2017-08-18
J. Markauskas: Robust income growth in Lithuania – a goal, rather than a threat
In early August, the European Central Bank (ECB) published its commentary on the considerable economic progress in Lithuania, Latvia and Estonia. The analysis also presented challenges that could potentially hinder the Baltic States’ convergence towards the average per capita income of the old EU Member States.
Comment by Justinas Markauskas, Economist, Bank of Lithuania
The ECB’s assessment has sparked great interest in Lithuania, yet, unfortunately, it also led to misleading interpretations. The long-term challenge raised in the analysis – the ‘middle income trap’ – is not directly related to the formation of a middle class. The ECB’s assessment does not state that Lithuania may face economic hardship should formation of the middle class accelerate. On the contrary, a strong and broad middle class is the mainstay of a prosperous society.
The challenge of avoiding the ‘middle income trap’ actually entails that it might be difficult to maintain the current pace of robust income growth in Lithuania in the long run. If Lithuanian businesses continue to create production that generates low to medium value-added, their ability to compete on an international scale will diminish on the back of persisting robust wage growth. Hence, with Lithuania failing to adjust its economic structure, there will be a risk of gradual deceleration of income growth in the country long before it reaches the standard of living in advanced Western European countries.
International experience also suggests that the ‘middle income trap’ is a considerable challenge. According to the ECB’s assessment, out of 101 middle-income economies in 1960, only 13 had become high-income economies by 2008. Thus it is important to understand that even though Lithuania’s economy currently shows more rapid expansion, this does not automatically guarantee that without any structural reforms it will continue to grow at a steady rate until the standard of living in advanced Western European countries is reached.
So how could we avoid falling into the ‘middle income trap’? The ECB presents several possible solutions: encouraging strong institutions, seeking a low old age dependency ratio, fostering high investment share and diversifying trade and output. It is important that Lithuania competes in the international arena in terms of its innovations, not its low wages. Lithuania’s economy should be driven by sectors that yield high value added, for example, information technology, biomedicine, high value-added manufacturing, etc.
No one is suggesting that growth in wages or formation of a middle class is a bad thing. Rather the opposite – it is bad when growth in wages looses steam, which may be the case in Lithuania if we do not start to promote productivity, invest in education and create high-quality products and services.