World Development Report 2024: The Middle-Income Trap

Investment is a fundamental pillar of economic progress. Not only does investment growth allow countries to enhance their stocks of physical capital such as factories, offices, roads, bridges, schools, and clinics, but it is also a necessary condition for infusing global technologies in domestic production possibilities. Because technology is embodied in capital, a country will find it challenging to advance technologically without scaling up investment.

Investors look for macroeconomic stability and ease of doing business in deciding where, in what, and how much to invest. The experiences of Colombia, Türkiye, and the Republic of Korea are examples. In 2001, Colombia implemented a comprehensive reform package to stabilize its economy by restraining public spending, increasing central bank independence, and introducing a floating exchange rate. Similarly, in the early 2000s Türkiye implemented a primary surplus target, the central bank became independent, and reforms to improve the business climate and liberalize the banking sector were adopted. Earlier, Korea implemented two rounds of reform packages. In the mid-1980s, Korea adopted a balanced budget, improved the business climate by promoting competition, and liberalized trade. A second round of reforms in the late 1990s improved the independence of the central bank, consolidated government finances, strengthened the financial sector, and liberalized the capital account.

Following these reform efforts, all three countries experienced investment accelerations: Colombia from 2001 to 2007, Türkiye from 2003 to 2008, and Korea in 1985–96 and from 1999 to 2007. Investment accelerations are periods with a sustained increase in investment growth. During these periods, investment as well as productivity grew much faster than in nonacceleration years (figure B2.3.1). More broadly, across a sample of 104 economies, including 69 emerging market and developing economies (EMDEs) and 35 advanced economies covering the years 1950 to 2022, 192 episodes of investment acceleration occurred in which per capita investment growth averaged at least 4 percent per year over at least six years.a On average, an EMDE has experienced about 1.7 investment accelerations. During these accelerations, investment growth more than tripled to 10 percent a year over that of nonacceleration years; output growth increased by 2 percentage points; and productivity growth quadrupled to 1.7 percent per year.

In the sample of 104 economies, 82 percent of the transitions from middle-income status to high-income status that occurred over the last three decades happened during or shortly after investment accelerations. Sectoral shifts gained momentum during investment accelerations because output grew substantially faster in the manufacturing and services sectors than before the acceleration. Accelerations were also often periods during which more progress was made in reducing poverty, living standards improved, and the pace of convergence to advanced economy income per capita levels increased.

a. World Bank 2024.

[Some countries tried] to leapfrog prematurely into “knowledge economies,” with none of the institutional infrastructure in place to accomplish this. Poor quality universities, low levels of human capital, limited venture capital, regulatory barriers and incomplete rule of law present significant barriers to becoming an innovation-driven economy. Middle-income countries that invest heavily and prematurely in trying to become “knowledge economies” can find low returns to such investments. The combination of wasted fiscal spending and a faulty growth diagnostic can lead to substandard performance—another example of the middle-income trap.