Greece, Argentina, and the Middle-Income Trap

Andrs Velasco
SANTIAGO Aside from an established tradition of bad macroeconomics, what do Greece
and Argentina have in common? One answer is that they were the worlds longest-held
captives of the so-called middle-income trap and remain within its reach to this day. With
countries in Asia, Eastern Europe, and Latin American fearing that, having reached the
international middle class, they could be stuck there, Greece and Argentina shed light on
how that might happen.
A recent paper by economists from Bard College and the Asian Development Bank
categorizes the world economy according to four groups with the top two categories
occupied by upper-middle-income and high-income countries and tracks countries
movements in and out of these groups. Which countries were stuck for the longest period
in the upper-middle-income category before moving to high income? You guessed it:
Greece and Argentina.
Correcting for variations in the cost of living across countries, the paper concludes that
$10,750 of purchasing power in the year 1990 is the threshold for per capita income
beyond which a country is high income, while $7,250 makes it upper-middle income.
(These thresholds may sound low, but the World Bank uses similar cutoffs.)
By these criteria, Argentina became an upper-middle-income country all the way back in
1970, and then spent 40 years stuck in that category before reaching high-income status
in 2010. Greece joined the international upper middle class in 1972, and then took 28
years to reach the top income group, in 2000.
No other country that became upper middle income after 1950, and then made the
transition, took nearly as long. In fact, the average length of that transition was 14 years,
with economies such as South Korea, Taiwan, and Hong Kong taking as little as seven
years.
Data in the paper stop at 2010, but the story may well be worse today. According to IMF
figures, Greeces never-ending crisis has cut per capita GDP (in terms of purchasing power
parity) by 10% since 2010, and by 18% since 2007. Indeed, Greece may have dropped out
of the high-income category in recent years.
Argentinas per capita income has risen, albeit slowly, during this period, but the country
was never far from a full-blown macroeconomic crisis that could reduce household
incomes sharply. So it seems fair to conclude that both countries are still caught in the
middle-income trap.
What kind of trap is it? In Greece and Argentina, it is both political and economic.
Start with the politics. In their book Why Nations Fail, Daron Acemoglu and James A.
Robinson argue that societies with political arrangements that concentrate power in the
hands of a few seldom excel at innovation and growth, because innovators have no
guarantee they will keep the fruits of their labors. And, to the extent that outsiders cannot
generate wealth, they have few resources with which to challenge the power of insiders;
as a result, exclusionary political arrangements are mostly self-sustaining.

That is a useful account of why there is a poverty trap which is the question the book
seeks to answer but it does not clarify why there is a middle-income trap. Greece and
Argentina are, after all, democracies, however imperfect, and so are most of the countries
in Latin America or East Asia that worry about being stuck at middle-income level. The
Acemoglu-Robinson account of a single small elite pulling all the strings needs to be
replaced by a different narrative, in which an array of politically powerful groups exercise
veto power over decisions that affect their economic interests.
Think of powerful business groups vetoing moves to improve tax collection or strengthen
competition policy. This helps explain why the Greek and Argentine governments are
perennially in deficit (until borrowing options dry up and adjustment is inevitable), or why
prices and profits are high in sectors (for example, transportation and telecoms) that
provide would-be entrepreneurs with crucial (but often unaffordable) inputs.
Or think of public-sector unions vetoing changes in benefits for their members. That goes
a long way toward explaining (add a bit of ideology to the mix) why the current Greek
government has gone to the brink of default before agreeing to restrain public-sector
pensions, as its European Union partners demand. It also helps explain why both Greece
and Argentina have sizeable governments (public spending accounts for 46% and 39% of
GDP, respectively) but puny public investment and outdated infrastructure.
This is not a case of too much democracy, as conservative commentators sometimes
claim, but of too little. Underdeveloped democratic institutions allow for decisions that are
individually rational but collectively shortsighted and harmful.
And bad politics makes for bad economics. To go from middle-income to high-income
status, countries have to redeploy resources to high-productivity, knowledge- and skillintensive sectors. That is a transition that Greece and Argentina, with their financial
instability, poor infrastructure, and weak education systems, have never made.
Greece exports refined petroleum products, olive oil, raw cotton, and dried fruit. Argentina
exports corn, soybeans, fruits, and wine as well as cars and auto parts to the rest of the
regional Mercosur trade bloc, where it enjoys ample tariff protection against third-country
competition.
According to the Atlas of Economic Complexity, developed by Ricardo Hausmann and
colleagues at Harvard University, the 2008 gap between Greeces income and the
knowledge content of its exports was the largest in a sample of 128 countries. By 2013,
Greece ranked 48th in the Atlass index of complexity of exports by far the lowest of any
developed country in Europe while Argentina ranked 67th.
Sluggish exports mean slow growth, which in turn places limits on social mobility and the
expansion of an entrepreneurial middle class. That helps preserve the political power of
entrenched veto-wielding players, closing the trap. Perhaps a weighty tome entitled Why
Middle-Income Nations Fail will tell the story in full. Societies will then understand why
high-income status eludes them and what they might do differently.