Where is PNG Headed?

Long after the Thai Prime Minister Yingluck Shinawatra had graced our shores I came across the East Asia Forum Quarterly with the headline: Where is Thailand headed? The Quarterly is about the economics, politics, and public policy in East Asia and the Pacific. This particular issue was published in October-December 2011.

Some of the critical discussions that public policy experts and scholars made about Thailand are useful to Papua New Guinea.

I was drawn immediately to the discussion on how Thailand was caught up in what is called ‘the middle-income trap.’ Peter Warr, the John Crawford Professor of Agricultural Economics and Head of Arndt Corden Department of Economics in the Crawford School of Economics and Government and Executive Director of the National Thai Studies Centre at ANU explains this phenomena in his essay: “A nation caught in the middle-income trap.”

How did Thailand find itself trapped in the middle-income trap? What is a middle-income trap? What is the right solution?

“The middle-income trap”, according to Professor Warr “is an empirical generalization based mainly on East and Southeast Asian experience: once a country reaches middle-income levels the growth rate often declines and graduation from middle-income to higher-income levels stall.”

“During the decade of economic boom ending in 1997 Thailand’s average annual growth rate of real GDP per person was a remarkable 8.4 per cent. Like most booms, this one ended badly. It collapsed with the Asian Financial Crisis of 1997-99. Since 2000 the corresponding growth rate has been 4.1 per cent. The immediate culprit was a contraction of private investment, which declined as a proportion of GDP from an average of 30 per cent to 18 per cent over the same two periods.  The effect of lower investment was twofold: it reduced aggregate demand, lowering income in the short run; and it reduced the rate of capital formation, lowering long-run growth prospects,” writes Professor Warr.

The same was experienced in major Asian economies in the same period: “Indonesia, Malaysia, the Philippines and South Korea had the same results in the decline in investment portfolio around the same time. Thailand experienced the largest decline.”

“The contraction of investment occurred primarily among Thai-owned, rather than foreign-owned, firms. Put simply, after the crisis Thai firms became less confident about their prospects and hence less inclined to invest. An expectation of this kind is self-fulfilling. It reduces investment, which does indeed ensure that growth will be lower.”

Earlier political and economic development in Thailand explains a lot.

“Between the 1960s and 1990s Thailand achieved the transition from a poor, heavily rural backwater to a middle income, semi-industrialized and globalized economy. The transition was primarily market-driven and the central policy imperative was to avoid those policies that impeded absorption of low-cost labour into export-oriented labor-intensive manufacturing and services. This transition required some elementary market-supporting policy reforms: promoting a stable business environment (not necessarily meaning stable politics); open policies with respect to international trade and foreign investment; and public provision of basic physical infrastructure, including roads, ports, reliable electricity supplies, telecommunications and policing sufficient to protect the physical assets created by business investments.”

Most of the East and Southeast Asian economies quickly moved to protect their business investments after the Asian Financial Crisis of the late 1990s.

“The core of this growth process is expansion of the physical capital stock, resting overwhelmingly on private investment. The private financial system facilitates the link between private savings and business investment. But the process is self-limiting. As labour moves from low-productivity agricultural to more rewarding alternatives elsewhere, wages are eventually driven up. As wages rise, the profitability of labour-intensive development declines. As the return to investment in physical capital falls, the rate of private investment slackens and growth slows.”

Professor Warr observes this predictable trend in Asia: “The frontier for further expansion of labour-intensive export-oriented development soon moves to other lower-wage countries. The result is the dreaded ‘middle-income trap’. This describes Thailand and Malaysia today and China in the very near future.”

“Progress from middle-income to higher-income levels requires a different kind of policy reform,” according to Professor Warr, because “addressing a market failure that the private financial system cannot resolve: the undersupply of human capital. Human capital is a crucial input, created primarily by investment in education, broadly defined. But it differs from physical capital in that it does not provide the collateral that can ensure repayment of loans. Unlike physical assets, human beings can walk away. The private financial system is therefore unable to support investment in human capital.”

Individual citizens then shoulder the burden: “Individual families can and do invest heavily in the education of their own children, but because their resources are limited and because the recipient of the educational investments reaps only part of the returns it generates this is insufficient to prevent the overall underinvestment in human capital.”

The lesson from Thailand is this:  “Increasing the supply of human capital is central to overcoming the middle-income trap. It raises labour productivity directly and raises the return to physical capital, encouraging greater investment in physical capital as well. In Thailand, as in many other middle-income countries, the problem lies in the quality of education and not just the bare numbers of total school enrolments. And the problem is primarily not at the tertiary level but at the primary and secondary levels. Massive public investment and reform of the education curriculum is needed to redress these problems, requiring the raising of sufficient tax revenue to finance it and combating the backward and self-serving practices of the Ministry of Education and the teachers’ unions. These are formidable obstacles.”

Perhaps the visit of Thai Prime Minister Yingluck Shinawatra left an indelible mark for Papua New Guinea to see the writing on the wall regarding its own twin-imperative of economic boom and the sudden shocks that lurk behind the corner after the private financial investment in physical infrastructure and capital development begins to slow down

Will Papua New Guinea face the middle-income trap after the euphoria of LNG investments?