Today’s post is the third and final in a series examining why developing countries have difficulty moving up the economic ladder.
Escaping the “low- and middle-income traps” has proven to be a challenge for many developing nations. In a recent article in The Regional Economist, Assistant Vice President and Economist Yi Wen and Senior Research Associate Maria Arias used the experiences of Mexico and Ireland to shed light on the middle-income trap.
A previous post examined some of the theories that have attempted to explain why developing countries haven’t been able to converge with developed ones in terms of per capita income. Wen and Arias noted that many of these theories simply don’t hold up in practice. “Instead, both regional economic inequality and the failure or success stories of nations that have attempted industrialization could be explained by the specific development strategies and industrial policies adopted.”
Both Ireland and Mexico maintained a roughly similar level of development in terms of per capita income going back as early as the 1920s, and both adopted political democracy. Yet they took dramatically different approaches to development in the postwar era.
The authors noted that Ireland’s economy did not experience fast growth between the 1920s and 1950s due to since-discredited industrialization policies. Since the 1950s, however, Ireland:
Since 1950, Ireland’s per capita income relative to the U.S.’s has risen from less than 40 percent to more than 80 percent.
Mexico, on the other hand, had a much more open economy than Ireland between the 1920s and the 1970s. However, the authors noted: “Mexico lacked sufficient government effort and discipline to build its state capacity to steer the economy.”
In particular, Mexico rapidly expanded its public debt in the 1970s. Wen and Arias noted that this debt became very expensive in the 1980s when the U.S. increased interest rates drastically to fight inflation. In turn, this pushed the Mexican economy into default and prompted a large currency devaluation.
Other issues hindering Mexico’s development include:
These developments have contributed to Mexico’s per capita income relative to the U.S.’s being roughly the same in 2010 as it was in 1950.
The authors concluded: “Comparing the divergent growth paths of Mexico and Ireland in the 20th century suggests that state capacity and industrial policies are critical in explaining the issue, rather than differences in political institutions or vast interests of local monopolies, per se.”