Escaping the Middle-Income Trap: The Experiences of Ireland and Mexico

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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.”

The Experiences of Ireland and Mexico

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.

Ireland

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:

• Adopted industrial policies to gradually open up to global markets to attract foreign direct investment (FDI), instead of fully liberalizing its capital markets at once
• Created special government agencies to guide and steer FDI to its manufacturing sector
• Increased government spending on public education for all
• Adopted new tax, fiscal and monetary policies to control high government deficits and inflation
• Promoted domestic investment and targeted its exports to Europe and the U.S.

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

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:

• Not investing highly in education
• Not establishing government agencies to design industrial policies to promote foreign and domestic investment in areas consistent with Mexico’s comparative advantages
• Investors looking outside the banking system for financing following economic reform and banking system nationalization in the early 1980s

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.”

Follow the Series

• Getting Caught in the Low- or Middle-Income Trap
• Why Can’t Developing Countries Catch Up?
• Escaping the Middle-Income Trap: The Experiences of Ireland and Mexico

Additional Resources

• Regional Economist: Trapped: Few Developing Countries Can Climb the Economic Ladder or Stay There
• On the Economy: Improving Business Climates and Escaping the Middle-Income Trap
• On the Economy: Which Regions Have Recovered from the Great Recession?