The Politics of Latin America’s Middle Income Trap

Many of Latin America’s largest economies are stuck in the so-called “middle-income trap,” with slowing productivity growth making it unlikely that they will catch up to the top global economies in the near term. Countries in the middle income trap are losing competitiveness with poor economies on manufactured exports, but are also unable to compete with wealthier economies in high-skill innovation.  As a result, they are “stuck” in the middle income category, and they have been stuck for a long time. According to the World Bank, of 101 countries that were middle-income in 1960, only 13 had graduated to high-income 48 years later. Large middle-income countries today have now been in the middle-income bracket for more than six decades, as opposed to only 42 years for the earlier industrializers.

Social scientists have long recognized the problem of the middle income trap, and a general consensus exists that the only way to break out is to save and invest more, invest in education, improve infrastructure, and increase innovation, research and development (R&D). But a recent article by Richard Doner and Ben Ross Schneider points to a larger political problem that has received far too little attention: middle income countries must build strong institutions despite weak societal demand for such institutions. 

Although their paper extends beyond Latin America, it will be of particular interest to scholars and practitioners interested in Latin America’s development trajectory. In Latin America’s large middle-income countries—Brazil, Mexico, Argentina, Colombia, and Peru— the middle income trap is evident in multiple ways. These Latin American countries have less than a quarter of the technical personnel in R&D by comparison with higher-income Asian or OECD countries, and their R&D spending is also less than a quarter of their richer peers. The share of the labor force that has higher education is less than 60 percent that of the wealthy countries. Latin middle-income countries’ scores on PISA educational attainment tests are over one-fifth lower than their wealthy peers. Income inequality is high, informal employment is above 50 percent on average, and the shadow economy has been growing, rather than shrinking. As a consequence of all of these factors, large Latin middle-income nations’ GDP per capita, in purchasing power parity terms, remains about 38 percent of the OECD high income countries, and 29 percent of the Asian high-income nations. 

Doner and Schneider note that much of the development literature has focused in recent years on the importance of institutions. But this prescription is unsatisfying in that it tells us little about how to build the coalitions needed to create those institutions. Many of the policies required to achieve middle income status—devaluation or trade liberalization, for example—a could be implemented by insulated technocrats through a stroke of the pen, so coalition-building was seldom a central concern. The “upgrading reforms” needed to move into the higher income category, by contrast, are difficult and complex processes of institutional construction, and require coordination to monitor and reconcile the interests of multiple actors. Furthermore, those upgrading reforms oftentimes are in direct conflict with the conditions that facilitated movement to middle-income status in the first place, such as foreign investment or large pools of low-skilled labor.

Using studies of R&D and education reforms, Schneider and Doner demonstrate that all too often in large middle-income nations, the incentives for key actors to support “upgrading reforms” are missing. Building the political coalitions needed to move into the higher income category requires overcoming challenges that are particularly pronounced in Latin America: inequality that makes politics more vulnerable to dysfunction, informality that generates disincentives to educational investment, and high rates of foreign investment, especially by multinational corporations that have few incentives to join coalitions investing in upgrading policies, such as education or R&D. 

If Doner and Schneider’s excellent analysis can be faulted for anything, it is that they offer a devastating critique of the situation facing large middle-income countries, but few constructive policy recommendations for how to escape it. This is partly—as they acknowledge—because it is difficult to know what will work, given that the countries that escaped the middle income trap during the twentieth century did so under unique conditions. Those countries were either East Asian nations with strong developmental states, late entrants into the EU, or small countries. External security threats, contentious politics, and few exportable natural resources were conditions that helped some of these countries to build developmental coalitions; most important was that elites did not get in the way by capturing institutions and policy for their own purposes. It will be hard to recreate many of those conditions on the ground in Latin America’s large middle-income countries today. But Doner and Schneider’s diagnosis provides us with a better sense of where the problem lies: the lack of incentives that might galvanize reform coalitions to move in the right direction. Researchers and policymakers may be able to build on this crucial insight to think about how best to develop long-term strategies that would encourage pragmatic policies, good institutions, and the coalition-building needed to support both.

Postscript: In a happy coincidence for readers in Washington, DC, I have just learned that the authors will be presenting their work at the Inter-American Development Bank on June 2, from 12:00 p.m. to 2:00 p.m.