The middle-income trap has become a concept deployed frequently in conversations among policymakers and academics in East Asia. The term is used by those trying to understand failed industrial upgrading in the region, which has occurred against a backdrop of prolonged economic slowdown in Asean middle-income countries. These bleak economic developments can be traced to a trend in Asean middle-income countries: growing dependence on foreign multinational companies (MNCs).
The middle-income trap is a prolonged slowdown of economic growth for a country at the middle-income stage and was first explicitly discussed in a report by the World Bank. Although the empirical evidence for and theoretical background supporting the middle-income trap is still developing, the concept still provides valuable insight into an observable slowdown in gross domestic product per capita in Asean countries since the early 2000s.
In 2010, the Malaysian government officially admitted that they were in the middle-income trap. As a consequence, the government recently delayed its national target to achieve high-income economy status by 2024. Thailand’s economic growth slowed to less than 1 per cent in 2011 because of severe flooding. Recovery has been unexpectedly slow since then.
Although the literature supports various causes of the middle-income trap, it is considered almost equivalent to a failure of industrial upgrading for Asean countries. After 2000, industrial upgrading in Asean countries digressed from the paths of Northeast Asian countries such as Japan, South Korea and China.
Stagnant industrial upgrading in Asean countries is often linked with a failure to accumulate industrial human capital, weak industrial linkages and insufficient research and development capacity. These phenomena are closely related to deficiencies of home-grown MNCs in the manufacturing sector.
This becomes apparent when observing Japan, South Korea and China — all three of which have plenty of home-grown MNCs in various areas of manufacturing. On the 2018 Fortune Global 500 list, 27 listed manufacturing companies are based in Japan, nine in South Korea and 44 in China. Only one company each from Malaysia, Thailand and Indonesia made the list. None of these top Asean companies are manufacturing firms.
In developing countries, a dependence on foreign MNCs can cut both ways. On the one hand, it can be a short cut to industrial and technological development. Developing countries often do not have the capacities to participate in global value chains (GVCs) without the assistance of foreign MNCs. Developing countries also benefit from the technological spill-over stemming from MNCs transferring production knowledge to host countries in order to support the production of specific parts and compartments at lower costs.
On the other hand, MNCs can hinder the ability of middle-income countries to accumulate industrial knowledge by controlling the flow of knowledge to their host countries. The speed of knowledge transfer is naturally slower compared with home-grown MNCs, which conduct research and development (R&D) autonomously. Between 10 and 30 per cent of MNC R&D activities occur in foreign subsidiaries, with 80 per cent of total R&D concentrated in the Organisation for Economic Cooperation and Development (OECD) countries. Although foreign MNCs are expected to enhance the technological upgrading of host economies, this effect diminishes as the income level of host economies exceeds upper middle-income levels.
Even though homegrown MNCs seem desirable for industrial upgrading, fostering national MNCs is not a solution for Asean countries — such as Malaysia introducing another national car maker. The point of no-return when fostering national MNCs with endogenous technology in the manufacturing sector passed long ago — Asean countries have been firmly integrated into GVCs through foreign MNCs since the 1970s. Asean countries must now work to complement, not compete, with foreign MNCs in order to upgrade their industrial structure.
In the midst of the third unbundling of the global economy and further reductions in the costs of face-to-face communication, countries with middle-income status have more opportunities to attract the global R&D activities of MNCs. Not all R&D activities of MNCs are cutting-edge nor require a large number of leading researchers. Some R&D activities are more cost-effective if conducted in middle-income countries. These activities can provide jobs for Asean graduate students and provide students with an important first step on the global R&D ladder.
While dependence on foreign MNCs is a major factor driving the middle-income trap in Asean countries, MNCs may hold the key to escape. It is now evident that accumulating knowledge to produce more sophisticated products is essential for a country to continue to grow. Asean countries must consider the benefits and challenges of both homegrown and foreign MNCs, enabling their economies to slowly but steadily move up the R&D ladder.
Satoru Kumagai is director of the Economic Geography Studies Group at the Institute of Developing Economies, Japan External Trade Organisation. This article first appeared in East Asia Forum.