One of the leading storylines these days is, the rapid economic growth of so called emerging markets. Over the last 70 years, many low-income countries have developed rapidly. Millions of people have been lifted out of poverty. However, relatively few countries have reached the high-income status. In recent years, policymakers of the slower-growing middle-income countries are worrying that they are stuck in a "middle-income trap." But at the same time, many economists deny even the existence of this term. Now let's put all the beliefs aside, and find out what is a middle income trap. And how it is affecting the world.
If we speak in simple words, the middle income trap is an economic development situation in which a country that attains a certain average income, gets stuck at that level. While failing to graduate into the ranks of high-income countries. At the same time, other countries make significant progress. For example many countries made tremendous progress through industrialization. They were able to expand the national income, and thus the per capita income.
The World Bank has classified countries in terms of per capita income. In this, the low income countries are those with a per capita income lower than $1005. Second category is the middle-income group with a per capita income varying from $1006 to $12235.
For many countries the conversion from low income to a middle income country is very rapid most of the time. But after that, the economic growth is very slow. And they might observe the phenomenon of a “middle-income trap". Latin America and the Middle East seem to provide compelling support for this phenomenon. As many economies in both regions have remained at middle-income levels for four or five decades. Infact, out of 101 middle-income countries in 1960, approximately only 13 became high-income by 2008.
Now, what are the causes of the middle income trap?
Well by analysing the history of economic growth of many countries, one of the main reasons are rising wages or you can say rising cost of labour. Countries which rely heavily on labour intensive manufacturing could be more vulnerable to the middle income trap. You see, for labour intensive manufacturing, a huge number of labourers migrate from rural to urban areas. But over the time, labour supply and the demographics have just become less favourable. The surplus supply of labour coming from rural to urban areas starts to fade away. And countries hit the lowest turning point where labour supply shrinks, and wages start to increase. After that these countries lose their competitiveness, and this starts to decelerate their economic growth.
The next cause might be a slow down in the rate of growth of productivity, or labour efficiency. This could happen if countries do not invest sufficiently in human capital, especially in education. Slow rate innovation could also be the reason for slow productivity. Similarly, the average age of the country's population may start to get older before they get rich. And this can also reduce productivity.
The middle trap might also be the result of institutional failure. Government and financial sectors may not be able to cope up with a rapid expansion of the economy. Also, high inflation rate, and credit buble could also damage economic growth.
Now we have to understand that. Transitioning to high-income status is rare and difficult. It requires different growth strategies, than the ones that propel countries out of low-income levels. Every country has a different set of economic, social, cultural, demographic, and political circumstances. So there is no unique policy to avoid the middle income trap. But there are some ways which could be useful to avoid the middle income trap. First, it is difficult to achieve high growth without strong macroeconomic stabilization policies. Fiscal, monetary, and financial policymaking supports long-run economic growth. This helps countries to control inflation and avoid crisis.
Second, strong institutions and rule of law are essential for growth. The quality of governance including public sector efficiency, control of corruption, effective legal systems, and civil and political rights are all strongly correlated with economic growth.
Third, investment in education and human capital development are again crucial for growth. As productivity increases, it helps the technological innovations, which depend upon highly skilled human capital. And to prompt innovation, investment in R&D and advanced infrastructure needs to accelerate.

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