IMAGE: SK HYNIX
IN THE AUTUMN of 1960, as John F. Kennedy campaigned for the American presidency, the Republic of Korea was a place of desperate poverty. Its income per head stood at little more than $1,200 in today’s money, below that of Ghana or Sudan. When Mr Kennedy took his fateful trip to Dallas three years later, a young military strongman named Park Chung-hee was beginning to consolidate power in Seoul. Few outsiders would have predicted that this poor, war-battered country, with almost no natural resources, would within a single lifetime become a high-technology powerhouse. Yet by 2023 Koreans enjoyed an income per person of $33,000, comfortably above Portugal’s.
Korea’s journey from destitution to wealth is the sort of economic transformation that Robert Lucas, a Nobel laureate, once called a “miracle”. The trouble is that miracles have been vanishingly rare.
Since 1990 only 34 middle-income economies have graduated to high-income status. Their combined population is less than 250m, roughly the size of Pakistan’s. The other 108 countries that the World Bank currently classes as middle-income—those with annual income per person between $1,136 and $13,845—are home to 6bn people, or three-quarters of humanity. Nearly all of them, including Nepal, aspire to reach high-income levels within the next two or three decades. To do so, they will have to navigate a passage that has defeated almost everyone else.
The middle-income trap, as development economists call it, is not just about growth slowing down. It is about what happens when an economy exhausts the easy gains from accumulating capital and copying basic technologies. Countries that have done well at the low-income stage typically rely on what the World Bank calls a “1i” strategy: investment, investment and more investment. Factories are built, roads are paved and ports are expanded. Returns are high because the economy is starting from such a low base. But diminishing returns set in. The marginal product of capital declines. Without a change of approach, growth stalls at around 11% of American income per person, roughly $8,000 today.
Escaping that plateau means not one shift but two. The first is from a 1i strategy to a “2i” approach, adding “infusion” to investment. Infusion means deliberately bringing technologies and business methods from abroad and spreading them through the domestic economy. This is not the same as just opening up to trade or foreign investment, though both help. It calls for active efforts to connect local firms with global know-how; to train workers in the skills needed to absorb new techniques; and to create competitive pressure that forces companies to modernise or exit.
Chile’s experience shows the power of infusion. In the 1960s mining accounted for four-fifths of its exports. By the time it joined the OECD in 2010, that share had fallen to about half. A public agency, ProChile, helped small exporters find markets. A private non-profit, Fundación Chile, adapted Norwegian salmon-forming technology to local conditions, turning the country into a global leader in salmon exports. By 2012 Chile had become the first Latin American country to reach high-income status.
The second transition is harder still. Once a country has largely absorbed the technologies available from abroad, it must begin to innovate on its own: moving to a “3i” strategy that adds innovation to the mix of investment and infusion. This means pushing out the global technology frontier, rather than just approaching it. It requires deeper capital markets, stronger competition policy, better universities and closer links between industry and academia. It also demands something less tangible but no less important: greater economic and political freedom, social mobility and the kind of creative ferment that allows new ideas to challenge established interests.
Korea made both transitions, though not in a linear way. In the 1960s and 1970s, Mr Park’s government directed massive investment into heavy industry while forcing conglomerates, the chaebol, to adopt foreign technologies. Tax credits encouraged royalty payments for technology licences. Engineers were sent abroad for training. By the 1980s, as Korean firms neared the technological frontier, the government shifted support towards research and development. Universities expanded, particularly in science and engineering. By the 1990s Korean companies were copying Japanese and American products as well as inventing their own.
Poland’s path was different but followed a similar logic. After communism collapsed, the government disciplined state-owned enterprises by cutting subsidies and exposing them to import competition. Then came infusion: foreign direct investment poured in, particularly after Poland joined the European Union in 2004. Polish workers, increasingly well educated, absorbed technologies from Western Europe. More recently, Polish firms have begun to innovate in their own right, though the country remains more of a sophisticated adopter than a frontier innovator.
The failures are as instructive as the successes. Brazil, which reached middle-income status in the 1970s, tried to leap straight to innovation without first mastering infusion. In 2001 it imposed a 10% tax on payments for foreign intellectual property, using the revenue to subsidise domestic research. Patent applications rose sharply but the patents were of low quality and had little commercial relevance. Meanwhile Korean workers, who in 1980 were only a fifth as productive as Americans, had by 2019 reached more than 60% of the US level. Brazilians, who in 1980 were 40% as productive as Americans, had slipped to 25%.
The reason these transitions are so difficult is that they need constant wrestling with three forces: creation, preservation and destruction. Creation is the engine of growth: new firms, new products, new ways of doing things. Preservation is the instinct of those who benefit from the status quo: established firms, privileged elites, powerful interests. Destruction is the painful but necessary process of clearing away what no longer works: bankrupt companies, obsolete technologies, outmoded policies.
In successful economies, these forces are roughly in balance. Incumbents are disciplined by competition, so they must keep improving. Talented people, regardless of background, can rise and start new ventures. Outdated arrangements are swept aside, often in moments of crisis. In middle-income countries, by contrast, preservation tends to dominate. Large firms do not grow much over time, but neither do they exit. In India, Mexico and Peru, a firm that survives for 40 years will roughly double in size. In America, a firm that lasts that long will grow sevenfold. The dynamic in middle-income countries is “flat and stay”; in America it is “up or out”.
Talent is also misallocated. Middle-income countries have smaller pools of skilled workers than advanced economies, and they use them less efficiently. Women, minorities and people from poor backgrounds are often shut out of the most rewarding occupations. Intergenerational mobility is about 40% lower than in rich countries. The children of elites keep their advantages; the children of the poor stay poor.
If anywhere, it is in energy that the problem is laid bare. Middle-income countries have greenhouse-gas intensity three and a half times that of rich countries. They subsidise fossil fuels heavily and protect incumbent state-owned power companies. Renewables struggle to break in even where their costs have fallen sharply. The cost of capital for solar and wind projects in lower-middle-income countries is more than twice that in high-income countries, reflecting higher perceived risks and weaker regulatory frameworks.
What then is to be done? The World Bank offers a three-part answer: discipline incumbency, reward merit and capitalise on crises. Disciplining incumbents means opening markets to competition, whether from foreign firms or new domestic entrants. It means strengthening antitrust enforcement, reforming bankruptcy laws to allow unproductive firms to fail, and resisting the temptation to coddle small businesses simply because they are small. In Mexico eliminating tax distortions that favour small firms could boost output by 9%.
Rewarding merit means ensuring that talent and not birth determines who gets educated; who gets hired; and who gets funded. That means investing in foundational skills, as well as monitoring learning outcomes and expanding access to higher education for women and disadvantaged groups. It also means using digital technologies to create “digital capital” that can help previously excluded people build credit and start businesses. India’s Aadhar system, a digital ID, has enabled small vendors to access finance and increased entrepreneurship in lagging districts.
Capitalising on crises is the most difficult task. Crises are destructive but they also weaken the forces of preservation. The oil shocks of the 1970s accelerated energy efficiency. The global financial crisis of 2007-09 coincided with a surge in renewables, partly because stimulus spending went into green technologies. Today the climate crisis and the energy crisis, however painful, create opportunities to dismantle outdated arrangements. The question is if governments have the courage to seize them.
None of this will be easy. The global environment facing today’s middle-income countries is less forgiving than the one Korea or Chile enjoyed. Protectionism is rising in advanced economies. The energy transition is urgent and costly. Demographics are turning unfavourable in many places. Debt levels are high. The headwinds are strong.
Yet the goal is not impossible. It requires clarity about what development entails: transforming the structure of an economy so growth endures long after the easy gains fade. That demands the right sequence—investment first, then infusion, then innovation. It also demands discipline: there are no shortcuts, and skipping stages leads to stagnation. Ultimately, the forces of preservation, however entrenched, must give way to creation.
In the early 1960s, few would have bet on Korea. The country lacked capital, technology and democratic traditions. It had only a fierce determination to escape poverty and a willingness to learn from abroad. That turned out to be enough. For the 6bn people now living in middle-income countries, the lesson is that miracles are made not born. ■
