World Development Report 2024: The Middle-Income Trap

Modern Schumpeterian thinking on creative destruction has the potential to provide much more reliable diagnostics than what analysts, researchers, and regulators have been using so far. No longer is it enough to decompose aggregate output growth into the growth of measurable production factors—physical and human capital and the residual, total factor productivity. Nor is it enough to rely solely on measures such as firm employment and size distribution to gauge an industry’s health. These diagnostics are much like using two-dimensional images from X-ray machines to analyze economic structures. They are necessary but not sufficient.

A nuanced understanding of the process of creative destruction emphasizes the tensions that arise between entrants and incumbents, as well as among incumbents competing for market leadership. Diagnostics that examine these links need the latest instruments—akin to three-dimensional images from MRIs. As with MRIs, using these instruments also requires more skilled practitioners, more data, and more care.

New questions to answer. Moving beyond firm employment size, diagnostics will need to examine the following questions: Do firms grow from “within” by enhancing their existing product portfolio, or do they expand “across” the market by challenging other incumbents in different markets? If growth is from within, are gatekeepers hindering firms from developing new products for new markets? Examining the health of an economy and measuring its vital signs require a comprehensive approach to weighing its business dynamism, including responsiveness to productivity shocks, job creation and destruction rates, turnover among market leadership, entry and exit rates, life cycle (age and size) dynamics, R&D investment, and spending on technology licensing, among other things.

New sources of data and new opportunities for data-driven policy analysis. The creative destruction framework offers a distinctive advantage in understanding aggregate economies by addressing microlevel intricacies and frictions that combine to form the macroeconomy. Although certain underperforming countries may exhibit analogous macroeconomic trends in terms of investment dynamics and sluggish productivity growth, their microlevel challenges can vary significantly. For example, one economy may grapple with financial frictions affecting the “cost” of investment for firms, while another may contend with high market concentration hindering investment incentives by lowering “returns.” Similarly, entrants may face obstacles in one economy, while incumbent firms encounter distinct challenges in others. A microlevel investigation, informed by reliable data on firms and individuals, is needed. The recent digital revolution facilitates not only the collection and organization of extensive firm-level data sets but also their processing through innovative techniques for data-driven policy analysis.

Several “must-have” data sets exist. One noteworthy example is the census of firms, a thorough and complete collection of information about all businesses or firms within a specific geographic area or industry. Many countries now grant experts access to their census of firms for research purposes. Unlike a sample survey, which gathers data from a subset of the population, a census aims to encompass every entity within the defined scope. Typically, census of firms data include details such as the number of firms, their size, location, ownership structure, industry, number of employees, revenue, and other pertinent information. This data collection method provides a detailed, accurate representation of the entire population of firms, enabling a comprehensive analysis of many measures of business dynamism.

The World Bank’s Enterprise Surveys are the go-to resource for cross-country analysis of firm-level information about the business environment. More recently, the surveys have been expanded to include the informal sector. The World Bank also conducts the Firm-level Adoption of Technology (FAT) survey, collecting information on the adoption of general business functions and sector-specific technologies in 11 developing economies. Some commercial databases have also been widely used in the literature. Salient examples are the Orbis database, produced by Bureau van Dijk, and Worldscope, accessible via online platform.

Social Security records are also widely utilized. These records often contain employment-related information, including earnings, work history, and contributions to social security programs. Experts can scrutinize labor market dynamics, employment patterns, and strategic hiring, even investigating “killer acquisitions” by examining which firms hire workers from their rivals to stifle competition. Emerging online platforms present invaluable opportunities for real-time tracking of businesses. In middle-income countries, especially among small firms with limited internal resources, susceptibility to macroeconomic conditions has increased, underscoring the need for frequent real-time monitoring of the health of the small business sector. Meeting this need was previously challenging because of a lack of the appropriate data. However, the emergence of online cloud-based accounting software has bridged this gap. Many businesses now leverage these platforms for improved efficiency, accessibility, security, and flexibility in managing their financial processes. As a result, platform data can provide information, even on the smallest businesses, almost in real time, even when government statistics are unavailable.

Several additional “good-to-have” data sources are available for conducting in-depth firm-level investigations, including Orbis Europe, Orbis M&A, PitchBook, and PATSTAT. These data sets offer valuable insights into firm performance at the micro level.

Greater analytical expertise. As the sources and volume of data soar, avoiding misdirection and framing the appropriate questions become challenging. A starting point is to carefully investigate whether promising new firms can easily enter the economy or they face obstacles, be it from direct means such as licensing or indirectly from a significant presence of SOEs. Furthermore, a better understanding of the productivity dynamics among incumbent firms is needed. As firms expand, there is typically an upsurge in the concentration of economic activities. Market concentration can either signify “productive behavior” or be linked to rent-seeking and “strategic behavior.” The challenge lies in distinguishing between the two. Analysts must therefore scrutinize whether growing firms are expanding due to enhanced productivity or are exhibiting strategic behavior without an actual improvement in productivity. Improving the analytic capabilities of analysis is just as important as improving the quality of data.

In conclusion, the forces of creation will need strengthening in middle-income countries. Both entrants and incumbents can create value—by infusing global technologies and by innovating. Outdated rules of thumb, a preference for SOEs, and political capture by large incumbents stymie the forces of creation. By modernizing data and diagnostics, governments can help in the modernization of productive firms, leading to better managers, better professionals, and better technologies. Governments can also discipline dominant incumbents.