World Development Report 2024: The Middle-Income Trap

The World Bank presently classifies 108 countries as “middle-income”—that is, those with annual income per capita ranging from US$1,136 to US$13,845. These countries are critical to long-term global prosperity. They account for nearly 40 percent of global economic activity, more than 60 percent of people living in extreme poverty, and more than 60 percent of global carbon dioxide (CO2) emissions (table O.1).

Developing economies change in structure as they increase in size, which means that changes in the pace of growth stem from factors that are new to them. Although these imperatives can vary across countries, economic expansion, on average, begins to decelerate and often reaches a plateau in income per capita growth, typically at about 11 percent of US GDP per capita. Today, this figure would be about US$8,000, or around the level at which countries are firmly considered upper-middle-income. A systematic slowdown in growth then occurs. Development strategies relying largely on capital accumulation that served these countries well in their low-income phase, for many even during their lower-middle-income phase between US$1,136 and US$4,465—begin to yield diminishing returns. Strategies based on factor accumulation alone are likely to steadily worsen results—a natural occurrence as the marginal productivity of capital declines.

To see why, consider this: if capital endowments were the only economically relevant difference between middle-income and high-income countries today, the GDP per capita of a typical middle-income country would have been nearly three-quarters of that of the United States in 2019 (figure O.2). In fact, it is about one-fifth that of the United States. Its growth prospects now depend increasingly on its ability to boost the sophistication of its production methods.

Since 2007, the World Bank has called this dependence the “middle-income trap.” And over the last 34 years, only 34 economies have succeeded in breaking out of it.

To achieve high-income status, a middle-income country needs to ramp up the sophistication of its economic structure. Using the economic complexity of a country’s export basket—a measure of sophistication—there is a rising relationship between sophistication and income for all economies that transitioned from a GDP per capita of less than US$13,000 to more than US$31,000, regardless of whether their export baskets became more or less diversified (figure O.3).

However, the pace of progress in middle-income countries is slowing. Average annual income growth in these countries slipped by nearly one-third in the first two decades of this century—from 5 percent in the 2000s to 3.5 percent in the 2010s. A turnaround is not likely soon because middle-income countries are facing ever-stronger headwinds. They are contending with rising geopolitical tensions and protectionism that can slow the diffusion of knowledge to middle-income countries, difficulties in servicing debt obligations, and the additional economic and financial costs of climate change and climate action.

Investment, infusion, and innovationÑadditively and progressively

To achieve more sophisticated economies, middle-income countries need two successive transitions, not one. In the first, investment is complemented with infusion, so that countries (primarily lower-middle-income countries) focus on imitating and diffusing modern technologies. In the second, innovation is added to the investment and infusion mix, so that countries (primarily upper-middle-income countries) focus on building domestic capabilities to add value to global technologies, ultimately becoming innovators themselves. In general, middle-income countries need to recalibrate the mix of the three drivers of economic growth—investment, infusion, and innovation—as they move through middle-income status (table O.2).

What makes the move from middle-income status to high-income status so difficult? One reason is that as they move through middle-income status, countries cannot leap all at once from investment-driven growth to innovation-driven growth. Infusion of technology comes first and then innovation.

Infusion first

Economic success in lower-income countries stems largely from accelerating investment. As these economies move to middle-income status, continued progress requires complementing a good investment climate with measures deliberately designed to bring new ideas from abroad and diffuse them across the economy—so-called infusion.

To intentionally import state-of-the-art technology, knowledge of market potential, and business practices from abroad, as well as expedite their diffusion at home (figure O.4), newly minted middle-income economies have to change tack. Policy makers must support firms that are ready and able to incorporate global technologies into production. For firms to make the most of new technologies, they need technically skilled workers in large numbers and a sufficient supply of engineers, scientists, managers, and other highly skilled professionals. Countries that are relatively open to economic ideas from abroad and have instituted strong secondary education and vocational training programs at home tend to perform better than those that have not.

The experiences of three economies that have grown quickly from the lower-middle-income to high-income levels in recent decades—Chile, the Republic of Korea, and Poland—illustrate these ideas (figure O.5).

Korea’s success may be the best support for the argument that sustaining high growth requires adding infusion to accelerations of investment, and then again augmenting the 2i mix with innovation policies. Korea was among the least developed countries globally in the early 1960s, with income per capita of less than US$1,200 in 1960. By 2023, after an unparalleled five-decade run of high output growth, Korea’s income per capita had risen to about US$33,000.

In the 1960s, a combination of measures to increase public investment and encourage private investment kick-started growth. In the 1970s and 1980s, Korea’s growth was powered by a potent mix of high investment rates and infusion, aided by an industrial policy that encouraged firms to adopt foreign technologies (figure O.6). Firms received tax credits for royalty payments, and family-owned conglomerates, or chaebols, took the lead in copying technologies from abroad—primarily Japan. As Korean conglomerates caught up with foreign firms and encountered resistance from their erstwhile benefactors, industrial policy shifted toward a 3i strategy supporting innovation. Then, as Korean firms became more sophisticated in what they produced, they needed workers with specialized engineering and management skills. The Ministry of Education, through public universities and the regulation of private institutions, did its part, setting targets, increasing budgets, and monitoring the development of these skills. These firms also required more specialized capital: for a growing middle-income economy, investment remained important.

Poland’s case is different because of both its socialist past and its membership in the European Union (EU), the most powerful association of economies ever assembled. But its rapid increase in income is well known, and a Korea-like 1i to 2i to 3i transition is still discernible.

In the early 1990s, Poland underwent a transition from a planned economy to a market economy. It has since boosted its income per capita from 20 percent of the average for the European Union to 50 percent. What is Poland’s winning strategy? It began by disciplining the large state-owned enterprises (SOEs). It hardened their budget constraints by cutting subsidies, tightening bank loans, and liberalizing import competition—including at the iconic Stocznia Gdańsk shipyard, where the Solidarność (Solidarity) movement began. This discipline paved the way for comprehensive reform. In Polish SOEs, managers shifted their focus from production targets to profitability and market share, and they upgraded firms’ capabilities to prepare for privatization. Poland then built on this foundation to attract investment, focus on infusion next, and turn to innovation last. It followed this sequence largely by raising productivity with technologies infused from Western Europe—a process accelerated in the 2000s by its entry into the EU common market, which spurred foreign direct investment. Poland also increased tertiary education rates from 15 percent in 2000 to 42 percent in 2012. Educated Poles put their skills to work across the European Union, opening another channel to infusing global knowledge into the Polish economy.

Chile’s success has similar features. In 2012, Chile became the first Latin American country to reach high-income status, just two years after joining the Organisation for Economic Co-operation and Development (OECD). Chile has grown and diversified its exports since the 1960s, when mining made up about four-fifths of its exports. This share is now about half. Knowledge transfers from advanced economies have been supported by both public and private institutions. The public Chilean Agency for Exports Promotion (ProChile) has bolstered small and medium enterprises (SMEs), which over 2013–16 contributed one-third of export value added—the other two-thirds being contributed by large domestic exporters. And Fundación Chile, a private nonprofit created in 1976, promotes technology transfer for domestic ventures. One example is the adaptation of Norwegian salmon farming technologies to local conditions, making Chile a leading world exporter of salmon.

Innovation next

Once a middle-income country has begun to exhaust the potential of infusion in the most promising parts of its economy—running out of technologies to learn and adopt—it should expand its efforts to become an innovation economy. But this transition is as or more daunting than the preceding one. Infusion is powered mainly by the technology transfers embodied in flows of physical and financial capital.

Although innovation requires both of these flows, it also needs increasingly vigorous exchanges of human capital—often triggered by a reengagement with the emigrant diaspora, but also creating the conditions cherished by innovators such as freer economies, human rights, and livable cities. Moreover, to enable firms to innovate, governments must have done a lot during the infusion phase to reform and strengthen institutions. Weak institutions are as debilitating as premature attempts to leapfrog from investment to innovation. In some cases, ignoring the imperative of infusion to quicken innovation can even worsen the investment climate, setting middle-income economies back years if not decades. Latin America, ground zero for the middle-income trap, provides a cautionary example.

After reaching middle-income status in the 1970s, Brazil veered in the wrong direction. Its policy makers attempted to encourage firms to innovate by bypassing the infusion of foreign technologies. In 2001, the government implemented an innovation-driven economic growth strategy, driven in part by fears that foreign technology would exacerbate domestic inequality and lead to dependence on the more advanced economies in the North Atlantic. Notably, it imposed a 10 percent marginal tax rate on payments for international intellectual property. These tax revenues were used to subsidize innovation in targeted sectors, including biotechnology, aviation, health, and agriculture.

One study found that the subsidies stimulated a rapid rise in applications at the Brazilian patent office, but the patents turned out to be of low quality and lacked any relevance to global markets. Moreover, as the share of firms that applied for patents within the economy increased, the wage premium for skilled workers declined, as did the value added.

While Brazil was stumbling at home, Korea was racing around the world, making the infusion of foreign technology the cornerstone of domestic innovation. In 1980, the average productivity of a worker in Korea was just 20 percent that of the average US worker. By 2019, it had tripled to more than 60 percent (figure O.7). By contrast, Brazilian workers, who had been 40 percent as productive as their US counterparts in 1980, were just 25 percent as productive by 2018.

There are no shortcuts to innovation. It is unlikely that industrial policy will enable countries to leapfrog from an investment- and manufacturing export–driven model to an innovation-oriented model or services-led model of economic growth. The development literature is littered with reports recommending a leap from investment to innovation, skipping the stage of painful reforms to attract foreign investment and ideas. However, middle-income governments that have tried to spare their citizenry the pains associated with reforms and openness have also kept from them the gains that come from sustained growth.