In an age of globalization marked by unprecedented poverty reduction optimists can be forgiven for thinking that poor countries will eventually catch up to the developed ones. Indeed, perhaps for the first time in history, governments around the world are showing a commitment to reducing poverty and inequality.
But what about those countries in the middle? In the midst of all the good news over the reduction of poverty and inequality globally, middle income countries have struggled to get out of the so-called middle-income trap. A great majority of countries that now fall within the middle income range—including Uganda and China—will not likely make it to the next level of development. What happens to them?
As Latin American nations struggle to sustain the rise of their middle class, policymakers need to look at history’s lessons for the risks of middle-income status and ways to adjust their economies to make the next step up the global development ladder. Argentina, Brazil and Mexico, for example, were expected to grow at a pace sufficient to maintain a stable and growing middle class, but initial success stagnated in the mid-1970s and has been anemic ever since. Worldwide too, only 13% of middle income economies made the transition to high-income economies between 1960 and 2008. Part of this is due to insufficient qualified human capital, limited access to finance, and lack of infrastructure; in other words, middle-income countries have struggled to increase their productivity, and thus have become stuck. But can Latin American countries reverse their fate and boost productivity to escape the dreaded trap?
An exception to the rule
Uruguay is an exception, since it was able to make the leap from middle to a high-income country in recent years. Despite facing similar headwinds—the end of the 1970s commodity super cycle, the devastating economic consequences of the increase in petroleum prices and the financial liquidity crisis—this small southern country managed to transform itself into a successful export-oriented economy.
How it did it was pretty straightforward, but not easy: Uruguay developed and implemented an industrial policy. That policy entailed a government-coordinated effort to guide the economic progress that revolved around attracting more foreign direct investment (FDI), increasing the volume of exports and creating technological clusters with the coordination and collaboration of the private sector. All these efforts combined increased the productivity of the economy; the success came in an average annual growth rate of 8 percent from 2004 to 2008.
Today, Central America has the potential to follow Uruguay’s footsteps. In doing so, it has a distinct advantage: its collective trade agreement with the Dominican Republic and the United States. Trade within the region and with external trade partners generated an average growth rate of 3.9 percent in 2016, in the face of an economic contraction of 0.6 percent across Latin America in the same period. But despite these positive economic trends—which of course can stand even further improvement—the current conditions do not guarantee a transition to a higher status.
An incipient industrial policy in Costa Rica and Panama, for example, has already delivered some remarkable results. Costa Rica’s public spending in education and health services—the highest in Central America as a percentage of GDP—has allowed the country’s bilingual population to offer high value-added services to national and multinational enterprises and to consolidate a service-sector economy.
In the case of Panama, its key asset has been the ability to attract foreign direct investment. This is due in large part to the 2007 Regional Headquarter Law that streamlined and strengthened the country’s business climate, allowing the country to host a range of transnationals in specialized industries, such as finance and insurance.
Both countries are trend-setters. But while there has been progress, the core elements of a comprehensive industrial policy are still missing. To get there, both country governments need to create an ecosystem that coordinates and better directs human capital, foreign direct investment and technology to focus on strategic economic sectors and goals.
For Latin America, and Central America in particular, overcoming the middle income trap requires moving beyond the regular patterns of scattered and often improvised policies and actions. It requires demands a coordinated, consistent, consensus-based vision of economic development, directed and led—but not controlled—by the government. Uruguay was able to achieve it, and it has clearly reaped the rewards.