World Development Report 2024: The Middle-Income Trap

Switching from a 2i to a 3i strategy also has implications for how firms access finance. Equity markets can be instrumental in supporting innovative activities, especially in private firms, which typically face larger financing gaps than publicly listed firms. However, private markets for equity financing lack depth and access in emerging economies (figure O.11). Start-up incubators and accelerators can be particularly helpful, providing mentorship, resources, networking opportunities, and sometimes funding to help start-ups grow and compete.

Education, social mobility, and entrepreneurship

As more parts of an economy shift from 1i to 2i and 3i strategies, demand increases for highly skilled workers—technicians, managers, scientists, and other professionals. This demand can increase income inequality. But, if it is accompanied by policies that expand access to higher education and reduce barriers for women and other disadvantaged groups so that they are now rewarded for their skills and able to create new businesses, it also generates greater social mobility. Such conditions can provide both social stability and economic dynamism, which are equally necessary for middle-income countries to grow to high-income status. In fact, barriers to social mobility can derail a country’s plans for moving beyond a 1i strategy.

Discipline, not vilify, elites

Social and economic elites can be either creative or inimical to creation. For a middle-income country seeking rapidly to enrich its talent pool, it would be self-defeating to lower elites’ ambitions. Elites are most able to invest in their children’s education—and larger investments, and better investment choices, yield increasing returns to parental background. Elites are also best connected for job searches and placements. And elite women can most readily become role models for other women through education and professional work. However, elites—like large incumbent firms—need to be disciplined because of their power to capture institutions. If elites hog education, jobs, capital, and assets for themselves, thereby limiting access to outsiders, a middle-income country is suffering from elite capture: by preserving privilege, it is stymying creation.

Invest in talent and reward merit

People who are not only talented, but also—crucially—educated and have access to labor markets, enterprise opportunities, and business financing are key to the 2i and 3i strategies. Policy makers should especially consider initiatives to educate women, along with other excluded and marginalized groups, and to let families become more socially and economically mobile with each succeeding generation.

From the successes of former middle-income countries that have attained high income, three simple lessons emerge for education reform:

• Broaden access to foundational skills. Graduate more students from high school, broadening and deepening the talent pool.

• Monitor learning outcomes using student assessments. Gauge progress toward explicit policy goals.

• Embed educational reforms in a national economic growth strategy. For example, in the early 1970s, as Finland’s economy became less resource-dependent and agrarian and more urban and industrial, the country reformed education to meet the demands of firms and of a growing middle class.

Growing the talent pool takes time, and past mistakes can impede countries for decades. Although many middle-income countries have expanded tertiary education, a critical difference between those that graduated to high-income status and those that did not is that the former never wavered in their commitment to foundational skills, thereby developing a large pipeline of talent. Missing the opportunity to learn while in school is largely irreversible for children; they may not have a chance to study later in life. Strengthening foundational skills requires efficient and effective spending on education because spending by itself is not a guarantee of better learning outcomes. Countries may consider adopting the “progressive universalism” principle: add incrementally to higher education investments as the quality at lower schooling levels rises to include more students.

Meanwhile, middle-income countries are not only talent-scarce relative to advanced economies, but also not nearly as effective in allocating the existing talent to tasks. For example, these countries do not fully reward the talents of women and people from less privileged families, while simultaneously protecting less able people from privileged families from competition in education.

Policies to ensure equal opportunities for women, minorities, and other disadvantaged groups whose talents have been undeveloped or unrewarded are likely to increase both economic efficiency and equity. However, in many countries patriarchal gender norms are part of a deeply entrenched system of preservation, limiting women’s earning power and social and economic mobility across occupations and generations. Where economic and social rights favor men, middle-income countries that aspire to grow quickly must work hard to grant the same opportunities to women. Institutions and policies are needed to counter the exclusion of women—among others—from education, employment, enterprise financing, and contracting and to provide policies such as childcare support or flexible work for both men and women.

In education, policies that support girls who stay in school longer by offering them scholarships or conditional cash transfers can improve outcomes for women. To boost female students’ interest in science, technology, engineering, and mathematics (STEM), mentoring and information interventions have proven to be among the most effective methods. However, because women face social, family, and logistical constraints—including household and childcare responsibilities—educating women is most effective when complemented by other interventions to address these constraints.

Leverage digital technologies

Digital technologies—such as the internet, mobile phones, social media, and web-based information systems—can promote both social mobility and talent development. When Nandan Nilekani, one of India’s leading technology entrepreneurs, was tasked with developing Aadhar (the country’s digital identification system) in 2009, he paved the way for Indians to accumulate digital capital (digital footprints of online activity and digital payments). Digital footprints become digital capital, which individuals own and can choose to make available to lenders when getting access to credit. Digital data on payments, receipts, taxes, and loan repayments all make it possible to assess financial credibility. According to a recent study, digital capital has increased entrepreneurship and business income in India and has favored small-scale vendors and economically lagging districts. By delivering instructional material, digital technologies also provide students from disadvantaged backgrounds with opportunities to learn.

Reward innovators and scientists to match brain drain with brain gain

Investing in advanced skills is costly. Individuals invest in these skills with the expectation that their talent and acquired ability will be rewarded. However, these rewards are often found on foreign shores. World Development Report 2023 reported that in middle-income countries, 10 percent of highly skilled workers emigrate, with high-level skills in greater demand in Western Europe and North America. To counter the brain drain, the report recommended that origin countries expand their capacity for training highly skilled workers because greater capacity increases the likelihood that a sufficient number of highly skilled workers will stay even when others migrate.

As countries adopt a 3i strategy, they will need to tap into the knowledge and know-how of a country’s diaspora. The emigration of highly skilled individuals can serve as an opportunity for the origin country if emigrants remain connected to the origin country—or even return. This is particularly relevant in conflict-affected countries such as Ukraine that have experienced a large outflow of highly skilled individuals. When the demand for advanced skills increases, the diaspora becomes an important talent pool to germinate innovation at home.

As migrants acquire skills abroad, migration may drive a brain gain in the sending country. Whether the sending country experiences brain drain or brain gain varies across countries, depending largely on how the sending country’s policies address emigration. The most likely migrant to be exposed to modern production processes and technologies and to transmit valuable knowledge back to the origin country is highly skilled, moves to an advanced economy, and works there in a leading occupation as a manager, professional, or technician (figure O.12).

Building and expanding high-quality universities—institutions that can train top talent and contribute to innovation—require an efficient system of public funding for research, along with fluid university-industry connections to promote exchange of knowledge. Most efficient for middle-income countries is to focus public funding on a few strategic research areas, such as STEM, health, and energy transition, with funds allocated competitively and based on performance. Partnerships with world-class universities can be a strategy for developing a research base.

To encourage knowledge exchanges between universities and industries, countries could grant R&D funding for such partnerships. Governments could also offer firms tax incentives for collaborating with universities. Establishing a regulatory framework for knowledge exchange is key—especially to define the government’s intellectual property rights to knowledge produced by universities with public resources. One desirable outcome of university-industry collaboration is venture creation by university faculty, staff, students, and postdoctoral fellows, with private investors serving as venture capitalists. Universities can also form partnerships to provide services to local companies.