 9 and 6 per cent annually, respectively. When reaching the highincome tipping point its trade positions are seen to grow more rapidly. This is reflected in the AAGRs of exports and imports during the whole upper middle-income period. These are 16 and 13 per cent, respectively. Ireland s inward FDI is very high, having an average ratio of 147 per cent to GDP during its upper middleincome period. When it reached high-income status this ratio amounted to 79 per cent. Ireland s outward FDI is also relatively high, ranking 31 per cent at its high-income tipping point. While passing the highincome threshold, inward and outward FDI both increase moderately. At the end of the 199s, when Ireland 14

is a high-income country for almost a decade, particularly inward FDI but also outward FDI increases rapidly. This reflects the country s attractiveness to foreign investors and the increased international competitiveness of its domestic companies. Political influence helped achieve this. In 1981 the Irish government initiated the ten per cent manufacturing relief scheme which provided manufacturing companies with a discount. This is particularly attractive in the light of its European Economic Community (EEC) membership (since 1973), allowing for free trade in the region. In addition, the government proposed the Finance Act in 1999, reducing corporate tax from 32 per cent to 12 and a half per cent, coming into effect in 23. This resulted in a strong influx of inward FDI. The country s exports are higher than its imports. Therefore, it is plausible that most foreign investors set up manufacturing activities, creating products for international markets. Portugal and Greece have a comparable development path. Greece s trade openness increased from 2 per cent at its upper middle-income tipping point to 3 per cent at its high income tipping point. Portugal s degree of trade openness amounted to 33 per cent and 49 per cent at the respective tipping points. During their lower middle-income period Greece s and Portugal s exports increased on average with 1 per cent annually, while imports increased with 12 per cent (Greece) and 11 per cent (Portugal). During their upper middle-income periods these rates remained relatively stable (ranking between 1 and 13 per cent). In absolute terms, Greece and Portugal s imports exceeded exports during the middle-income period. This gap is seen to have increased for both countries during the upper middle-income period. Upon reaching high-income status, Greece s ratio of inward FDI to GDP was 1 per cent, while Portugal s ratio of inward FDI to GDP was 15 per cent. At this tipping point, Greece and Portugal both had a ratio of outward FDI to GDP of 2 per cent. In this period, particularly inward investment increases rapidly. The fact that growth of inward FDI is aligned with growth of imports leads to the hypothesis that inward investors are particularly interested in serving domestic markets that increasingly gain purchasing power due to rising income levels. Outward investment is seen to increase only after having been a high-income country for a number of years. Therefore, the countries companies can be argued to only become internationally competitive after the countries attained high-income status. The transition to high-income status of these three countries coincided with regional integration and cooperation agreements. While in their lower middle-income periods free trade and economic integration initiatives were relatively scarce. The European countries serve as a progressive exception. In 196, Portugal, together with Austria, Denmark, Norway, Sweden, Switzerland and the United Kingdom created the European Free Trade Agreement (EFTA). This free trade agreement was meant to serve as a trade-bloc alternative to the European Economic Community (EEC) which was joined by Ireland in 1973 by Greece in 1981 and by Portugal in 1986. This laid the foundation for the Economic and Monetary Union (EMU) which the countries are a part of. Another prominent initiative is the OECD, which came into existence in 1961 and aimed to collectively promote policies that will improve economic and social well-being. Ireland, Greece and Portugal are founding members of the OECD. Additionally, these countries joined the WTO in 15

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ 1995, in which Greece was still classified as an upper middle-income country, while Ireland and Portugal had already reached high-income status. All in all, Ireland is characterized by a transit development path due to its many foreign investors engaging in trade. Portugal and Greece, on the other hand, show a high degree of inports coinciding with a high degree of inward investments, while exports and outward FDI are less important. As such, their domestic markets are strongly influenced by foreign firms, and to some extent dependent thereof. Their development paths can thus be termed exogenous. The paths of these three countries is depicted in figures 8 (Ireland), 9 (Portugal) and 1 (Greece) below. Figure 8 - Ireland's development path (195-212) 3, 25, 2, 15, Global Financial Crisis Finance Bill in effect Dot-com bubble Finance Bill Proposed 1% Manufacturing WTO Accession Relief Scheme 4 3 2 1 1, 5, -1-2 16

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ 195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ Figure 9 - Portugal's development path (195-212) 16, Global Financial Crisis 14, 12, Dot-com bubble WTO Accession 1, EU Membership 8, 6, 4, 2, 14 12 1 8 6 4 2-2 -4-6 Figure 1 - Greece's development path (195-212) 18, 16, 14, 12, 1, 8, 6, 4, 2, EU Membership 1 Global Financial Crisis 8 Dot-com bubble WTO Accession 6 4 2-2 -4 17

3.6 A long trail of escaping - Latin American Countries: Chile and Uruguay Chile and Uruguay, over the course of their transgression through the middle-income segment, became increasingly open to trade. At their upper middle-income tipping points, both in 1991, Chile s degree of trade openness was 47 per cent, compared to 29 per cent for Uruguay. This increased to 57 per cent when Chile became a high-income country in 24. With a degree of 4 per cent Uruguay s trade openness also increased upon obtaining high-income status. During its lower middle-income period, Chile s exports and imports both increased with an average of eight per cent annually, while Uruguay s exports and imports experienced AAGRs of five per cent. In their upper middle-income segments average annual growth rates of exports increased to ten and nine per cent for Chile, and eight and nine per cent for Uruguay. Hence, their passing of the high-income tipping point coincided with growth of trade. Additionally, in absolute terms Chile s exports and imports are comparable in volume over the course of its middle-income period. Uruguay, on the other hand, reflects more volatility in absolute importance of exports and imports. Even though both countries experienced growth of trade, these rates are low compared to other countries in this sample. However, the countries differ regarding FDI. Whereas Chile s inward FDI was very high and increased rapidly, Uruguay s level and rate of growth of inward FDI were moderate. At Chile s upper middle-income tipping point its ratio of inward FDI to GDP was 43 per cent, compared to six per cent for Uruguay. Nevertheless, during their upper middle-income periods both countries prove to be attractive investment destinations. At their high-income tipping points the countries had inward FDI to GDP ratios of 66 per cent (Chile) and 32 per cent (Uruguay). At this time Chile s exports start to grow more rapidly. As is further discussed in chapter five, mining and quarrying is Chile s largest exports sector. Therefore, there seems to be a link with inward FDI focused on this sector and its increase in exports, thereby supplying international markets with natural resources. Opposed to Chile s trade position, Uruguay s imports prove more important when reaching high-income status, even though exports also rise. Therefore, foreign investors are likely to import more to serve the Uruguayan market as well as import inputs to use in subsequent exports. Furthermore, Chile s outward FDI increased from a low one per cent of GDP at its upper middle-income tipping point to 19 per cent of GDP at its high-income tipping point. This shows that Chilean firms have become more competitive in international markets. However, Uruguayan foreign investments are not seen to take-off: its outward FDI to GDP ratio decreased from two per cent at its upper middle-income tipping point to one per cent at its high-income tipping point. Hence, Uruguayan firms are not competitive in international markets. This, in combination with Uruguay s high inward FDI position allows for the conclusion that its economy is still dependent of foreign countries. 18

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ The growth of exports, imports, inward FDI and, for Chile, outward FDI, particularly during both countries upper middle-income years, are surrounded by regional integration and cooperation initiatives. Uruguay acquired Mercosur membership in 1991, the year in which it reached the upper middle-income threshold. Chile gained associate member status of Mercosur in 1996. Additionally, Chile became a member of APEC in 1994, and both countries joined the WTO in 1995. Furthermore, in 25 Chile signed a free trade agreement with China. In sum, the countries heavily rely on foreign investors who are hypothesized to be accountable for a large share of the countries trade positions. Whereas Chile s domestic firms are increasingly becoming competitive on international markets, Uruguay s firms are not. Therefore, both countries development paths are characterized as exogenous and they are displayed in figures 11 (Chile) and 12 (Uruguay) below. Figure 2 - Chile's development path (195-212) 16, 14, 12, 1, 8, 6, 4, 2, Coup Dot-com bubble Democratic elections Associate Member Mercosur China - Chile FTA WTO Accession APEC Membership Global Financial Crisis 25 2 15 1 5-5 -1-15 19

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ Figure 12 - Uruguay's development path (195-212) 14, 12, Global Financial Crisis Dot-com bubble WTO Accession 2 15 1, 8, 6, 4, 2, Mercosur Membership 1 5-5 -1-15 -2 3.7 From transition states to late European integration: the Baltic States - Estonia, Latvia and Lithuania The Baltic States gained independence from the Soviet Union in 1991. In this year the countries were all in the upper middle-income segment. As a consequence of their independence, the countries rapidly opened up to trade. At their high-income tipping points the countries had trade openness ratios of 144 per cent (Estonia), 86 per cent (Latvia) and 111 per cent (Lithuania). The three countries are located at the Baltic Sea and thus constitute an important link between the Scandinavian countries and Central and Eastern Europe, explaining these relatively high ratios. Furthermore, over the course of their upper middle-income segments Estonia s exports and imports increased most rapidly (on average with 4 and 5 per cent annually), while Latvia s and Lithuania s trade positions grew at a similar pace. More specifically, Latvia s exports AAGR was 16 per cent and its imports AAGR amounted to 2 per cent. These rates were 15 per cent and 17 per cent, respectively, for Lithuania. In absolute terms, during this period all countries recorded larger imports than exports. After their independence, foreign investors increasingly obtained presence in the Baltic States. This is reflected by high average inward FDI growth rates. During their upper middle-income period (starting from 2

1992) this rate amounted to 64 per cent in Estonia, 29 per cent in Latvia, and 39 per cent in Lithuania. At their high-income tipping points, foreign investments in Estonia compared to 33 per cent of Estonian GDP, while investments in Latvia and Lithuania amounted to 31 per cent and 36 per cent, respectively. This in relation with the high level of imports in the Baltic States makes it likely that foreign investors particularly aim to serve the domestic markets. The Baltic States outward investments, on the other hand, are still in an early phase. When obtaining highincome status, the countries had outward FDI to GDP ratios of two per cent (Latvia), three per cent (Lithuania) and four per cent (Estonia). Nevertheless, Estonia s outward investments quickly gained pace. When Lithuania passed the high-income threshold in 26, Estonia s outward FDI to GDP ratio already reached 21 per cent. Estonia obtained high-income status earlier than the other two Baltic States. This is likely to have increased the competitiveness of its domestic companies compared to Latvian and Lithuanian firms. The growth of trade and FDI positions occurred together with regional integration and cooperation initiatives. In 1994, the Baltic States established the Baltic Free Trade Agreement. In addition, in 1999 Estonia and Latvia acquired WTO membership in 1991, while Lithuania became a member in 21. Furthermore, in 24, all three countries became a member of the European Union All in all, the Baltic States have favorable geographic location and serve as a trade hub, thereby attracting FDI. The development of these countries is characterized as transit and they are depicted in figures 13, 14, and 15. 21

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ Figure 13 - Estonia's development path (199-212) 25 2 15 1 5 WTO Accession Baltic FTA Global Financial Crisis EU Membership Dot-com bubble 3 25 2 15 1 5-5 -1-15 Figure 14 - Latvia's development path (199-212) 22

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ Figure 3 - Lithuania's development path (199-212) 16 14 12 1 8 6 4 2 Global financial crisis EU Membership Dot-com bubble WTO Accession Baltic FTA 25 2 15 1 5-5 -1-15 3.8 the benchmark group: Thailand and the Philippines The trade and FDI positions of the clusters of countries that successfully navigated through the middleincome categories can be compared with Thailand and the Philippines. These countries are at risk of landing in the middle-income trap after having been in the middle-income segment for a long period of time. Thailand and the Philippines obtained lower middle-income status in 1977 and 1976. However, Thailand has managed to reach the upper middle-income segment. It entered this segment for the first time in 1995 but retired to lower middle-income status in 1998. This is likely to be due to the Asian crisis of 1997 and the negative impact on trade and FDI this had for the country (see figure 19). Nevertheless, Thailand passed the upper middle-income tipping point again in 21 and has subsequently consistently experienced GDP growth. Analyzing these countries trade positions, it is found that they increasingly became open. When Thailand passed the upper middle-income threshold in 21, its degree of trade openness was 17 per cent. The Philippines has not yet managed to pass this tipping point, but in the year 21 its level of trade openness reached 92 per cent. Whereas in 212 this ratio has increased to 131 per cent for Thailand, it decreased to 47 per cent for the Philippines. As such, Thailand ranks among the most open countries in this sample, while the Philippines became less open even though it still is a relatively open economy. This is further 23

reflected in the countries AAGRs of exports and imports. Until 21 these were comparable for both countries, ranging between ten and twelve per cent. However, from 21 onward Thai exports grew on average by twelve per cent annually, compared to eleven per cent for its imports. In the same period of time, Philippine exports and imports increased on average with four per cent and five per cent, respectively. Analyzing these countries FDI positions shows that when Thailand maneuvered through the lower middleincome segment (from 198 to 21) its inward FDI to GDP ratio increased from three per cent to 3 per cent. In the same period of time this ratio increased from four per cent to 14 per cent for the Philippines. Outward FDI increased in this period from zero to four per cent of GDP for Thailand, while it increased from zero to one per cent of GDP for the Philippines. These ratios continued to increase in the period of 21-212. For Thailand, inward FDI increased to 44 per cent of GDP, whereas this ratio reached 12 per cent for the Philippines. Along these lines, Thailand s outward FDI increased to 14 per cent of its GDP in 212, while the Philippines outward FDI in this year amounted to four per cent of its GDP. In general, the countries are seen to follow a similar macroeconomic development path in which inward FDI and increased trade (exports and imports) go hand in hand. As chapter five will show, the countries are increasingly linked in GVCs. As such, foreign investors are likely to set up in the countries, importing inputs to be used in manufacturing, the output of which is subsequently exported. Yet, the difference between the two countries is that Thailand s trade openness, trade growth rates, and FDI growth rates are all larger than the Philippines. This is particularly evident in the years after it passed the upper middleincome threshold and could explain its higher degree of development. Both countries are also involved in regional cooperation and integration agreements. They are both among ASEAN s founding members in 1967. Additionally, Thailand and the Philippines joined APEC in 1989. Moreover, in 22 the Asia Cooperation Dialogue (ACD) was created. This is an intergovernmental organization that aims to promote Asian cooperation at a continental level. It further sets out to integrate separate regional organizations such as ASEAN and the South Asian Association for Regional Cooperation (SAARC). 24

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ The development of Thailand and the Philippines over the same period of time as the development of the above discussed countries is displayed in figures 16 and 17. Figure 16 - Thailand's development path (195-212) 1, 3 9, 8, 7, 6, 5, 4, 3, 2, ASEAN member APEC member Global Financial Crisis Dot-com bubble Asia Crisis ACD 25 2 15 1 5-5 1, -1-15 25

195 1952 1954 1956 1958 196 1962 1964 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 GDP per capita (199 int. GK$) Bln current US$ Figure 17 - The Philippines' development path (195-212) 3,5 25 3, Global Financial Crisis 2 2,5 2, 1,5 1, ASEAN member APEC member Dot-com bubble Asia Crisis ACD 15 1 5 5-5 4. INCLUSIVE GROWTH DEVELOPMENT PATHWAYS: LINKING COMPETITIVENESS AND INCLUSIVENESS These national development paths provide interesting insights to the development of the specific economies. In order to provide a more complete perspective on these countries development, the distribution of income among participants needs to be included by examining the Gini index of the countries. Additionally, even though the development paths of the countries provide an initial glance of competitiveness by showing the extent to which the firms active in the countries are successful in international trade and investments, a more comprehensive perspective can be provided by examining the countries competitiveness scores as obtained through the World Economic Forum. The competitiveness scores and Gini indices of the sample countries were collected and plotted against one another (figure 21). 26