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Peter Warr
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Desc Peter Warr is John Crawford Professor of Agricultural Economics, emeritus in the Arndt-Corden Department of Economics, Crawford School of Economics and Government and Executive Director of the National Thai Studies Centre at ANU


Org National Thai Studies Centre

2011 12 18 Publish: Thailand, a nation caught in the middle-income trap

Thailand is caught in a middle-income trap of its own creation. How did this come about? Are current policies making it better or worse, and what needs to be done to escape the trap?

The ‘middle-income trap’ is an empirical generalisation based mainly on East and Southeast Asian experience: once a country reaches middle-income levels the growth rate often declines and graduation from middle-income to higher-income levels stalls

During the decade of economic boom ending in 1997 Thailand’s average annual growth rate of real GDP per person was a remarkable 8.4 per cent. Like most booms, this one ended badly. It collapsed with the Asian Financial Crisis of 1997-99. Since 2000 the corresponding growth rate has been 4.1 per cent. The immediate culprit was a contraction of private investment, which declined as a proportion of GDP from an average of 30 per cent to 18 per cent over the same two periods. The effect of lower investment was twofold: it reduced aggregate demand, lowering income in the short run; and it reduced the rate of capital formation, lowering long-run growth prospects

A decline in this investment ratio occurred in all of the crisis-affected Asian economies, including Indonesia, Malaysia, the Philippines and South Korea. The decline in Thailand was one of the largest. The contraction of investment occurred primarily among Thai-owned, rather than foreign-owned, firms. Put simply, after the crisis Thai firms became less confident about their prospects and hence less inclined to invest. An expectation of this kind is self-fulfilling. It reduces investment, which does indeed ensure that growth will be lower

Beneath these short-term macroeconomic events lies a deeper and longer-term phenomenon. Between the 1960s and 1990s Thailand achieved the transition from a poor, heavily rural backwater to a middle-income, semi-industrialised and globalised economy. The transition was primarily market-driven and the central policy imperative was to avoid those policies that impeded absorption of low-cost labour into export-oriented labour-intensive manufacturing and services. This transition required some elementary market-supporting policy reforms: promoting a stable business environment (not necessarily meaning stable politics); open policies with respect to international trade and foreign investment; and public provision of basic physical infrastructure, including roads, ports, reliable electricity supplies, telecommunications and policing sufficient to protect the physical assets created by business investment

This transition has now occurred in most of East and Southeast Asia and the pattern was similar in all countries that undertook the basic policy reforms listed above. During this transition average real incomes rose significantly, the share of the workforce employed in agriculture contracted and the incidence of absolute poverty fell

The core of this growth process is expansion of the physical capital stock, resting overwhelmingly on private investment. The private financial system facilitates the link between private savings and business investment. But the process is self-limiting. As labour moves from low-productivity agriculture to more rewarding alternatives elsewhere, wages are eventually driven up. As wages rise, the profitability of labour-intensive development declines. As the return to investment in physical capital falls, the rate of private investment slackens and growth slows

The frontier for further expansion of labour-intensive export-oriented development soon moves to other, lower-wage countries. The result is the dreaded ‘middle-income trap’. This describes Thailand and Malaysia today and China in the very near future

Progress from middle-income to higher-income levels requires a different kind of policy reform, addressing a market failure that the private financial system cannot resolve: the undersupply of human capital. Human capital is a crucial input, created primarily by investment in education, broadly defined. But it differs from physical capital in that it does not provide the collateral that can ensure repayment of loans. Unlike physical assets, human beings can walk away. The private financial system is therefore unable to support investment in human capital. Individual families can and do invest heavily in the education of their own children, but because their resources are limited and because the recipient of the educational investment reaps only part of the returns it generates this is insufficient to prevent the overall underinvestment in human capital

Increasing the supply of human capital is central to overcoming the middle-income trap. It raises labour productivity directly and raises the return to physical capital, encouraging greater investment in physical capital as well. In Thailand, as in many other middle-income countries, the problem lies in the quality of education and not just the bare numbers of total school enrolments. And the problem is primarily not at the tertiary level but at the primary and secondary levels. Massive public investment and reform of the education curriculum is needed to redress these problems, requiring the raising of sufficient tax revenue to finance it and combating the backward and self-serving practices of the ministry of Education and the teachers’ unions. These are formidable obstacles

During Thailand’s boom almost everyone gained, including the poor, though not all at the same rate. Economic expectations rose, even among groups like lower-income rural people, who previously benefited only marginally from economic growth. But when the boom collapsed in July 1997, the new opportunities vanished and the newly-expanded expectations were crushed. A sense of economic and political injustice, latent for decades, then became more acute. For large numbers of people redistributive politics then became more appealing as a focus for their anger and as a vehicle for collective economic advancement. Opportunities arose for political entrepreneurs who could mobilise the frustration and use it to capture power

Enter Thaksin Shinawatra. He had made a fortune by exploiting government-granted concessions in the telecommunications industry and had been a deputy prime minister under two conservative governments in the 1990s. But around the year 2000 Thaksin saw the political opportunity created by the frustrated expectations of many low- and middle-income people, especially those in the predominantly rural north and northeast regions. He articulated the discontent felt by these people and offered hope. According to his new rhetoric, Thailand’s problem was not a flawed macroeconomic strategy that had strangled growth, but injustice inflicted on ‘the people’ by their fellow Thais, ‘the elite’. Thaksin would look after them. This was standard Latin American-style populism and it worked. Thaksin’s new party won an unprecedented election victory in 2001 and repeated the achievement in 2005

What is wrong with that? At one level, it is simply democracy in action. But a problem remains, in that Thaksin’s populism fails to address the sources of the middle-income trap and distracts attention from it. The policy platform successfully taken to the 2011 elections by the Pheu Thai Party, led by Thaksin’s sister and in absentia by Thaksin himself, illustrates this point. There were two economic components: capital-intensive mega-projects and redistributive initiatives, each designed to attract new sources of political support

Each of the mega-projects appealed to a significant segment of the population and, like all large construction projects in Thailand, offered the prospect of huge kickbacks for politicians, bureaucrats and others. The redistributive initiatives were similarly designed to appeal to specifically targeted groups. They included a three- to five-year debt moratorium for people owing 500,000 to 1 million baht; a 10 million baht minimum revenue guarantee for local administrative organisations; a farmers’ credit card project, backed by the government; a 15,000 baht per month minimum salary guarantee for bachelor’s degree graduates; a 1 billion baht education fund for state and private universities; a tax-cut for first-home buyers and another for first-car buyers; free wi-fi in public areas; a guaranteed price of 15,000 baht per tonne for unmilled rice; and an increase in the minimum wage to 300 baht per day

Aside from the problem of paying for these initiatives, the important point is what the policy did not contain: anything about reforming Thailand’s antiquated systems of primary and secondary education, the single greatest impediment to long-term economic progress in the country; anything else about raising the long-term productivity of Thailand’s masses of unskilled and semi-skilled workers; anything about reforming the country’s regressive and inadequate tax system; or anything about reducing corruption

Thailand’s version of economic populism wastes public revenue, feeds corruption, ignores the sources of long-term improvements in human productivity and diverts attention from them. Until this changes the jaws of the middle-income trap will surely remain closed

2014 09 22 Publish: Why Thailand must decentralise

Bangkok’s iconic Democracy Monument is currently fenced off. A large, hand-written sign reads ‘closed for renovation’. In April the monument was damaged by shots fired at protesters demonstrating against the Pheu Thai government of Yingluck Shinawatra. At least three protesters died

On 22 May a military coup claimed power, for the 12th time since the 1930s. Yet again, a familiar cycle has been acted out: a military government gives way to a democratic opening, there are violent protests against the elected government, the military stages a coup to ‘restore order’, an authoritarian military government promises ‘reform’ and a later return to democracy, and so on

Thai democracy is seemingly unstable, but why? Successive Thai governments have been known for their corruption and protests against the allegedly high level of corruption within the Pheu Thai government was a focus for at least some of the popular movement against it

Corruption wastes public resources, contributes to inequality and is an important source of public discontent. Reducing it is clearly desirable. But although corruption is a problem, it is not the problem. The focus on this one issue misses a key feature of Thailand’s political instability - its regional nature

The Pheu Thai party of Thaksin Shinawatra and his followers derives its strength from the rural-based North and Northeast regions of the country, where it has won huge majorities in every election this century. Pheu Thai has never won an election in Bangkok and its support in the South is only slight, where the opposition Democrat Party wins most elections and minor parties win the rest. But the population and parliamentary representation of the North and Northeast regions are so large that Pheu Thai’s popularity there is sufficient to capture government at the national level.

During the Democrat Party government led by Abhisit Vejjajiva, from 2008 to 2011, protests by the ‘Red Shirt’ supporters of Pheu Thai were primarily people who either normally resided in the North or Northeast, or whose families had recently relocated from there

During the more recent anti-Pheu Thai protests, led by former Democrat Party deputy prime minister and leader of the People’s Democratic Reform Committee Suthep Thaugsuban, the demonstrators were overwhelmingly from Bangkok and the South

For countries of its size, the Thai state is one of the most centralised in the world. There are 76 provinces and the governors of all but one - Bangkok - are appointed by the central government’s Ministry of Interior. The provincial government’s powers and revenues are modest and derive from the central government. Beneath the provincial level, local governments are elected, but their meager resources are directly dependent on the central government

Thailand’s major problem is the incompatibility of a regionally divided populace and a highly centralised government. It is not exaggerating too much to say that attaining government at the national level is a winner-takes-all victory for either the North-Northeast coalition or for Bangkok and the South. Only one long-term solution is seemingly possible - political decentralisation to empower and democratise regional governments. Thailand needs more democracy, not less

At the end of the 20th century, Indonesia was hardly a promising candidate for a successful democracy. Decades of highly centralised, authoritarian government under President Soeharto had ended with collapse of the government under violent street protests. But something remarkable subsequently happened. A radical decentralisation was implemented. Some say it was too radical, but Indonesia’s democracy is now the success story of Southeast Asia. The country has now experienced a most unusual event: the loser in a presidential election has grudgingly accepted defeat and walked away

Indonesia’s decentralisation did not remove corruption. It probably increased it, as checks and balances have been undermined by the huge task of monitoring disbursement of funds at the regional level. But the contest for control of the central government is no longer the sole political struggle. Regions not close to the central government’s ruling elite can still exercise a substantial degree of autonomy, with considerable resources at their disposal

Significant decentralisation is not included in the Thai military government’s understanding of ‘reform’. The policy package being proposed apparently contains no such measures. It may be too much to hope that a group of command-and-control generals could implement a decentralisation of power, even if they wanted to. They are doing the opposite. The budget allocated to local governments has been halved, on the grounds that local government is too corrupt

When the generals relinquish power and restore electoral democracy, as they must, more of the same seems probable: regionally-based conflict that an overly centralised system of government cannot resolve, except through repression

2019 01 14 Publish: Thai prosperity depends on smarter education reform

Thailand is in temporary limbo. The current government, which came to office in May 2014 via the country’s 12th military coup, has promised elections in February 2019. The Thai people wait in uncertainty for the outcome. Many major economic decisions, both private and public, remain on hold

Thailand’s economy is the eighth largest in Asia and the second largest in Southeast Asia, after Indonesia. During 2018, the Thai economy grew moderately at just under 4 per cent in real terms, about the same as in 2017, and GDP per capita reached just under US$7000

The Thai economy is heavily export-dependent, with gross exports accounting for two-thirds of GDP. Economic performance is thus dependent on global economic activity, especially in the major markets of China, Japan, the United States and Europe. Exports are dominated by manufactured goods such as electronics, vehicles, machinery and foodstuffs

Private investment, the most volatile component of aggregate demand, is driven by business expectations regarding domestic stability and export demand. Both remain highly uncertain

The upcoming election could produce a stable political outcome, restoring business confidence and promoting growth, but it could also bring a return to the political turmoil of the pre-coup decade

Bans on political activity and restrictions on press freedom were instituted by the military government following the 2014 coup. These bans are only now being relaxed in the lead-up to the election. The lack of open political discussion during the tenure of the military government has contributed to the uncertainty about Thailand’s future

Export demand is threatened by global events over which Thailand has no control. The possibility of an escalating US–China trade war is especially concerning because Thailand’s manufactured exports are enmeshed in complex production networks that involve both China and the United States. The country’s short-term economic prospects are sufficiently worrying that private investment remains at around a quarter of GDP, not enough to raise growth above 4 per cent

On the other hand, Thailand’s long-term future depends on factors that are very much within the country’s control. Although the coup leaders promised to ‘restore happiness’ to the Thai people, the junta’s reform agenda does little to address the country’s long-term economic problem - its archaic and ineffective public education system

For decades, successive Thai governments of all persuasions have attempted to reform the education system. But these attempts have been successfully blocked by the Ministry of Education and teachers’ unions. The result is poor standards of literacy and numeracy among young Thai people, leaving them ill-equipped to provide the skilled workforce that an industrialising economy requires

Consider Thailand’s manufacturing export industries and in particular the automotive industry. Exports of both vehicles and automotive parts have grown impressively. But the automotive industry is largely foreign-owned, especially in the final assembly stage, which consists almost entirely of Japanese firms. All design and major managerial decisions occur in Japan. According to the manufacturers, their main difficulty in upgrading their activities within Thailand is the lack of an educated workforce that can readily be trained to a high level of skill

The proliferation of private schools is another manifestation of education failure. For middle-class Thais who can afford them, private schools provide an escape from the failures of the public school system. Private schooling is a thriving business. One such school, a Singapore-based for-profit enterprise, was recently listed on the Thai stock exchange - the first such listing for a private school. This is perfectly legal in Thailand, but it is not the solution to the country’s education problems because so few Thais can afford to attend

For most Thais, the result of an inadequate public education is a lifetime of unskilled or semi-skilled employment, dooming them to the lower rungs of the economic ladder. For the country, the result is the much-quoted but little-understood ‘middle-income trap’

The experience of many developing countries, including Thailand, is that a development strategy relying on cheap labour and a business-friendly economic environment has elevated them to middle-income levels, virtually eliminating mass poverty in the process

These are commendable achievements. The economic growth that underlies them is based on private investment in physical capital, supported by an efficient financial system and public investment in complementary physical infrastructure such as roads, ports, electricity supplies and law enforcement. But this process cannot get countries from middle-income to high-income levels

Typically, as a country reaches middle-income levels, growth rates steadily decline as low productivity labour is absorbed. Upgrading beyond cheap-labour manufacturing and services requires upgrading skills, which in turn requires massive investment in human capital. The private financial system cannot finance that form of investment because unlike investment in physical capital, investment in human capital does not produce an asset that can be used as legal collateral

The tenure of the military government could have been used as an opportunity to address this fundamental development problem. Tragically, education reform was ignored. It remains to be seen whether the restoration of democracy can produce a better outcome