Columbia International Affairs Online: Working Papers

CIAO DATE: 10/2011

Making the Transition: From Middle-Income to Advanced Economies

Alejandro Foxley, Fernando Sossdorf

September 2011

Carnegie Endowment for International Peace


Few middle-income countries have successfully transitioned into advanced economies in the past twenty years. As the world struggles with a new economic slowdown, middle-income countries should look at the lessons from the economies that successfully made the jump. The more successful countries in the bunch—particularly Finland and South Korea—set themselves apart from the rest by investing early in improving the quality of education and inducing high investment in research and development. By opening up to world trade and using tax incentives and access to subsidized credit, successful countries were able to attract foreign direct investment in high-technology sectors. And to allow for continued growth, Finland and South Korea were able to turn financial crises into opportunities to undertake much-needed economic reforms—this was only possible because there were broad political and social agreements on the essential elements for sustaining high growth rates. But not every newly developed economy enjoyed this level of success, notably Spain, Portugal, and Ireland. Domestic demand led to phases of high growth, but these weren’t accompanied by countercyclical fiscal and monetary policies and effective regulation of the financial sector. Inevitably, high inflation, loss of competitiveness, and slow or negative growth ensued. The situations were made worse by fixed exchange rate regimes like the euro area, rigid labor markets, and a lack of competition in key markets, such as utilities and banking. With these experiences in mind, there are four lessons that middle-income countries should learn to increase the probability that they will break through the so-called middle-income trap and successfully maintain strong economic growth rates.