This year’s World Development Report: the Middle-Income Trap could be the most globally important economic report of any major institution, for many years. That is, in part, because of its attention to the broad range of ‘middle-income countries’, for which The World Bank’s definition covers 108 countries with average per-capita income anywhere between US$1,136 and US$13,845. These comprise 75% of global population, 38% of global GDP, and now almost two-thirds of global CO2 emissions (or, 30% of GDP, and 50% of CO2 emissions, for the upper-middle income category).
The extent to which its recommendations are taken on board thus matters not just to those countries and three quarters of the world’s population, but in fact, to the entire world. But the report also presents an important intellectual evolution in the analysis of economic progression now entails.
The high-level policy narrative
The major policy thrust of the WDR is on the question of whether and how middle-income countries can aspire to join the league of rich, developed countries – to escape the ‘middle-income trap’ of the title. The WDR points out that they are far from on track to achieve this, and is very direct about prioritising growth. The question it addresses is why their growth has slowed down after basic industrialisation, leaving most of them still ‘trapped in the middle’.
The core argument is that the old mantra of investment to increase capital stock is inadequate – the economic returns to further capital accumulation, in itself, decline rapidly. The focus thus needs to turn towards the enablers of better technology and innovation.
I say ‘technology and innovation’ as distinct, because the WDR argues that in fact there are two different “traps” – or at least, structural bridges to cross.
One is moving from a focus on investment per se, to the adoption of better available technologies, to maximise efficiency in its broadest meanings. This builds on many years of World Bank research on the fact that many developing countries – and particularly the low and lower-middle income countries – still predominantly use technologies that are far from the best available. In economic language, most are far from the technology frontier, that reflects the trade-off of cost and performance across the range of available technologies. In theory, they have had huge potential to catch up by absorbing better technologies, but few have done so. The implicit assumption of much neoclassical economics – and certainly, many optimising models – is that at least those economies with market economies and cost-reflective prices, by enabling people to buy the best products (in terms of the cost-performance trade-off), should gravitate naturally to the frontier. The fact that they have not – for some, decades after basic industrialisation took them to middle-income status – seems to fly in the face of the conventional economic reasoning.
Infusion …
In the area of energy, some of the statistics are particularly striking: the WDR notes (p.13) that “Middle income countries have .. both misallocation in the use of energy (with the energy intensity of GDP also 2.5 times higher than in high-income countries) and the lower diffusion of low-carbon energy technologies”, which the WDR notes as now often highly cost-effective. An ‘energy efficiency gap’ has long been noted and debated globally amongst energy economists, and energy intensity is an imperfect measure. But the World Bank has developed extensive methods to measure distance from the technology frontier and its focus on developing countries being much further still from the frontier brings a new lens to what amongst my own research colleagues we came to term ‘first domain’ economic analysis – understanding the reality of why people and economies seem to be structurally inefficient, often operating far from the technology fronter, and (maybe) especially so with respect to energy.
To follow basic investment, the WDR thus notes the corresponding task as infusion of better technologies. They chart the difficulty of moving from capital accumulation to adoption of leading technologies, as the first of the two ‘traps’. Of course, that requires countering growing protectionism and barriers to trade, but the WDR also charts numerous other barriers, many arising from domestic policy, governance, institutions.
… and innovation
To varying degrees, the upper-middle income countries have managed to bridge this step to ‘infusion’ in at least some sectors – though they remain constrained by other path-dependencies. In energy, this includes the powerful role of incumbent fossil fuel industries and State-Owned enterprises, which typically dominate the coal investments (and are mostly marginal in renewables).
More generally, most of the of them still languish in the ‘second trap’ – the step to becoming innovators, and thus sharing the leading edge of innovation-related economic benefits, where the OECD countries (and increasingly, China, the main exception) dominate.
It is in this area that the WDR really starts to break new ground. It had to, because the traditional focus of much equilibrium-focused economic theory, stressing optimal resource allocation, has had little useful to say about innovation beyond stressing the role of open markets. It involves going well beyond the traditional World Bank policy mantras of placing the central challenges as market liberalisation and subsidy removal to foster optimal resource allocation. Understanding what moves the technology frontier, and in what directions (what we have come to call ‘third domain’ economics), thus becomes crucial – for that has been a key fount of wealth for the rich world, which most middle-income countries have failed to access.
New thinking on processes of creative destruction are woven into the intellectual fabric of the WDR. This includes the Janus-like roles of incumbent industries, as both blockers and innovators. The traditional attention to SMEs as the fount of entrepreneurial innovation in market economies, shifts to understanding the interactions between SMEs and larger players.
Another key foundation is that innovation is fundamentally cumulative. It builds on the shoulders of existing capacities and nurtured capabilities, as well as supportive social environments. Hence, the WDR contends, developing countries cannot ‘run before walking’, pointing to the mixed (and limited) record of countries that tried to ‘leap-frog’ by shielding domestic industries from infusion of better international technologies. The step from ‘infusion’ of leading technologies to becoming innovators is itself difficult – the second ‘trap’ – and cannot be short-circuited.
Prescription and the new focus on energy and ‘emissions intensity’
To those of us directly engaged in energy and climate change, the WDR is especially interesting for its treatment of these topics. As in the wider development community, past years have seen extensive debates within the World Bank between those emphasising the imperative to tackle climate change, and those stressing the need (and right) to prioritise development – often wary of the perceived ‘western-led’ climate agenda. The WDR is emphatically not a report about climate change, but it emphasises the additional challenges that climate change is posing for development. Indeed, the very first page of the WDR refers to the fact that “prospering while keeping the planet liveable will now require much more attention to energy efficiency and emissions intensity.”
That is useful but hardly revolutionary. What is truly striking is the way the WDR redirects the attention of the growth agenda away from accumulation (of capital and labour resources), to more directly metrics of positive progress in relation to each of the three principal component factors of socio-economic improvement: capital, labour, and energy.
Specifically, it calls for a focus on
- Monetary value-added as the metric of productivity of a nation’s capital, particularly regarding the productivity of firms;
- Social mobility, including education and social structures which allow the broadest application of talent by breaking down the barriers to progression of disadvantaged groups;
- And Emissions intensity reduction, as a metric which combines the intrinsic economic value of enhancing energy efficiency, the value of countries harnessing the rampant innovation now under way in clean energy technologies – and the avoided environmental damages (including climate change).
Thus the WDR clearly recognises not only the severe risks to development from climate change (and other environmental costs), but also the benefits of enhanced energy efficiency and the opportunities arising from the renewables revolution – including that middle-income countries, on both counts, are clearly lagging relative to the developed countries (whose own economies are now also clearly ‘behind the frontier’).
There are some really interesting technical dimensions of the WDR’s analysis that I will return to in a fuller article (maybe, along with some reservations about aspects of its energy policy analysis). But I’ll finish with emphasising one broad global point, beyond the explicit scope of the WDR, which tbh has only recently really struck me. Emerging from the confluence of different strands of research, is the extent to which the global energy system is currently still biased against the transition that almost everyone now acknowledges to be needed.
An article by Martin Wolf in the Financial Times highlighted two major aspects of this, and I was glad to get a letter in the FT outlining three more sources of structural economic imbalance – aside from some of the more institutional dimensions of incumbency highlighted in the WDR. The UCL European Institute helpfully put these together in blog on the way current global energy markets are structurally stacked against clean energy, underlining the need for sustained government policy internationally – and the potential benefits just from ‘levelling the playing field’.
That, and the energy transition as a frontier of global innovation, is something that all economists should consider. And those are things that governments not only of the rich world, but all the 108 middle-income countries, would do well to ponder as they begin to prepare their second round of Nationally Determined Contributions on climate change, due next year.
***** Background Papers *****
At UCL our own efforts contributed two background papers to the WDR, available on their website:
And
Nice to see several hundred downloads already of these rather substantial efforts. Abstracts pasted below, in case of interest.
