Is Romania in the middle-income trap? Economists say it needs to invest in infrastructure and remove barriers to entrepreneurship to become a high-income nation

Romania is one of the best candidates for the “middle-income trap” category, according to many economists, who suggest middle-income countries need to invest in infrastructure and to remove barriers to entrepreneurship in order to become part of the high-income world.

According to a recent European Bank for Reconstruction and Development (EBRD) report, Central and Eastern European countries have become stuck in a “middle-income trap” and need new growth strategies and infrastructure to kick off again.

“Many of those countries have now reached middle-income status and have to overcome the problem of the ‘middle-income trap’,” EBRD Chief Economist Sergei Guriev said, cited by Reuters.

The EBRD called for new economic models, focusing on improving productivity of individual firms, expanding infrastructure and green growth.

The trap is common phenomenon for developing countries, and Romania is seen by many economists as a good example for it.

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A World Bank study shows that some former middle-income countries have succeeded to become high-income countries during the last two decades, while others – like Romania – did not.

“In comparing new high-income countries (Chile, the Czech Republic, Hungary, the Republic of Korea, Poland, and the Slovak Republic) with trapped middle-income countries (Brazil, Mexico, Romania, and Turkey), the study found that while in the late 1990s these countries were fairly similar in many aspects, by 2015 barriers to entrepreneurship, trade, and investment were much lower in the new high-income countries, which also had lower perceived economic and political risk,” the study said.

Historic trap

Romania is considered a middle-income nation since 1962 and has remained in this category for more than five decades.

In a study made in 2012, the World Bank found that out of 101 economies ranked in the middle-income category in the 1960s, only 13 managed to become developed countries by 2008: Equatorial Guinea, Greece, Hong Kong, Ireland, Israel, Japan, Mauritius, Portugal, Puerto Rico, South Korea, Singapore, Spain and Taiwan.

CEB countries and Romania have a high percentage of industries with low productivity (relative to Germany) and a low percentage of industries with high productivity

Another study, conducted by Robertson and Ye in 2013, sets up a table of middle-income countries (middle 40 percent ranked by income in purchasing power parity (PPP) in USD).

According to their study, in 2007 there were 46 middle-income countries out of 189 countries in total, and 19 out of these 46 countries are stuck in the trap.

The countries stuck in the middle-income trap according to this definition were the following: Botswana, Bulgaria, Costa Rica, El Salvador, Guatemala, Honduras, Iran, Iraq, Jordan, Lebanon, Mexico, Peru, Panama, Romania, South Africa, Syria, Thailand, Tunisia, and Turkey.

Some economist have countered that the middle-income trap is a myth, but the fact remains that it is difficult for middle-income nations to progress towards high-income status.

According to many experts, the quality of the infrastructure could play a key role for development.

Romania ranked 128th out of 138 for its road infrastructure in the World Economic Forum Global Competitiveness Report, while its out-dated railway system was only moderately better ranked at 79.

Across the Central and Eastern European region, nearly 10 percent of firms cite poor transport infrastructure as a major challenge that has a daily impact on their businesses.

Barriers

Romania has also another major obstacle to become a developed nation: oversized, low productivity state-owned enterprises sector and large barriers to entrepreneurship.

The Romanian government has imposed barriers to employment in many sectors.

A recent article in the press showed that working as a DJ in Romania requires a DJ diploma sold for RON 1,000 (EUR 215) by some companies in exchange for “DJ lessons”.

For many experts, labour market reform is urgent in Romania to support employment.

“Without labour market reform to improve labour force participation which stands at 66.3 percent (in Romania), one of the lowest in Europe, pressure will remain to the upside for salaries and is likely to limit growth,” a recent ING Bank report said.

High-income status

However, Romania is about to become part of the “high income” world this year, as its gross national income (GNI) per capita reaches the threshold set by the Word Bank for this status, despite the large differences in terms of development between it and the Western world.

According to the latest definitions by the World Bank, low-income economies (a politically correct name for “the third world”) are defined as those with a GNI per capita, calculated using the World Bank Atlas method, of USD 1,005 or less in 2016, lower middle-income economies – between USD 1,006 and USD 3,955, upper middle-income economies – between USD 3,956 and USD 2,235, and high-income economies – USD 12,236 or more.

In 2016, Romania, with a GNI per capita of USD 9,480 calculated using the World Bank Atlas method, was classified as an “upper middle-income economy”.

Last year, due to its impressive economic growth rate of 6.9 percent, the highest in the European Union, Romania’s gross domestic product (GDP) reached a level of RON 858.3 billion, the equivalent of EUR 187.9 billion (around EUR 9,600 per capita) or USD 211.8 billion (USD 10,800 per capita), according to Business Review calculations based on official data.

However, experts say Romania still lags behind not only the rich Western countries, but also most other new Eastern members of the EU.

“Currently, Romania has a 7-10 year development lag over other Central and Eastern European countries like Poland, Slovakia, Hungary, or the Czech Republic (i.e. it needs 7-10 years to reach their current development level) and a 35-year development lag over OECD counties (i.e. it took OECD countries 35 years to develop from Romania’s current development level to their current development level),” the report “Magnet Cities: Migration and Commuting in Romania” recently released by the World Bank points out.