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Tackling the ‘MICs traps’: a role for development cooperation in middle-income countries?

Date: 
18 November 2013

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José is Professor of Applied Economics at Universidad Complutense de Madrid.

Cash transfer - Oxfam (Creative Commons licensed via Flickr)

Next in our financing progress series we have José Antonio Alonso who takes a look at the role that international aid has to play in middle-income countries (MICs), whilst identifying three potential traps that affect these MICs during the course of their development.  

As some studies reveal, up to two-thirds of the world’s poorest people now live not in low-income countries (LICs), as in the past, but in middle-income countries (MICS). As a result, some analysts are asking whether international aid should be focused on poor people (wherever they live) rather than on poor countries. However, this approach could present problems: the allocation of aid must consider a country’s capacity to tackle its own problems. The purpose of aid is to complement and encourage the development capacities of recipient countries, not to substitute for them.

But how can we best estimate these capacities? One measure could be, as a minimum, to transfer the income that the fifth quintile (the richest people) in each country would have to pay to lift that country’s poorest people above the poverty line. My own estimates of this ratio show huge differences. In upper MICs, for example, the average transfer needed to raise the poor to above the $2 per day poverty line approaches just 0.28% of the fifth quintile’s income. This ratio climbs to 5.32% in lower MICs, and as high as 56.8% in LICs. 

Given these results, LICs should continue to draw the greatest donor attention. A large number of MICs already have enough fiscal space to eradicate poverty by themselves. And taxpayers in donor countries will not be happy if their aid contributions exempt the richest people in these MICs from playing their part in tackling inequality. However, a number of MICs (mainly LMICs) do exhibit high ratios (close to 10%), revealing that they lack the fiscal space to support redistributive efforts. In these cases, international aid could still be required to complement national resources for poverty reduction.

Reducing poverty is not, however, the only role that aid can play in MICs. Historical experience reveals that even though many MICs have had periods of accelerated economic growth, this has not necessarily led their economies to sustainable growth over time.  In fact, the club of MICs that have gone on to become high income countries is very small indeed.

Once such economies evolve and reach higher levels of income, they face new constraints that challenge the continuity of their development path. If the purpose of the cooperation system is to create incentives to maximise development achievements, aid should also target the specific problems that affect a MIC’s process of development – known as the MICs traps.

Most studies link these traps to the difficulties MICs face in sustaining a process of technical and productive change (the ‘structural change trap’). Factors that generate high growth in poor countries (low-cost labour, abundant natural resources and copying foreign technology) disappear when those countries reach higher levels of income per capita. Countries then need to search for new sources of growth, based on the reallocation of productive factors in higher productivity activities, with more skilled labour and technological capacities. It is no simple task to move productive specialisation toward this radically different profile.

Two other traps are just as crucial for the development of a MIC. One is the ‘trap of governance’: as long as countries continue to progress, they require more complex institutions that can respond to a more demanding society in terms of quality of governance. However, that process of change doesn’t always happen, given the depth of inertia in institutions and the resistance of certain interest groups. Sometimes the problem lies not only in the weakness of institutions, but also in their reduced credibility. And this problem is fuelled by, among other things, the levels of social fragmentation and inequality that characterise many MICs.

The third trap is the ‘financial trap’: the difficulties these countries face in achieving firm and stable integration into international financial markets, while maintaining enough space for counter-cyclical macroeconomic policies. This is linked to the effects of international financial markets on countries with a high tendency toward indebtedness in foreign currencies, limited fiscal space, weak financial institutions and narrow capital markets.

While the role of development cooperation may be rather limited in all of these MICs traps, it is not irrelevant. Aid could have a significant impact on problems related to social fragmentation, inequalities, the fragility of civil society and institutional weaknesses. It could have a lesser, though still perceptible, impact in promoting innovation or technology transfer and would probably have little or no impact in promoting a wider fiscal space for counter-cyclical macroeconomic policies or financial stability. As a result, aid will be effective in MICs only if it is highly selective, helping countries to overcome the specific constraints that block their particular development process.

The intensive changes in the international landscape, with the old divisions between ‘developing’ and ‘developed’ countries beginning to blur, requires MICs to play a more committed role in building cooperative responses against global common problems. Donors should also support the efforts of MICs to assume a more active role in the global agenda:  particularly in their contribution to development through South-South cooperation and in their provision of international public goods.

In most cases aid will represent a minor element in the international financing obtained by MICs. For this reason, the effectiveness of that aid will depend on its leverage: its capacity to mobilise additional resources and capacities (most of them outside the ‘aid perimeter’), or its ability to create the right incentives to promote changes. As a catalyst, rather than a source of finance, aid could play a significant role in encouraging the development achievements of the world’s middle-income countries.