Several ASEAN member states such as Malaysia, Thailand, the Philippines, Vietnam and Indonesia have sustained impressive growth rates in recent decades. Whilst this is a good news for ASEAN, they are also trapped in a pattern where the growth based on low cost comparative advantage is curtailed as incomes rise. Political economists called this pattern “Middle Income Trap”.
This issue has been increasingly important as ASEAN moves forward after its 50th anniversary. In moving from middle to high income status, middle income countries (MICs) must move their factors of production from capital and labour intensive (intrinsic) production to knowledge and innovation-driven production.
Are Middle Income Countries (MICs) able to make this transition smoothly? Not necessarily. MICs are finding it increasingly difficult to make this transition, as they are sandwiched between the lower cost competitors, and high income economies who have the institutional and human capital bases to drive innovation and technology.
They thus find themselves uncompetitive and trapped in this pattern of income.
Some have put forward regional economic integration, such as through the ASEAN Economic Community (AEC), as a strategy to avoid the middle income trap. However, the AEC is unlikely to provide a route to escape the MIT, and national strategies are likely to remain the priority for individual ASEAN governments.
Over time, ASEAN members progressed through the value chain by upgrading production processes and investing in human capital. It is worth noting that ASEAN’s success in maintaining security and stability in the region has been a key to unlocking the economic benefits regional stability brings.
This cannot be sustained forever, however. As illustrated by the Lewis Turning Point, when these economies have exhausted their surplus labour, wages begin to rise. This income growth erodes comparative advantage of low cost labour if wage rises are not accompanied by increasing productivity and technological upgrading. Growth rates subsequently slow as countries become uncompetitive.
Consider, for example, Indonesia, Malaysia and Thailand. They have not seen growth levels as experienced before the Asian Financial Crisis. Future growth is also of no guarantee. In essence, economies who experience this process become ‘trapped’, as they reach a certain level of income but find it difficult to move to high income levels. Only 13 out of 101 countries have moved from middle to high income since 1960.
ASEAN economies are facing significant challenges in relation to the MIT. In particular, innovation in ASEAN is low, which is indicated by the origins of patent registration. Data shows that the majority of patents registered in ASEAN economies come from multinational corporations, whose profits often flow back to the high income economies.
In addition, research and development funding in ASEAN economies is significantly low. For example, Indonesia under invests in Research and development, with only 0.1% of GDP spent in this sector and 0.3% on higher education. This contrasts with South Korea who escaped the middle income trap, and spends 4.4% of GDP on research and development, ranked first in the OECD.
We could see a problem here: Middle income ASEAN members are stuck in the middle, with higher labour and logistical costs and imperfect institutions making them uncompetitive. They are also lacking in innovation capacity and human capital for technological capabilities.
What could be done to resolve this problem? As Gill & Kharas convincingly argued, there is a need for institutional reform in areas of finance, governance and legal systems. ASEAN members need to become more specialised in what they produce –as well as shift from investment driven to innovation driven growth. This necessitates another factor: a structural transformation in ASEAN economies.
But could ASEAN provide a regional strategy for such transformation? Whilst ASEAN does provide some institutional anchoring, the AEC –regional platform for economic integration—are not institutionally deep enough to bind countries faster to reform. Rather, ASEAN tends to become a trend follower instead of a trend setter.
This is evident from various economic agreements and integration strategies adopted by ASEAN. To sum up, ASEAN’s institutional design are made to increasingly attract investment from to the region. Therefore, they are relying upon Foreign Direct Investment (FDI) rather than building up a more ambitious regional strategy.
This strategy might be relevant to facilitate transitions for some lower middle income nations –Vietnam, Indonesia and the Philippines— to middle income or from low income to lower middle income status like Myanmar, Cambodia and Laos. But still, it does does not represent the structural transformation necessary to escape the middle income trap, as growth continues to heavily rely on FDI rather than innovation.
The institutional weakness of ASEAN economic community has, to some extent, prevented the transformation from middle income countries higher to high income economies.
In light of this, the ASEAN Economic Community would have the potential to increase income growth for its member states. They could also allow economies to transition from lower middle income to middle income status. But the prospects of a regional strategy to transition from middle to high income do not hold as much promise, given the institutional weakness of the ASEAN Economic Community.
ASEAN member states who are seeking to avoid the middle income trap will need to unilaterally focus on their own political and institutional reform processes rather than relying on a regional commitment such as the ASEAN Economic Community. ASEAN policy makers should concentrate on implementing current agreements rather than focussing on grand designs.
As ASEAN is a trend follower rather than trend setter, middle income member states should focus on unilateral reform whilst keeping cooperation with neighbours in mind. This would provide fertile ground for ASEAN to follow. But it also provide future prospects of regional strategies for avoiding the middle income trap for current lower income members.
Let us see this happens in the next 50 years of ASEAN Economic Community.
*) Suraj Shah is MSc Candidate in the Political Economy of Emerging Markets, King’s College London and Visiting Fellow at ASEAN Studies Center, Universitas Gadjah Mada