World Development Report 2024: The Middle-Income Trap

Creative destruction requires talent; individuals, in turn, need opportunities to develop their talents and an expectation that investing in such talent will improve their lives. In the early twentieth century, a high school or college degree held the greatest potential for fostering inventions. However, in today’s world marked by ever-advancing and complex technologies, the focus on innovation has moved toward even more specialized education, exemplified by the pursuit of advanced degrees such as PhDs. When deciding how much to invest in their own human capital—or that of their children—individuals weigh the expected returns of those investments against their costs, largely based on societal norms and rules that determine an individual’s access to the relevant markets and services.

When these norms and rules are biased—for example, in favor of the wealthy and the elite—they restrict access to opportunity. Inequitable access to opportunity exacerbates social immobility, which preserves the existing social hierarchy, perpetuating inequality. Social immobility, in the aggregate, holds back the energies that drive the forces of creation.

Elite pacts hinder learning, employment, and entrepreneurship

Networks facilitate the formation of groups that can determine access to jobs, services, and policy making. Better-educated and wealthier parents have broader social networks to assist in their child’s job search. Networks also matter for entrepreneurship. Because better-educated and wealthier entrepreneurs have access to wider and better social networks than others, they have greater access to opportunities and credit.

Networks keep outsiders out

Networks and group memberships based on parental and family ties can secure access to jobs, public services, and political power for individuals from wealthy and close-knit groups. Such tight social groups are common in many countries. Although these social relationships are often instrumental in building trust and facilitating business transactions, they also create unequal playing fields, limiting opportunities for those outside the network. And they keep outsiders out. In fact, the majority of people in many countries believe that social connections, mostly through family, are a key to success, as opposed to personal effort, grit, or talent.

In the Middle East, an implicit social contract known as wasta obliges those within the group—typically a tribal group—to aid others from the group. The use of wasta is common when searching for a job, procuring a driver’s license or business license, gaining admission to a university, and performing many other day-to-day transactions. Compared with other individuals, those who have access to a wasta obtain more favorable rulings from agencies and courts, are more likely to obtain government contracts, and benefit more from government rules that limit competition. Other examples of such social contracts include guanxixue in China, blat in the Russian Federation, compadrazgo in Latin America, and the “old boys network” in Western countries.

A situation in which only well-connected individuals obtain rewarding jobs, irrespective of skills and talent, can have profound negative effects on the incentives for outsiders to attend school and even to perform well in school. Cronyism and corruption in education lead to lower academic achievement for a given level of public spending on education, thereby lowering the efficacy of such expenditures.

Networks also facilitate the formation of interest groups, which block the entry of new actors. For example, in public school systems there is often a symbiotic relationship between teachers’ unions and political leaders, which can hamper children’s achievement. When in office, political leaders provide teachers with benefits such as higher salaries. Teachers then pay union fees from their salaries, and unions contribute a portion of this revenue to politicians’ campaigns. Although replacing the lowest-performing teachers with more effective ones would improve children’s achievement, the often politically powerful teachers’ unions typically block efforts aimed at improving education quality. This occurs in many middle-income countries, including Indonesia and Mexico.

Connections in job recruitment and starting a business can worsen existing inequalities

Job-seekers and firms alike rely on social networks for recruitment. Social networks provide job-seekers with information about job opportunities, access to hiring managers, and other support. When official credentials (such as degrees) convey little information about a job candidate’s skills and personal traits, recruitment through social networks helps employers lower the risk of choosing unqualified candidates. But because social networks are mostly defined by a person’s socioeconomic background and where they grew up, they can worsen existing inequalities. Research shows that new technologies, particularly when introduced by entrants, can foster social mobility, although this effect diminishes in economies where incumbents spend more time and money on lobbying activities.

In lower- and middle-income countries, between 40 and 80 percent of workers find jobs through social networks. Hiring through social networks can lead to discrimination against individuals without access to high-quality networks. One reason is people’s tendency to associate with others of similar backgrounds or characteristics. In Malawi, for example, men systematically refer fewer women than men to jobs.

Social connections matter to entrepreneurial success—and the connections that matter most are often parents and extended families. Social and ethnic networks help the next generation of entrepreneurs by facilitating access to credit. They also help with enforcing contracts, providing operational support, and developing further connections. Because many entrepreneurs in developing countries lack a legal and institutional framework within which to operate, they rely instead on their kinship networks.

Developing social networks from scratch is costly for entrants to any circle, which strengthens the status quo—the forces of preservation—and leads to persistent social inequality. Furthermore, the persistence of social networks is resistant to shocks.

An inability to trust people and institutions beyond one’s own family and social network can limit firm growth and productivity. In developing countries, firm owners generally make major management decisions themselves because they fear the consequences of delegating to their managers. But because their time and talent are limited, owners are compelled to manage firms through their children. Consequently, the number of male children emerges as one of the best predictors of firm size, thereby impeding the growth and profitability of their firm. In India, for example, this factor underlies firms’ inability to grow. Its effect is sizable; poor delegation of managerial responsibilities could account for 11 percent of the difference in income per capita between India and the United States.

Insiders keep outsiders out of sight in distant and disadvantaged neighborhoods

Where a person is born, grows up, and lives shapes that person’s access to opportunities and aspirations. In the United States, children of similar family incomes raised in nearby neighborhoods with different postal codes may have vastly different chances of succeeding as adults. This is equally true in middle-income countries, where social mobility is typically limited to only some geographic areas. Individuals who live in areas with high levels of poverty fare much worse than others on a wide range of economic, health, and educational outcomes.

In middle-income countries, income inequality is typically higher in urban areas than in rural areas because cities attract both highly skilled and unskilled workers. But cities also have higher social mobility because they offer more opportunities to develop talent than rural areas. For example, since 1950 social mobility in Latin American cities has been higher for larger cities, although not for all cities. In Brazil, dynamic cities such as São Paulo and Rio de Janeiro offer scant opportunities to poor children. In India, social mobility has improved greatly in urban areas in recent decades, and has delivered larger gains for the disadvantaged than in rural areas during the period following India’s economic liberalization.

Cities can be formidable engines of social mobility, but cities in middle-income countries are less socially mobile than cities in high-income countries. Further, they have greater inequality (figure 5.4). For example, inequality between urban neighborhoods is high in Cape Town, and overall in South Africa, and mobility between generations is quite low. Cities where consumption is more unequal across neighborhoods—due, for example, to income differences across neighborhoods—are located in countries with fewer opportunities for social mobility.

By shaping the laws, regulations, and rules determining who lives where, the social elite keep outsiders out—relegated to rural areas or disadvantaged neighborhoods. A dominant mechanism is setting urban planning standards that are unaffordable for outsiders. When the US city of Philadelphia was settled, for example, city authorities set a minimum lot size of about 30 square meters. By contrast, minimum lot sizes in Ethiopia range from 75 to 300 square meters.

Even in accessing finance for housing, there is a long history of discrimination. In the United States, the Home Owners Loan Corporation (HOLC) drew maps in the 1930s for more than 200 cities as part of its City Survey Program to document the relative riskiness of lending in neighborhoods. Risk factors included race, ethnicity, and immigration status. The lowest-rated neighborhoods, most of whose residents were African American, were drawn in red. Borrowers from these “redlined” neighborhoods were denied access to credit due to the demographic composition of their neighborhoods. For more than two decades, the redlining in effect barred African Americans from buying homes in attractive neighborhoods, even when they could afford them, and kept their home values low.

Although this discriminatory practice was banned by the Fair Housing Act in 1968, the effects still linger today. Neighborhoods that were formerly redlined fare worse in terms of housing value, homeownership rates, racial composition, and exposure to pollutants. The inability to own a home prevented those discriminated against from generating home equity, the main source of wealth for most American households and the major source of inherited (intergenerational) wealth.