The Adding-up problem & Wage-productivity dynamics in exports of developing countries facing the middle-income trap

Keun Lee, Seoul National University

This study revisits one strand of the recent economic growth literature that pays attention to the concepts like adding-up problem (Spence 2011), and the middle income trap and observes that sustaining economic growth is very difficult for developing countries. Jones and Olken (2005), Hausman et al. (2005) and Rodrick (2006) noted that many developing countries were able to show growth spurts for a certain period of time (usually less than a decade) but were unable to sustain it over a longer period; discuss the slowdown of growth of middle income countries. Relatedly, there is an increasing volume of literature about the middle-income trap (MIT hereafter), which is a situation in which middle-income countries face a slowdown of growth as they get caught between low-wage manufacturers and high-wage innovators because their wage rates are too high to compete with low-wage exporters and the level of their technological capability is too low to enable them to compete with advanced countries (Lin 2012a; Williamson 2012; Yusuf and Nabeshima 2009; World Bank 2010 and 2012; Lee 2013).
While there are studies on the sources of the MIT, this paper focuses on the adding-up problem (and the fallacy of composition). In Cline (1982; 2010), Balassa (1988) and Spence (2011), the adding-up problem is defined as the situation in which all the developing countries flood the market with similar goods that they tend to be good at producing and thus relative prices of these kinds of goods would decrease, making these sectors less profitable (Spence 2011). They argue that one cause for the adding-up problem is the limited size of the market in the developed countries.
We first test their view but also propose an alternative hypothesis that the essence of the adding-up problem is the mutual competition among the developing countries in terms of wage rates (hence costs of production) to be applied for their export products or offered for FDI from the developed countries, as pointed out by Lee and Mathews (2012). Thus, we consider the variable of wage rate increases, relative to the growth of labor productivity, in developing countries, to argue that the lagging growth of productivity in the South, compared to wage rates, is one of the cause of the slow-down of exports and growth, and the hence the middle income trap. Therefore, this study suggests a new variable of wage-productivity dynamics, namely the relative ratio of wage rate and productivity growth, and then examine the hypothesis that the adding-up problem happens not because of the limited size of the markets in the developed countries, but because of the rising wage rates or slow productivity growth.
Focusing on the adding-up problem and the middle income trap, this study will deal with the several contending factors all together in a single framework, such as undervaluation, market size, and the wage-productivity gap. In our econometric analysis of export growth as the dependent variable, explanatory variables include undervaluation, the market size measured by the top 5 trading partners’ weighted GDP growth rate, and the wage-productivity growth ratio relative to the world average. In terms of methodology, we use panel-estimation as well as system-GMM estimation to control endogeneity, and also look for any difference between developing and developed countries.

About the speaker
Keun Lee is a Professor of Economics at the Seoul National University, and the founding director of the Center for Economic Catch-up. He has been awarded the 2014 Schumpeter Prize for his monograph on Schumpeterian Analysis of Economic Catch-up: Knowledge, Path-creation and the Middle Income Trap (2013 Cambridge Univ. Press) by the International Schumpeter Society. He is also the President-Elect of this Society. He is currently a member of the Committee for Development Policy of UN, a co-editor of Research Policy, a member of the governing board of Globelics, and had also served as the President of the Asia-Pacific Innovation Network. He obtained Ph.D. degree from the University of California, Berkeley. He had working experience at the World Bank, University of Aberdeen, and the East West Center, Hawaii. One of his most widely-cited articles —with 710 or so citations (Google Scholar)—is a paper on Korea’s Technological Catch-up published in Research Policy (2001).

Venue: Conference room

Date: 09 September 2015

Time: 14:30 - 15:30  CET