Thailand: Avoiding the middle-income trap

• Sep 25, 2019

Slowing growth across emerging markets is placing some key nations at greater risk of becoming caught in the middle-income trap, which reflects stagnating gains in GDP per capita that effectively delay their convergence with higher-income economies.

South Africa, Brazil, Argentina and Thailand are at particular risk of getting caught in the middle-income trap, despite being on the cusp of the higher-income band on an absolute basis in the next 10 years. This is principally because of slowing growth in per capita income, coupled with weak reform momentum, elevated corruption, and high social and operational risk.

Even countries that seemingly manage to successfully transition to high-income status on an absolute basis — including Mexico, Russia and Turkey — could also be at risk as gains in relative GDP per capita remain stagnant relative to the US.

Many emerging markets such as Mexico, Russia, Turkey and China will move from middle-income to high-income status over the next decade; however, for other countries it will be more difficult to make this transition.

Indeed, several emerging markets are at risk of falling into the middle-income trap, which refers to the tendency to experience a marked slowdown in growth that persists for an extended period of time after reaching middle-income levels of wealth.

While studies on the phenomenon have revealed mixed findings, empirical evidence suggests it is more likely to occur in countries that are no longer experiencing the early growth tailwinds of cheaper labour and positive demographics, and where policymaking progress is insufficient to upgrade the economic model towards higher productivity and higher value-added industries.

Such a trend is often accompanied by rising levels of social unrest and political polarisation, and may indeed be precipitated by social instability.

MOST VULNERABLE

A number of factors place emerging market economies at greater risk of falling into a middle-income trap. For example, many will see slower growth than their wealthier OECD counterparts, and several will see a considerable gap in the rate of growth they are forecast to achieve relative to what is required to reach the high-income band in the next 25-50 years.

Key factors that will weigh on growth rates typically include: a lack of economic diversification — particularly for commodities-reliant economies; low levels of educational attainment and hence lower productivity; high levels of corruption and a weak business environment that serves to limit domestic and foreign investment; and slow reform momentum to address the challenges listed above.

In addition, demographics in certain countries will act as a headwind as populations age.

While we forecast Brazil and Thailand to move marginally above the threshold to high-income status by 2028, we also see them being at risk of missing out on this transition because of a failure to overcome considerable structural challenges.

Weak reform momentum and elevated levels of corruption are common to both countries and key factors hindering progress towards reaching higher value-added economic models.

Low levels of industrialisation further weaken the case for Brazil, while Thailand faces less attractive demographics.

We forecast Brazil to transition to the higher-income band by 2028, attaining a GDP per capita of $12,461, but the annual growth rate is set to slow to an average of 3.4% over this period, compared with 4.4% in the prior 20 years.

Despite likely reaching high-income status, it will nonetheless fall behind the US on a relative basis, and when considering this together with other structural challenges, Brazil is potentially at risk of missing out on attaining higher-income status by 2028.

As a major commodities producer, Brazil’s economy lacks diversification and this is reflected in the relatively small manufacturing footprint, which stands at 11.5% of GDP (the lowest in the sample and declining to 10% in 2028), with commodities comprising close to half of total exports.

Reform momentum is also relatively subdued, despite having recently improved because of the likely passing of pension reform.

Commodities producers often display higher levels of corruption relative to more industrialised peers, and Brazil is no exception.

The corruption score is one of the weakest in the sample, scoring 35 out of 100 in the Corruption Perceptions Index (where lower scores indicate higher levels of corruption).

TARGET FOR THAILAND

Thailand is also set to reach higher-income status by 2028, with GDP per capita of $12,853, which is rising in relative terms compared with the US.

In addition to positive signs on both absolute and relative measures of gains in GDP per capita (we expect average growth of 5.9% until 2028), Thailand has a number of other positive attributes such as one of the highest manufacturing footprints in the sample — at 26.5%, second only to China — coupled with the lowest risk of social unrest and one of the lowest operational risk scores.

Nevertheless, despite these strengths, Thailand falls short in terms of reform momentum, with a score of 4 out of 10, as the current government will struggle to pass meaningful reform given the large number of parties in the coalition and its small majority.

At the same time, corruption is one of the highest in the sample with a score of 36 out of 100.

An additional weak spot is Thailand’s relatively less positive demographic profile, with the oldest median age in the sample (39.7 years) — higher even than that of China (38.1).

In summary, slowing growth among emerging market nations increases the risk that many will get caught in the middle-income band of their development cycle for a prolonged period.

Many will see traditional drivers of growth — such as low-cost labour — fading well before levels of technological innovation are sufficiently sophisticated to compete with alternatives in more advanced economies, and thereby drive productivity growth.

The backdrop of slowing global growth and rising odds of a global recession places more emerging market nations at risk of falling into the middle-income trap.