Middle Income Trap, International Trade, and Economic Growth

Since World War II, only 13 economies have graduated from the mid-income status and become high-income economies. To explain this important growth phenomenon known as the middle-income trap, we develop a general-equilibrium growth model with three countries. We explore how a Mid-income country is sandwiched by an imitating South country and an innovating North country through international trade and technology diffusion. We find that the North-Middle income gap is only conditionally affected by the South and that the chasing effect either works in the extensive margin (variety expansion) or in the intensive margin (productivity improvement on existing varieties), but never both simultaneously. In contrast,the pressing effect from the North always exists in the intensive margin but may be absent in the extensive margin. Moreover, trade liberalization may sometimes amplify rather than reduce the North-Middle income gap. Empirical results support these findings.