Overcoming the middle-income trap: Study of institutional effects and international pathways

Since the conception of the middle-income trap was raised in 2007, scholars at
home and abroad have conducted extensive qualitative and quantitative studies on this
phenomenon, and explained it from many aspects, such as industrial structure, foreign
trade, financial and fiscal system, income distribution, education and innovation.
Corresponding policy recommendations are also given. However, more than ten years
have passed, the phenomenon of middle-income trap has not disappeared or been
properly solved. Latin American countries represented by Brazil and Argentina and
African countries represented by South Africa are still trapped in it. At the same time,
2021 is the 25th year for China to become a middle-income country, and the current
threshold between China and high-income stage has been very close. China is in a
critical period of moving from middle-income stage to high-income stage. However,
the closer to the goal of high-income country, the greater the internal and external risks,
contradictions and pressures on China’s economic development. Under the
unprecedented changes in a century, China’s economic and social stability is facing new
problems and challenges. Based on the existing studies, it is still an important research
topic for all middle-income countries, including China, to continue to explore the
mechanism behind the middle-income trap and its performance and characteristics in
the new era from a new perspective.
The school of institutional economics regards institution as the fundamental cause
of economic growth, and in recent years, the economic community has increasingly
attached importance to the role of institution. Scholars have included institution in the
analytical framework of their economic articles. However, on the whole, these articles
mainly focus on qualitative analysis, and the few empirical articles mostly include
institution as a control variable in empirical models, using it as one of the factors
affecting foreign trade, technological innovation, economic growth and other
explanatory variables. Fewer articles link institution and the middle-income trap issue
together. Therefore, from an institutional perspective, this paper analyzes the quality of
institutions as a way to cross the middle-income trap and further studies the impact of
institutions on the economic growth of middle-income countries, which is of great
theoretical significance and practical value.
Based on the World Bank’s national income classification criteria, this article
selects countries that have successfully transitioned from the middle-income stage to
the high-income stage during the sample period, as well as countries that are still in the
upper middle-income stage as of 2021, by counting the changes in the income stages of
nearly 200 countries worldwide during 1960-2021. Through statistical analysis of the
length of stay in the upper middle-income stage of countries that have successfully
crossed the upper middle-income stage, the desirable length of stay in the stage is
defined, and thus the criteria for determining whether a country is caught in the middle-
income trap are then determined. On this basis, 20 countries that have successfully
crossed the middle-income trap and 13 countries that have fallen into it are selected.
Based on the investigation of national history, this paper explores the institutional
characteristics of their economic development processes. By generalizing the
institutional experience of countries that have successfully crossed the middle-income
trap and the institutional lessons of countries that have fallen into it, this paper
summarizes the key institutional factors that are conducive to a country’s ability to cross
the middle-income trap, including a stable political system, a sound property rights
institution, an open trade institution, control of corruption, efficient government
operations and regulatory quality, a fair income distribution institution.
After conducting international studies and statistical analysis, this article further
uses econometric models to empirically test the relationship between institutions and
economic growth in 20 countries that have successfully crossed the middle-income trap
and 13 countries that have fallen into it between 1996 and 2021, to explore whether
institutions have played a significant role in the process of crossing the middle-income
trap at the level of aggregate institutional indicators and the six key sub-institutional
indicators summarized above. This paper also analyzes how these institutional factors
affect the transition from the middle-income stage to the high-income stage in these
countries, and then conducts robustness test and endogenous test. On the basis of
benchmark regression, this article further tests the heterogeneity of empirical results in
the extended analysis section, analyzes the mechanism of institutional influence on the
crossing of the middle-income trap, and explores whether the influence of institutional
factors on economic growth persists after entering the high-income stage, and the
relationship between the quality of institutions and the growth rate of high-income
countries. In the final part, this article draws attention back to China from the
international arena, analyzes China’s institutional construction and economic
development, and discusses the challenges and feasible institutional paths for China to
overcome the middle-income trap. It should be noted that in the entire research process,
the middle-income trap is only considered as a phenomenon of economic development
rather than an inevitable law. The main conclusions of this article are as follows:
First, the coefficients of the overall indicators and sub-indicators of the core
explanatory variable institutions are very significant in both countries that cross the
middle-income trap and countries that fall into it, suggesting that the improvement of
institutional quality can significantly contribute to the growth of a country’s per capita
national income, and in the same case, the coefficients of successful countries’
institutional indicators are much larger than those of the trapped countries, which
implies that institutions do play a key role in a country’s progress from middle to high
income stage. The magnitude and significance of each coefficient of institutional
indicator in the successful group are generally stronger than those in the trapped group,
indicating that institutions play an increasingly significant role in economic
development as the income stage increases. The variability in the quality of national
institutions may be an important reason for the divergence in economic development
between the two groups of countries.
Second, in terms of the coefficients and significance of the sub-institutional
indicators, factors such as political stability, property rights protection, government
efficiency, level of openness to the outside world, income distribution, and corruption
control are key institutional elements that affect whether a country can successfully
achieve leapfrogging. In addition to the overall low level of institutional quality,
countries trapped in the middle-income trap may also have issues such as the absence
of key institutional elements and institutional mismatch. Especially when they
transition from the upper middle-income stage to the high-income stage, with the
improvement of income level, the development of institutions gradually lags behind the
needs of real economic life, and these backward institutions become constraints on
economic development, making it difficult to achieve effective transformation of
economic growth mode, and even delaying economic growth, and then becoming a drag
on national economic development, resulting in the country wandering or stagnating in
the upper middle-income stage for a long time, finally caught into the middle-income
trap.
Third, after the heterogeneity analysis of institutions and the middle-income trap
in the extended analysis section, two intermediary variable, total factor productivity
(TFP) and net exports, are selected to test the impact mechanism. The results of the
mediating effect model show that TFP and net exports play a part of the intermediary
role in the process of institutional impact on a country’s national income per capita, that
is, the two transmission channels “institution → total factor productivity → national
income per capita” and “institution → net export → national income per capita” do
affect a country’s transition to the high income stage.
Fourth, the examination of national economic performance of countries entering
the high-income stage indicates that not all countries can continue to maintain growth
after crossing the middle-income trap. Institutions still significantly affect a country’s
economic growth performance, influencing the growth rate of its national income per
capita at the high-income stage. For few countries that once enter high-income stage
and then regress back to the upper middle-income stage, economic growth achieved
solely through natural resources without institutional improvement is unsustainable.
The existence of institutional shortcomings will not only increase the length of stay of
these countries in the middle-income stage, but also make them vulnerable to the
Resource Curse, thus making it more difficult for them to cross the middle-income trap.
Fifth, the study of China’s economic and institutional development since the
Reform and Opening up policy shows that China has achieved long-term, sustained and
stable rapid growth in the process of moving from a low-income country to a middle-
income country and then to a high-income country. Based on China’s current per capita
income and development trend, there is a high probability that China will successfully
cross the middle-income trap to become a high-income country in the next five years.
Currently, China is in a critical period of transitioning towards a high-income stage. In
order to successfully overcome the middle-income trap, China should strengthen its
institutional construction in the following areas, including property rights protection,
government governance, high-level opening-up, corruption control, and income
distribution, to promote the sustainable and healthy development of China’s economy,
and help China achieve smooth economic development towards and even after the high-
income stage.
In summary, institutions play a crucial role in whether a country can successfully
cross the middle-income trap. A high level of institutional quality is an important driver
of national economic development and affects the length of a country’s stay in the upper
middle-income stage. A good institutional environment can facilitate economic growth
and thus help middle-income countries to transition to the high-income stage. On the
contrary, poor overall institutional quality or the absence of key institutional indicators
will inhibit national economic growth. Differences in the level and structure of
institutional quality in different countries will, to a certain extent, affect their economic
development and thus affect the leapfrog from the middle-income trap.