ASEAN faces a tighter middle-income trap

ASEAN faces a tighter middle-income trap

ASEAN economies, having just recovered from the COVID-19 recession, now face rising geopolitical risks and uncertainties around US tariff policies. These challenges have made the development path harder for the region’s export-oriented economies. The ‘middle-income trap’ — a long period of slow growth that has stalled countries like Malaysia, Thailand and the Philippines for decades — now seems even more difficult to escape.

According to the World Bank, it would be a ‘miracle’ if today’s middle-income economies like Indonesia and Vietnam could accomplish in 50 years what South Korea achieved in just 25.

The trap ASEAN economies fell into is a failure of industrial upgrading, partly due to the lack of home-grown manufacturing multinational corporations compared to Northeast Asian powers. This economic stagnation reflects deeper institutional weaknesses. Countries trapped at middle-income levels typically suffer from what Daron Acemoglu and James Robinson call ‘extractive institutions’ — systems where elites monopolise opportunities and resist the creative destruction necessary for innovation-driven growth.

Innovation, the driving force of sustained economic growth, inherently involves ‘creative destruction’, where new industries replace established ones. While technological innovation drives prosperity, it simultaneously renders certain sectors obsolete. Under authoritarian political systems, such creative destruction is less likely to occur due to resistance from entrenched interests.

Many Northeast and Southeast Asian countries initially achieved economic development under extractive institutions, often labelled ‘developmental states’ in the post-war period. Even South Korea and Taiwan were no exception. But their democratisation in the late 1980s coincided with the rise of South Korean companies like Samsung, LG and Hyundai as global multinational corporations, and the emergence of Taiwanese firms such as Quanta and ASUS as dominant global laptop manufacturers. In 1987, TSMC was founded as the world’s first dedicated semiconductor foundry and is now a dominant player in the global chip industry.

Expecting ASEAN to follow the same path is difficult. Dependence on foreign multinational corporations provided ASEAN countries quick access to global value chains, but left key decisions about deep technological learning in foreign hands. Unlike South Korea and Taiwan, which nurtured domestic champions, ASEAN countries mostly joined global production networks as hosts for foreign multinationals.

The window to build national manufacturing champions from scratch — like Samsung or TSMC — has closed. ASEAN’s strategy must focus on working with foreign multinational corporations to upgrade domestic industrial structures, while strengthening governance institutions and innovation ecosystems to capture more value within existing global value chains.

Recent developments show promising signs of indigenous innovation emerging through an alternative route in ASEAN. In Malaysia’s Penang state, several new manufacturing technology companies in factory automation and semiconductor inspection — including Greatech Technology and Vitrox Corp — have emerged. This represents a shift from the traditional dominance of government-linked and resource-based conglomerates in wealth rankings.

The emergence of high-tech local companies from ecosystems built by multinationals like Intel suggests a distinct ASEAN model of industrial upgrading. Beyond manufacturing, regional and global champions have also emerged since the 2010s — including Grab from Malaysia, Gojek from Indonesia and Agoda with roots in Thailand — all of which have grown into major service platforms.

Research suggests that the relationship between economic growth and civil liberties shifts from negative to positive at approximately 25 per cent of US income levels, where authoritarianism starts to hinder rather than help development. As of 2024, Thailand’s income level is at 28.8 per cent of US level, Malaysia has reached 45.1 per cent and Indonesia stands at 19.2 per cent. This suggests that for ASEAN’s major economies, democratic institutions become essential rather than optional for sustained growth.

But unlike the era when Taiwanese and South Korean companies experienced rapid growth, the United States no longer serves as a reliable anchor for export-led growth that it once was. In this new era, a more reliable path to innovation lies in developing robust domestic markets.

A more integrated ASEAN can function as a massive ‘domestic’ market of 680 million people and US$3.9 trillion in GDP, creating stable demand less vulnerable to external shocks. To achieve this, ASEAN should pursue more comprehensive economic integration through aggressive removal of non-tariff barriers, harmonised standards and regulations and enhanced logistics networks.

This drive must be paired with efforts to boost domestic demand within each member state. Narrowing urban–rural and income gaps is essential for creating a broad middle class with the purchasing power to drive consumption. Without this, it becomes difficult to form ‘upgrading coalitions’ of political interests advocating for institutional development. Reducing domestic income inequality serves dual purposes — expanding domestic markets and building the consensus needed for the reforms necessary for industrial upgrading.

Escaping the middle-income trap in ASEAN requires a coherent agenda to address institutional and innovation gaps. Institutions must be reformed by replacing ethnically or politically based preferential treatment with transparent, merit-based rules. Innovation ecosystems should be centred on effective university–industry linkages and credible intellectual property protection.

Foreign direct investment needs to be managed strategically to prioritise verifiable technology transfer and local research and development commitments. Regional integration should be deepened to expand effective market size, alongside inclusive growth policies to bridge urban–rural divides. These measures are mutually reinforcing. None of them will succeed without credible state capacity, policy coherence and sustained implementation.

Satoru Kumagai is Senior Research Fellow at the Institute of Developing Economies, Japan External Trade Organization (JETRO).

https://doi.org/10.59425/eabc.1757498400

Source: East Asia Forum