Innovation can create economic success in developing countries facing the middle-income trap

A rising tide lifts all boats. While an age-old saying, the concept is relatively simple really. Of course, the path to broad based economic opportunity for all has been elusive for many countries. In the 21^st Century innovation is the name of the game and those nations not actively and aggressively fostering innovation are losing in the global economic opportunity game.

If underdeveloped and developing countries are going to transform economically, they need to encourage and support innovation. That means many countries like those facing the so called middle income trap like China, South Africa and Brazil, may want to think about IP protection and enforcement and what it could mean for economic development, in terms of encouraging foreign investment, and with respect to raising the quality of life.

What is the Middle Income Trap?

The “middle income trap” occurs when a country rapidly reaches middle-income status but does not manage to sustain a growth rate that pushes the economy to a level of one that is classified as a high-income economy. To the contrary, there is a sharp slowdown in growth and productivity, which means the country gets stuck at the middle-income level, unable to break through.

For example, during the beginning stage of development, low income countries can compete in international markets by producing labor-intensive, low-cost products using technologies imported from abroad. By reallocating labor from lower productivity areas (like agriculture) to higher productivity sectors (like modern services or manufacturing) large productivity gains are initially realized. But, when they hit the middle-income level, the number of underemployed rural workers decreases and wages begin to increase, which shrinks competitiveness. Productivity growth is eventually drained, while rising wages make labor-intensive exports less competitive in world markets—precisely at the time when other low-income countries may become engaged in a phase of rapid growth. Once this point is reached, the cycle cannot be repeated in order to boost productivity since there are no more agricultural workers to move into more productive sectors.

Over the past many decades, few developing countries have been able to avoid the “trap”. In fact, the World Bank has estimated that of the 101 middle income economies in 1960, only 13 eventually became high-income by 2008 – Equatorial Guinea, Greece, Hong Kong (China), Ireland, Israel, Japan, Mauritius, Portugal, Puerto Rico, the Republic of Korea, Singapore, Spain, and Taiwan (China). Conversely, Latin American and Middle Eastern countries that reached middle-income status in the 1960s and 1970s still have not grown to be high-income countries. Meanwhile, economic growth has declined, leading to high unemployment in the Middle East and North African nations.

How Can Intellectual Property Rights help?

The obstacles faced by developing countries include poor infrastructure, weak product, capital and labor markets, underdeveloped educational systems, regulatory gaps, and intense inequalities.

The success of the countries that were able to avoid the “trap” and emerge into the high-income economies occurred, in part, because of strong IP rights protection. In East Asia, they were able to move from being imitators and importers of foreign technology to innovators of their own technology. They would not have been able to become global leaders in patenting their own technology, if they did not have a patent system in proper working order.

Another way the once “trapped” countries became high-income was to invest largely in advanced infrastructure, like high-speed communications networks. Having access to quality information and communications infrastructure helps with innovation by allowing the cheap flow of ideas and knowledge across national borders and by reducing transactional costs of international trade and foreign investments. This increases productivity and wages, which then attracts more labor.

IP rights in the countries that made it to high-income level, like the Republic of Korea, Singapore, and Taiwan (China) are starting to rival those in the U.S. As an example, Taiwan produces nearly as many patents as the USA while Hong Kong, Korea, and Singapore are not far behind.   This has been made possible because of a commitment by these countries to support innovation by investing in ways to upgrade skills and spend more money on Research and Development projects.

Take China for instance. It has been seen as the manufacturing capital of the world for decades. Since it was making other people’s inventions from other countries, and not its own, the Chinese were unsure of why they would have any need to protect IP. However, now that they want to rebrand from just “manufacturers” to “innovators”, there is a strong desire to be more like the USA to protect their ideas from competitors, both foreign and domestic.

On March 3^rd of this year, China’s annual lianghui – which means “Two Sessions” and is an annual legislative conference akin to a blend of the U.S. State of the Union and the White House Correspondents’ Dinner – set forth a comprehensive vision for the country’s economic priorities through 2020. One major topic discussed was how to keep the country from falling into the middle income trap. Chinese President Xi Jinping set a goal to double the size of the economy from 2010 levels by the year 2020, which means growth has to average at least 6.5 percent through 2020.

According to some economists, fast-growing economies have a tendency to decelerate significantly once a GDP per capita of $16,000 is reached and China is close to reaching $15,000, which means that the trap could be around the corner. (Per capita GDP is a measure of the total output of a country which takes the gross domestic product (GDP) and divides it by the number of people in the country.) This explains why the government is placing more emphasis on increasing the size of the economy. See Can China Avoid the Middle Income Trap?

If China were to shift its key market from a traditional industrial and manufacturing economy to an innovation-driven and high value-added market economy, it would create growth. The 5-year plan indicates a desire to create 50 million new jobs by 2020 and to do so is relying on the service sector. For example, tech giants have invested heavily in creating digital economies based on e-commerce and online services. Additionally, the state driven industrial “Made in China 2025” initiative seeks to make the country a producer of high-value added goods and a leading manufacturing power by the year 2049, which will also be the 100^th anniversary of the founding of the PRC.

Nevertheless, this shift requires a healthy environment for the organic growth of the entrepreneurial spirit where inventors can operate independently and fail or flourish freely. Unfortunately, government plans like “Made in China 2025” which is top down and intend to maximize control, cannot dictate innovation. Instead, innovators will demand IP rights where their ideas and inventions are protected from infringers and domestic competitors. To achieve this, IP laws have to be strictly enforced.

Why should “They” try to be more like “U.S.”?

In 2015, the United States was ranked fifth in the World in WIPO’s Global Innovation Index, which uses 79 indicators to determine the order. The top four slots were earned by Switzerland, UK, Sweden, and the Netherlands and the top 25 countries were all high income economies. See Global Innovation Index 2015 Rankings.

In the category of innovation quality – which measures university performance, the reach of scholarly articles and the international dimensions of patent applications – the US and UK were the leaders. We earned this distinction because of our world class universities, investments in research and infrastructure. Countries like Rwanda (94^th), Mozambique (95^th) and Malawi (98^th) all got boosts in their rankings in this classification because of improvements to institutional and innovation frameworks, of a skilled labor force with better education, more integration with global credit investment and trade markets, and a sophisticated business community (business linkages to science and its institutions, foreign subsidiaries, and the recruitment of scientists). What also sets us apart from the lower ranked countries is the quality of our work, and our universities help with that too. Superior talent wants to be at the superior universities and having a highly skilled workforce drives innovation.

The United States has been successful for many other reasons. American citizens and the American government understand that innovation and turning an idea into a product for commercialization is more like a marathon, not a sprint. It demands persistent perseverance and commitment and this is a challenge for many developing countries. Innovation must be continuous and uninterrupted, not started and then stopped due to lack of investments or poor communication between private and public sectors.

It also requires communication between the private sector and academia. The USA is dedicated to creating some of the best technology the world has ever seen and can do so because of our business environment and accessibility to finance like grants, subsidies and tax credits. Furthermore, our government keeps innovation as a top priority on the political agenda and understands that there should be processes in place to facilitate setting up new businesses. Countries like Georgia (73^rd) and Kenya (92^nd), for example, are improving their status by having direct links to high level officials through innovation agencies and councils that ensure innovation policies are coordinated with other policies like education, skills, foreign investments and trade policy.

Not every country can earn the distinction of being among the best innovators of the world. Moreover, if lower ranked countries try to use the IP strategies that work in the highest ranking countries, without modification based on their unique environments, they will likely fail. The key for lower ranked countries is to learn from the lessons – both good and bad – of higher ranked countries. Adopting policies and rules to their unique circumstance so that it fits within their cultural traditions is critically important if reforms are to be implemented, adopted, respected and ultimately lead to the desired economic invigoration.

Additional Resources:

http://siteresources.worldbank.org/EXTPREMNET/Resources/EP98.pdf

http://english.gov.cn/policies/policy_watch/2015/05/08/content_281475103653822.htm

http://www.chinadaily.com.cn/bizchina/2015-05/19/content_20760528.htm

http://www.wipo.int/wipo_magazine/en/2015/05/article_0002.html