Avoiding the middle income trap
The challenges ahead for Thailand
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
 |
Kazi Matin, the lead economist for the World Bank in Southeast Asia and chief of the Bangkok branch, contributed an op-ed piece to the Bangkok Post earlier this week on July 2nd.
July 2nd was the 10th anniversary of the baht's devaluation at the start of the 1997 financial crisis, so it was a good time to review where Thailand has been and where it is going.
Export growth pulled Thailand out of the 1997 crisis.
Thailand is now a middle-income country.
It faces the challenge of jumping to higher levels of growth and becoming a higher income country, according to Kazi Matin.
It's moving in the right direction by developing the right export industries.
Export industries that move up the value chain, exporting parts, components, and equipment to China, moving away from low-skilled cheap labour industries that are difficult to remain competitive in, this is the right direction according to Kazi Matin.
New private investment and increased productivity, these are the future challenges for Thailand.
Policy certainty, better infrastructure, less regulations, and increasing the pool of skilled workers, this is what the Thai government needs to work on, according to Kazi Matin.
For further reading, read a freely downloadable report on Total Factor Productivity in Asian Nations including Thailand from the Asian Productivity Organisation.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. What was the main factor helping Thailand to recover from the 1997 crisis?
2. What is continued export growth dependent on?
3. What area of the world has driven Thailand's export growth after 1997 ?
4. What changes in the type of goods exported have occurred since 1997?
5. Why is this change in export composition good for Thailand?
6. What were factors enabling this change in export composition?
7. How does private investment in Thailand nowadays compare to the past?
8. What sector led the recovery in Foreign Direct Investment (FDI) after 1997?
9. What factors are behind the all-time low in private investment?
10. What kinds of regulations have contributed to the worsening investment climate in Thailand?
11. What kinds of skill shortages have contributed to the worsening investment climate in Thailand?
12. Where have infrastructure shortages contributed to the worsening investment climate in Thailand?
13. What uncertainties have contributed to the worsening investment climate in Thailand?
14. How is Thailand planning to improve its productivity in the future?
15. What can the government do to stimulate long-term growth?
Bangkok Post Article July 02, 2007
OPINION / ECONOMIC GROWTHObstacles on the road to prosperity
Despite successes, Thailand faces the challenge of avoiding the 'middle-income trap'KAZI MATIN
Ten years on from the 1997 East Asian financial crisis, Thailand is wealthier, has fewer poor people, is more integrated globally and regionally and less vulnerable, externally and financially.
But even as the country celebrates its successful recovery, new challenges loom, which could slow growth and poverty-reduction if not properly handled. Thailand could find itself in a "middle-income trap" with low rates of private investment, of innovation and of productivity-growth - in fact, private investment was the weak spot throughout the recovery - resulting in a slowdown in its targeted transition to a higher-income status. South Korea, Taiwan and Singapore have made this transition successfully, and Thailand can, too. But many in Latin America and the Middle East have not. Hence the challenge and the urgency that Thailand faces today.
Recovery
Thailand recovered strongly after a slow start. This remarkable recovery was led by strong growth in exports and private consumption, the latter promoted by fiscal incentives and directed credit, as well as supported by significant improvements in macro fundamentals. Private investment has remained the Achilles heel of the recovery to date.
Thailand achieved a very respectable per capita growth-rate recovery, a significant achievement given the most severe recession it experienced in 1997 and 1998. In fact, Thailand's average annual growth peaked at around 6% during 2002-04, but has fallen to around 4.5% since.
Thus the average annual growth rate for the last 10 years was lower than Thailand's own in the two decades before the crisis, and also lower than the growth rate of other emerging regions such as Europe and the Central Asia region and the South Asia region in this decade.
This growth was accompanied by significant poverty reduction in this decade and reduced inequality more recently. Sustaining strong growth will remain important, even if reducing inequality is the main objective since poverty and inequality reduction can continue only if the overall "pie" grows, permitting the government to adopt policies that provide an increasing share of the growth to poorer groups. Such policies could ensure that agricultural productivity growth receives adequate attention in efforts to raise productivity and labour reallocation towards more productive sub-sectors (both agriculture and manufacturing) is promoted through better quality education in rural areas.
Strong export growth
Thailand's growth recovery was driven largely by exports, something that will be increasingly dependant on rising private investment. The ratio of exports to GDP rose from around 47% to around 67% in the last decade as a result of strong export growth for most of the recovery period.
This was accompanied by significant transformation of the structure of Thai exports. Geographically, more of the growth in exports came from the East Asia region, especially a higher share of exports to China, and in terms of the commodity structure, Thai exports moved up the value-chain as the share of machinery and parts - automotive, electronics and non-electric - in total Thai exports rose from 32% to 43%, a very welcome development in the face of rising wage cost of unskilled labour. This augurs well for Thailand's potential for future competitiveness.
There is little doubt that Thailand benefitted from China's WTO accession, especially from China's expanding imports of parts, components, capital equipment and other kinds of industrial inputs for assembling into finished goods in China for export to the outside world.
But this was made possible by Thailand's greater openness after the crisis. Its reforms in respect of investment, trade policy and customs facilitation - the revised Foreign Business Act 1999, lower import tariffs on raw materials and intermediate goods and parts during 1998-2000 and beyond reducing average multilateral import tariffs and automated processing in customs - opened up the economy and facilitated Thailand's greater participation in regional production networking.
Weak investment recovery
The weak recovery of private investment in Thailand over the last decade, if it continues for long, can potentially prevent the country from achieving its goal of becoming a higher-income country.
Other countries are eager to get first-mover advantage in various sub-sectors and export niches with significant scale economies, making it difficult for latecomers into such sophisticated sub-sectors.
While foreign direct investment (FDI) recovered quite robustly after the crisis, led in part by the automotive sector, overall private investment recovery suffered from several fragilities. The rate of recovery in private investment has been more sluggish than in any previous Thai recessions and private investment as a share of GDP has remained more depressed not only relative to the pre-crisis boom years, but also relative to the more stable average rate of the 1980s.
Also, a large share of this lower rate came from residential construction and not additions to manufacturing capacity, and domestic private investment was significantly more sluggish than total investment.
This weakness in investment recovery is not explained by economic fundamentals or by the large demand shocks from the crisis. In fact, cyclical explanations have become less plausible as the time elapsed since the crisis has increased to nearly a decade and capacity utilisation has risen in Thailand to exceed full capacity in pre-crisis period.
Instead, more medium-term factors such as the quality of the investment climate in Thailand as well as more intense external competition appear to be playing a greater role in inhibiting higher private investment, with recent political and policy uncertainly adding an adverse short-term factor to the situation.
Investment climate constraints
The 2004-05 firm-level investment climate survey of 1,300 firms conducted jointly by the NESDB, FTPI and the World Bank show that four characteristics of Thailand's investment climate are constraining both private investment and productivity growth: regulatory burden, skill availability, infrastructure deficit and macroeconomic policy and market uncertainty.
More than 60% of firms identified high regulatory burden as a major or severe constraint to investment and productivity growth. Regulations in respect of customs, taxation, labour, business licensing and bureaucratic burden in general have been highlighted. Electronics, automotive and clothing sectors complain most about customs and virtually all sectors about taxes and general bureaucratic burden.
More than 50% of firms identify skill shortage as a major or severe constraint, taking much too long to fill vacancies in respect of skilled engineers, IT personnel and those with English language ability, often having to under-fill those positions after a long wait. And nearly 40% of firms highlight infrastructure deficit - including in the eastern and central seaboard, where manufacturing growth has been the strongest prior to the crisis and since.
Though macroeconomic conditions improved greatly by 2004 when the Thai survey took place, more than 30% of firms highlighted macroeconomic policy and market uncertainty as a major or severe constraint. This manifested firms' dislike of any kind of uncertainty - and the fact that their perceived level of policy and external market uncertainty was high, probably due to large and rapid changes in export market opportunities and comparative advantage experienced by East Asian firms, given more intense Chinese and other competition.
In fact, Thailand is feeling the squeeze from low-wage exporters of labour intensive goods as well as developed country and low-wage exporters of high-tech goods. As a result, Thai firms are having to pull back in a range of sectors and markets where they were previously competitive, while also having to invest time and resources in seeking out the new sectors and market channels where there are investment opportunities created by the rise of China. These inhibit new investment, though policies can remove or reduce constraints to make these efforts worthwhile.
Transition to high income
The development strategies that economies such as Thailand needed to make the transition from low-income to middle-income were different from those that are now needed to transition from middle-income to high-income status. Not only that, but these strategies are also more complex to implement. What is interesting is that middle-income countries on average have grown more slowly over the last two decades than low-income developing countries and the rich developed countries. This is the challenge that Thailand faces.
Among other things, countries that are successfully making a transition towards high-income status have begun to depend more on total factor productivity growth than growth in factors of production through specialisation in selected sectors and areas with significant potential for economies of scale and technological leadership.
Such specialisations require for example, substantial increases in the proportion of people with tertiary education and specialised skills, the transformation from economies that largely absorb knowledge from abroad (e.g. through FDI) to ones that also become a source of innovation, the development of deep financial systems that provide a diverse range of services, including support for innovation, the movement of much of the population into livable and efficient cities with efficient and highly competitive clusters, including an increased number of medium-sized cities so that the country itself gets better integrated within and growth benefits are better shared.
There is clearly evidence that Thailand is beginning to move into areas that have significant scale economies and potential for technological leadership. The automotive sector is one and the electronics sector is the other. There is also potential in services such as tourism and medical services sectors as well as in IT, logistics and in "farm-to-table" agriculture. The government and private sector is exploring these possibilities, but this may be happening too slowly, with Thailand falling behind.
Productivity growth
Up to now, Thailand has depended on limited rates of total factor productivity (TFP) growth, and most of this low TFP growth has come from labour-reallocation from less productive sectors to more productive and not from innovation within the manufacturing sector.
In fact, within-manufacturing sector TFP growth has been negligible in Thailand over more than four decades of strong growth. The country has also performed less well relative to comparable countries in respect of the indicators of innovation such as R&D expenditure, patents registration, number of science and technology graduates and so on. However, the country seems to be focusing on this agenda with the recent Productivity Master Plan.
Inequality and governance
At the socio-political level, successfully transitioning countries such as Thailand will have to promote a rising level of social cohesion and clean government even as they ensure productivity growth through innovation and specialisation.
The emergence of deep regional inequities of the kind that fuel social conflict and political instability, with potential to stall growth, have to be avoided.
Similarly, a clean government and the rule of law must increasingly become the norm; recent experience also suggests that without such improvements, growth can also stall. Fortunately, this is a central aspect of the government's agenda.
Thailand's growth will have to be increasingly based on productivity growth through innovations and specialisation, and that will be a necessity, as many middle-income countries in Latin America and the Middle East have found out during the last two decades. This will require private investment to go to sectors with potential for technological and innovation leadership.
The government could focus on some key actions that reduce policy uncertainty and unpredictability (which should be easy), lower costs of private investors (reduce regulations; improve infrastructure) and enhance skills (IT education, tertiary education in science and technology, higher secondary education). In order to ensure that this transition to more productive and specialised investments happens, it will also be important to increase integration within the country to reduce inequity, and to continue the process of improving governance.
Kazi Matin, a graduate of Oxford and Columbia universities, has worked with the World Bank for the past 17 years, both in the bank's research department as well as in countries from Vietnam, Hungary, Bangladesh and Iran to Ghana, Kenya and Uganda. He is currently the lead economist for the World Bank in Southeast Asia, and chief of the bank's economic unit in Bangkok.
Vocabulary (in discussion above)
Asian Productivity Organisation - The Asian Productivity Organisation (APO) is an intergovernmental regional organisation established by Convention in 1961 by several governments in Asia to hasten their economic development. It is non-political, non-profit-making and non-discriminatory.
obstacles - barriers, things that prevent you from doing something
prosperity - economic success, making money
middle-income trap - achieved middle income, but can't move beyond to the next high-income level
integrated - combined together
vulnerable - easily damaged or hurt, unprotected
loom - about to happen (in a threatening way)
new challenges loom - will soon face new problems to solve (challenges)
private investment - investment by companies (not government)
productivity - measure of efficiency (lack of waste) in the way that resources are used in production, labor productivity is the usual meaning (See Wikipedia on productivity and The Economist)
* productivity growth
total factor productivity (TFP) growth - "Growth in total-factor productivty (TFP) represents output growth not accounted for by the growth in inputs." (Source: About.com Economics citing Hornstein and Krusell (1996))
"Total factor productivity (TFP) as a measure of overall productivity has been gaining recognition and acceptance not only for its theoretical correctness but also for its practicality among policy makers and economic analysts. Some governments have begun to include the TFP growth rate as a target in national development plans." (Source: Asian Productivity Organisation)
urgency - must do quickly, high priority
recovery - economic recovery
* weak investment recovery
an incentive - a reward to encourage people to do something (See glossary)
fiscal incentives -
credit - making a loan to someone and creating debt (See Wikipedia and The Economist)
directed credit - loans that are given special strategic businesses
macro - macroeconomics (See The Economist and Wikipedia)
economic fundamentals, fundamentals - the most basic factors that determine the value of an economy or a company:
"refer to relevant factors or data that influence the value of a particular security, such as a company's stock or a country's currency. In the case of a stock, for example, the company's sales, earnings, debt and dividend prospects are fundamentals that would affect share price. Similarly, a country's economic growth rate, interest rate policy and trade patterns are factors that potentially influence the strength or weakness of its currency." (Source: TD Waterhouse Investment Glossary; See Wikipedia on fundamental analysis)
macro fundamentals - the macroeconomic variables for a country that indicate whether it has a healthy economy or not
an Achilles heel - a weak point, vulnerable or unprotected part
per capita - per person (the total amount / number of people in country)
the overall "pie" grows - imagine a pie cut into pieces, everyone gets a piece, no one can get a bigger piece unless the pie grows
augur - is a sign of what will happen in the future, predicts the future
augurs well for - is a sign that good things will happen
accession - joining, becoming a member
China's WTO accession - when China became a member of the WTO
open economy - an economy that does a lot of business with the outside world (trade and investment money enters and leaves the country)
greater openness - do even more business with foreign countries
customs - the government agency in charge of checking things coming into the country, to make sure they are legal and to collect duties or taxes (See Wikipedia)
facilitation - helping (See glossary)
customs facilitation - helping with customs
first-mover advantage - (See The Econmomist)
foreign direct investment (FDI) - (See The Economist and Wikipedia)
plausible - possible to happen
become less plausible - become less likely to happen
capacity, production capacity - the factories, equipment, workers, capital and other resources that are available to be used (See The Economist)
capacity utilisation - the percentage of all factories and production capacity currently being used
full capacity - using all the factories and production capacity available
short-term - over the period less than 2 years from now
medium-term factors - over the period between 2 to 10 years from now
long-term - over more than 10 years
quality of the investment climate -
adverse - unfavorable to you
an adverse short-term factor - something that hinders your achievement of goals in the near future
investment climate constraints -
regulatory burden - regulations and laws in the country that make doing business harder and project investments less attractive
skill availability - whether you can get people with the skills you need for your business
infrastructure deficit - don't have enough infrastructure as they should
macroeconomic policy and market uncertainty -
business licensing - permits issued by government agencies that allow individuals or companies to conduct business (See Wikipedia)
bureaucracy - the government departments and officials that enforce regulations (See Wikipedia)
bureaucratic burden - the time and cost it takes for a business to follow regulations and get approval from the bureaucracy
virtually - nearly or almost true
virtually all sectors - almost all sectors
constraint - a limit you face, something that controls what you can do
infrastructure - the basic services and facilities in a country such as water, electricity, transportation, and communication that make everyday life and business possible (See glossary and Wikipedia)
deficit - not enough, not as much as you should have
infrastructure deficit - not enough infrastructure
comparative advantage - (See The Economist and Wikipedia)
feeling the squeeze from... - feeling pressure from..., situation made more difficult to manage because...
labour intensive goods - products that use a lot of labour relative to capital, so cheap labour is more important in these industries, and it is difficult to remain competitive in these industries when there are countries around you with cheaper labour, so you have to move up the value chain to more knowledge intensive industries (See The Economist)
pull back - reduce, decrease, stop doing
inhibit new investment - reduce new investment
transition - the process from moving from one situation or state to another
* transition to high income
* transition from middle-income to high-income status
* making a transition towards
* successfully transitioning countries
factors of production - inputs into production like labour, capital, machines, factories, intellectual property, and land
* growth in factors of production
economies of scale, scale economies - (See The Economist)
technological leadership - being among the leading countries in certain technologies in the region or the world
tertiary education - university education
logistics - managing the acquisition, storage, transportation and delivery of goods along the supply chain or "having the right thing, at the right place, at the right time" (See variety of definitions and Wikipedia)
"farm-to-table" agriculture - the food supply chain (some argue that farmers should be more involved in providing value in this supply chain, food safety of food products from farm to table is becoming a greater with recent food contamination cases in the United States, tracking food with RFID devices from farm to table, making the origins of food contamination problems traceable, is necessary if Thailand wants to export food to advanced markets like
the EU, Japan, and the US, finally many argue that agricultural areas themselves should be self-sufficient in terms of their food supply (food security), this seems to be a fundamental part of the Sufficiency Economy idea)
allocation - giving a portion of the total amount to someone (imagine a pie, everyone gets a piece; See glossary)
reallocation - changing the portions of the total amount that people have
negligible - very little
R&D - Research and Development, scientific research in a company to create new or improve existing products, processes, or services (See Wikipedia on Research and Development and new product development)
patents registration - recording inventions with government to get exclusive rights to your ideas (See Wikipedia on patents)
social cohesion - when the different members of a society fit together and work together well
clean government - no corruption in government
rule of law - the principle that governmental authority is legitimately exercised only in accordance with written, publicly disclosed laws adopted and enforced in accordance with established procedure. The principle is intended to be a safeguard against arbitrary governance (See Wikipedia)
stall - stop or slow down temporarily
policy uncertainty and unpredictability - when government policies change often, reacting to new pressures as they arise, instead of working towards steady long-term goal
composition of x - the parts of x
export composition - all the different kinds of exports to be found
Answer Key:
1. What was the main factor helping Thailand to recover from the 1997 crisis?
Growth in exports.
2. What is continued export growth dependent on?
Rising private investment.
3. What area of the world has driven Thailand's export growth after 1997 ?
Asia and especially China.
4. What changes in the type of goods exported have occurred since 1997?
Thailand has moved up the value chain to more sophisticated goods. Machinery and parts rose from 32% to 43% of exports.
5. Why is this change in export composition good for Thailand?
Wages of unskilled labor have risen making Thailand less competitive in less sophisticated, more labout intensive goods.
6. What were factors enabling this change in export composition?
a. Increases in Chinese "imports of parts, components, capital equipment and other kinds of industrial inputs for assembling into finished goods in China for export to the outside world."
b. The greater openness of Thailand's economy after the 1997 crisis.
7. How does private investment in Thailand nowadays compare to the past?
Current private investment is at an all-time low.
("The rate of recovery in private investment has been more sluggish than in any previous Thai recessions and private investment as a share of GDP has remained more depressed not only relative to the pre-crisis boom years, but also relative to the more stable average rate of the 1980s.")
8. What sector led the recovery in Foreign Direct Investment (FDI) after 1997?
The automotive sector.
9. What factors are behind the all-time low in private investment?
a. Worsening investment climate.
b. More intense external competition (between other countries in export markets)
10. What kinds of regulations have contributed to the worsening investment climate in Thailand?
a. Customs
b. Taxation
c. Labout
d. Business licensing
e. Bureaucracy
11. What kinds of skill shortages have contributed to the worsening investment climate in Thailand?
Skilled engineers, IT workers, and fluent English speakers are difficult to fill or remain unfilled.
12. Where have infrastructure shortages contributed to the worsening investment climate in Thailand?
Along the eastern and central seaboard where manufacturing growth has always been the greatest.
13. What uncertainties have contributed to the worsening investment climate in Thailand?
a. Macroeconomic policy uncertainty (frequent and sudden policy changes)
b. Market uncertainty (large and rapid changes in export market opportunities)
14. How is Thailand planning to improve its productivity in the future?
Planning to improve its productivity within manufacturing by focusing on:
a. More science and technology graduates.
b. More R&D expenditure
c. More patent registration
15. What can the government do to stimulate long-term growth?
a. Reduce policy uncertainty and unpredictability
b. Reduce regulations
c. Improve infrastructure
d. Enhance skills (IT, tertiary education in science and technology, higher secondary education)
e. Increase regional integration in the country to decrease inequities between rural and urban areas.
