Economists call it the ‘middle-income trap,’ and they say that it happens on every continent. Unheralded and unwanted, it occurs after a newly industrialized economy such as South Africa, Brazil, or Thailand fails to rise above what the World Bank defines as the ‘middle-income range.’ At this point, such a country’s wage rates have become too high for it to compete against low-wage, low-income nations, and yet that country lacks sufficient innovation and highly skilled personnel to compete effectively against the highest tiers of knowledge-intensive products from Japan, Germany and the U.S. And so, such countries commonly suffer from low investment, slow growth, limited industrial diversification and poor labor market conditions.
Few countries are more concerned about this malady than Thailand, which has transformed itself over the past few decades from a low-income economy dominated by traditional agriculture into a significant player in electronics, automobiles and various agribusiness products. After Thailand’s per capita GDP rose from $682 in 1980, to $3,971 in 2002 and then $5,560 in 2012, the growth curve has flattened out, reaching $5,900 in 2016.
Most famous as a tourist-friendly, sun-drenched destination, Thailand ranks second in the world in the export of hard disk drives; sixth in the export of rubber tires; seventh in the export of computer devices; and 12th in automotive exports. One of the five largest petrochemical and biofuels producers in Asia, Thailand is blessed with a rich biodiversity comprising over 13,500 species of plants, enabling it to become the world’s second largest exporter of sugar (8.2 million tons/year), and biggest exporter of tapioca. It has also become a major producer of personal, homecare and hygiene products for such multinationals as P&G (U.S.), Beiersdorf (Germany) and Kao (Japan).
Yet despite all that progress, “Thai labor costs are not cheap and we are trapped in a middle-income sandwich,” says Bonggot Anuroj, deputy secretary general at The Board of Investment of Thailand. Because its wage rates have improved along with its standard of living, Thailand can no longer compete against such low-wage, low-income Asian producers as Cambodia, Laos, Myanmar and Vietnam. On the other hand, neither can Thailand compete against higher-wage Asian economies that are more innovative, such as Taiwan, South Korea and Japan.
How to escape that trap? The plan appears to be to make deep government investments and offer incentives in infrastructure and other areas in the hopes of luring in more foreign investment that can then help spark higher economic growth through innovation.
“If a country wants to position itself as a manufacturer of products, getting those goods out of the country into the market [at a competitive cost] is a necessary step.” Marshall Fisher
A few months ago, Thailand’s government announced a wide range of top-down initiatives — dubbed Thailand 4.0 — aimed at transforming the country from a middle-income nation into one that can compete against wealthier, more knowledge-based economies. Over its first five years alone, plans call for a combination of public and privately funded infrastructure initiatives costing about $45 billion, including sizable funding from China, where rising wage rates have priced many exporters out of low-margin products into such lower-wage countries as Vietnam and Bangladesh. But what are the goals, methods and inherent challenges of Thailand 4.0? How likely is the country to achieve the goals?
As elsewhere in Asia, international trade has played a growing role in the economy of Thailand. In 1977, Thailand’s export sector amounted to just 20% of GDP, according to the World Bank. However, in 2016 the value of Thailand’s exports of goods and services amounted to 68.9% of GDP compared with only 19.6% for China and 19.1% in India.
In an era when manufacturing has become increasingly globalized, “if a country wants to position itself as a manufacturer of products, getting those goods out of the country into the market [at a competitive cost] is a necessary step,” notes Marshall Fisher, Wharton professor of operations, information and decisions. In the case of Thailand, “it’s important because you want to get into the market quickly.”
How well has Thailand been doing that job? Fisher notes that Thailand ranks 45th in the world among the 160 countries on the World Bank’s Logistics Performance Index (LPI), or slightly higher than Chile and Greece. The LPI ranks the quality of a country’s logistics supply chain based on a survey of global freight companies.
Fisher sees clear parallels between the recent growth patterns of Thailand and China. However, “China’s GDP has gone up faster than Thailand’s and reached a higher level,” notes Fisher. “That’s forced China to abandon those manufacturing sectors where you need really cheap wages, and move into more sophisticated manufacturing, as Thailand is also trying to do.”
Fisher notes that it is critical for emerging markets like Thailand to raise the productivity of their transportation and logistics operations in order to further reduce the total cost of their exports. With that goal in mind, Thailand has been wise to locate many of its export-oriented factories and logistics facilities close to its largest port of Laem Chabang on the Gulf of Thailand, much as India has made the Bay of Bengal port of Chennai into a major hub of its trade because of its convenient access to ocean carriers and logistics services.
It’s no accident that the major global automakers that assemble vehicles in Thailand (including Ford, GM, Toyota and BMW) all operate their facilities within less than 100 miles of Laem Chabang port. The port already handles a higher volume of container traffic than any port in the United States except Los Angeles/Long Beach, but plans call for its capacity to double in coming years. It also became deep enough and wide enough to handle the most advanced post-Panamax vessels.
However, Thailand’s progress is impeded by major weaknesses, such as “the lack of infrastructure, a shortage of skilled workers, political uncertainty, piracy and counterfeiting,” said a report by the Santander TradePortal of Banco Santander. For his part, Arnupab Tadpitakkul, government affairs director at Ford Thailand, cautions that “the government infrastructure investments for roads, rail, and overall logistics as well as road maintenance needs to be coordinated, funded, and accelerated in order to alleviate the massive road congestion and logistics bottlenecks. This will enhance Thailand’s competitiveness with a lower logistics cost as a percent of GDP as well as tangible lasting infrastructure spending to boost economic activity.”
The Role of Incentives
The Thai government says it will boost inflows of foreign direct investment (FDI), which has been on the decline after reaching an all-time high of $15.5 billion in 2013. According to the UNCTAD World Investment Report 2017, FDI inflows into Thailand plunged to $1.55 billion in 2016 from $5.7 billion in 2015. “Despite the government’s seven-year strategy plan to stimulate investment, political uncertainty, increased by the death of King Bhumibol Adulyadej [in 2016], and a general decline in flows to developing Asian countries may result in a further decrease of FDI to Thailand in 2017,” said Santander TradePortal.
“The trap lies in competing by lowering taxes and other ways that the government recovers money from private capital.” –Philip Nichols
On the other hand, the report noted that Thailand’s strong points include its skilled workforce; its strategic location at the heart of Asia; a government policy that promotes investment and free trade; several government agencies to help investors; and an investment regime in total harmony with World Trade Organization regulations — no restrictions in the manufacturing sector, no local requirements nor export conditions.
By 2022, plans are to complete various transportation and logistics projects, largely on the Eastern Economic Corridor (EEC), southeast Bangkok. They include nearly $55 billion in spending for inter-city railways, highways, mass transit, airports and seaports. Apart from growth in its automotive trade, a growing percentage of Thailand’s manufacturing and global output are projected by officials to include consumer products, personal nutrition, specialty foods, organic produce and drinks and food safety services. Government investment incentives include eight years of tax exemptions for companies plus a 50% tax cut for five years and additional cost savings.
In the meantime, Thailand’s Board of Investment said it would divide investment opportunities in the EEC into the following: the digital economy, including robotics, and the bio-economy, including smart agriculture, and biomedical and biopharma goods. The fact that Thailand is putting so much importance on upgrading its food sector is not surprising, considering that “the food industry is a huge business for the United States” as well, notes Fisher.
Still, Thai officials and executives worry that the workforce may lack sufficient trained professionals to pull off the transformation of Thailand into a hotbed of innovation. Sampan Silapanad, general manager at Western Digital Thailand, says that Thailand is already competitive in such major sectors as electronics and automotive production “but we need to continue to promote new, advanced technology” such as products based on biotechnology and food technologies. All of the output from the Western Digital plant is exported, and the company has contractual obligations not to sell those products in Thailand.
Export volumes, meanwhile, have been flat over the past five years, and their dollar value has declined because of falling prices for its line-up of high-tech products, even as their quality and capacity has improved — as is typical for high-tech. Silapanad says he is optimistic that the Thailand 4.0 initiatives will yield significant benefits, but it is a “very big challenge” to raise the educational level of the country’s workforce. “We are working very hard on this, giving training programs. The Thai government is helping us, and we are helping the Thai government.”
“Corruption is rampant, courts are unreliable, and the political system is unpredictable to say the least.”— Philip Nichols
In autos, Ford’s Tadpitakkul agreed that “having a sufficient pool of trained local professionals [available] to meet the goals of Thailand 4.0 remains a challenge for Thailand. … In the short term, such deficiency can be alleviated through the government’s liberal scheme that allows easier movement of skilled labor from other countries, combining [it] with tax benefits and a longer duration of stay. The speed and progress at which the [Thai] government can implement all the key infrastructure projects, with a high priority placed for the Eastern Economic Corridor, will determine whether Thailand will solidify its status as ASEAN’s leading transportation and logistics hub for the region.”
A Second Kind of Trap
Nevertheless, Philip Nichols, professor of legal studies and business ethics at Wharton, questions the wisdom of Thailand’s government-led approach to jumpstarting development, which depends heavily on luring foreign investors with tax incentives. “Many emerging economies risk falling into a trap,” Nichols says. “These policies are, by definition, more interested in — and are more open to — foreign investment and other types of relationships.”
Given that the number of countries taking a similar approach is increasing, the result is more investment competition. “The trap lies in competing by lowering taxes and other ways that the government recovers money from private capital. If the government has little income, it cannot do the things that need to be done to create long-term social and economic growth, things like educating people, building infrastructure, supporting innovation, and so on.”
Nichols also warns that this approach to development “fails to acknowledge a real issue with respect to investing into Thailand: weak institutions. Corruption is rampant, courts are unreliable, and the political system is unpredictable to say the least.” That’s why investors who are serious about the long-term and seek durable investments pay attention to institutional strength; global bodies that promote real and durable investment thoroughly review and rate that type of institutional strength.
In the 2016 corruption ranking by Transparency International, Thailand ranked 101 out of 176 nations — tied with Gabon, Niger, Peru and the Philippines. The lower the rank, the lower the integrity standards of government institutions. The report also scored countries from zero (highly corrupt) to 100 (very clean). Thailand scored 35 points, which was lower than Indonesia (37) and India (40), and well behind Taiwan (61), Hong Kong (77) and Singapore (84).
As for Thailand’s strategic dependence on its geographic position within Asia, Nichols points out that “Thailand claims to be surrounded by the world’s economic powerhouses, [but] they seem to claim that these include countries like Laos and Cambodia. There are a lot of interesting things happening in Southeast Asia, and every country deserves respect, but I doubt that many observers would place Laos and Cambodia among the world’s economic powerhouses.”
Nichols adds that “people sometimes confuse growth with power. They are not the same thing. Southeast Asia is growing faster than the European Union, but it is nowhere near as powerful, and has nowhere near the same degree of structural integration nor infrastructural or institutional strength.”