Escaping Relative Income Traps: The Role of Productivity in Global Economic Equity

Low-income countries struggle to improve their economic standing relative to wealthier nations due to persistent productivity gaps, despite gains in education and capital. Addressing these income traps requires strong governance and structural reforms to boost total factor productivity.

The IMF working paper authored by Patrick A. Imam and Jonathan R.W. Temple as part of the Macroeconomic Research in Low-Income Countries project supported by the UK’s Foreign, Commonwealth, and Development Office (FCDO), investigates why many low-income countries struggle to advance economically relative to wealthier nations, particularly the United States. This paper delves into the idea of “relative income traps,” a situation where poorer countries, even when improving their economies in absolute terms, fail to close the gap with advanced economies. This persistence of low relative income, as opposed to an outright poverty trap, reflects a more nuanced challenge: despite economic development and rising standards of living in these nations, their position relative to richer countries remains unchanged or only slightly improved. The study uses finite state Markov chains to track economic mobility, finding that while many of these countries show improvements in aspects like capital-output ratios and human capital, their productivity levels, measured by total factor productivity (TFP), stagnate. TFP reflects the efficiency with which countries use their resources and is crucial to long-term economic growth and competitive standing globally. However, TFP is one area where low-income countries lag persistently behind, undermining their efforts to climb up the global income ladder.

Convergence in Capital and Education But Lag in Productivity

In exploring why productivity gains are so slow for many low-income nations, the authors note that, globally, convergence is happening in terms of factors like education and capital investment, with gaps narrowing between developing and developed economies. However, low TFP in poorer countries is a more deeply entrenched issue that has proven resilient to change, serving as a significant barrier to overall income convergence. They observe that TFP is not simply an outcome of available resources but involves how effectively these resources are employed an aspect tightly linked to innovation, technology, and infrastructure quality. The persistence of low relative TFP in many countries, as opposed to more robust productivity growth seen in high-income economies, suggests that these nations remain in a disadvantaged position that affects their income status over time. This dynamic means that while developing countries may gradually improve their income levels, they continue to fall behind in TFP compared to countries like the United States, which reinforces their relative income trap.

Education's Limited Impact on Economic Catch-Up

One focus of the study is the role of human capital, particularly education, in driving productivity growth. Education levels in low-income countries have generally improved over the past few decades, and the paper acknowledges that these gains are beneficial, particularly in helping countries with relatively higher levels of education experience some productivity improvement. Yet, Imam and Temple’s analysis shows that educational attainment alone has limited power in driving substantial TFP gains and, consequently, income convergence. They find that while higher education levels can foster some upward mobility within the TFP distribution, this effect is modest. This limited impact of education implies that, although human capital investment is necessary, it is insufficient on its own for achieving broad economic parity with richer nations. Structural factors beyond education, such as institutional quality and governance, emerge as significant contributors to this issue. The authors suggest that the quality of institutions and governance, particularly around aspects like state capacity and accountability, are critical for fostering an environment where productivity can grow more robustly. They observe that improvements in these areas are linked to better outcomes in productivity and economic stability; however, institutional convergence is often slow and can be vulnerable to political instability.

Governance and State Capacity as Catalysts for Growth

The paper also highlights the importance of state capacity and institutional checks and balances, noting that both show signs of convergence but remain inconsistent across low-income countries. The authors’ data shows that governance indicators, which measure aspects such as the capacity to implement policies effectively and uphold the rule of law, are gradually improving in some developing nations. Yet, these advances are not uniform or guaranteed, particularly in light of political risks and the global trend of “autocratization,” or the gradual erosion of democratic institutions. This poses a risk to the steady institutional improvements required for sustainable TFP growth, as poor political accountability and weak state capacity often hinder productivity-enhancing reforms and investments.

Persistent Weaknesses in TFP Limit Long-Term Economic Mobility

The findings suggest that low-income countries face a prolonged challenge in improving their relative income position, largely due to persistent weaknesses in TFP. While there has been some success in achieving convergence in education and capital accumulation, TFP remains a critical obstacle to reaching income levels comparable to wealthier nations. Imam and Temple argue that while educational attainment and capital investment are essential, they must be complemented by stronger governance and institutional frameworks to support sustainable productivity growth. The study thus highlights the need for a more comprehensive approach to economic development that addresses both the supply of human and physical capital and the structural constraints that limit productivity growth.

A Broader Approach Needed to Overcome Relative Income Traps

The research underscores that while relative income traps are not insurmountable, overcoming them will require broad, coordinated efforts to improve state capacity, uphold effective governance, and enable policies that promote technological adoption and economic dynamism. For many low-income nations, a path to convergence with advanced economies remains slow and uncertain, suggesting that these countries must look beyond traditional development strategies to break free from their persistent income traps.