Caught Between the Dragon and the Deep Blue Sea : Can Emerging Donors Offer a Way Out of the Middle-Income Trap?

Abstract

The story of economic growth is a fascinating one. Since the end of World War II, growth has occurred in countries across the world, and this has been rapid especially in low-income region. While historically, countries have followed a development trajectory, in recent years, the rate of graduation from middle-income to high-income have been poor. This led academia and policy practitioners to believe that a majority of middle-income countries are trapped in a ‘middle-income trap’. It is argued that given the absence of new sources of growth, countries find graduating from middle-income to upper-income status difficult. Given poor institutional set-ups and insufficient public finance management, middle-income counties struggle to make investments in productive sectors that could stimulate sustainable growth rates. While external financing could be seen as a viable solution to promote productive investments, given the structure of capital markets and the landscape of development financing, middle-income countries increasingly find themselves in a disadvantaged position. However, the landscape of external and development financing is rapidly changing with the entrance of dynamic sent of donors that follow financing policies quite different to that of traditional donors. Given the expanding role emerging donors play in middle-income countries, some argue if emerging donors could offer a possible avenue to escape the middle-income trap. This study aims to evaluate the same. This analysis employs methods of game theory, regression analysis and an empirical case study of Sri Lanka to obtain a comprehensive understanding of the research questions at hand. Results of this study show that given the choice between a donor that encourage reforms and a donor that would not underscore the importance of structural changes, a recipient would prefer the latter over the former. The analysis also confirms that emerging donors alone cannot offer a possible avenue out of the middle-income trap. While infrastructure investments done by emerging donors can function as a necessary precondition to stimulate new sources of economic growth, this analysis shows that capital investments in the absence of the right institutional and policy mix would fail to encourage a sustainable growth momentum. This highlights the fact that financing from emerging donors will fail to stimulate growth when other pre-conditions for growth are not met. And the fact that emerging donors, especially China downplays the importance of undertaking structural adjustments would mean that escaping the middle-income trap could be a distant dream.