<mark>its impact on the productivity of private inputs, or indirectly by fostering private investment. Sustained rates of</mark> capital accumulation have indeed been a key feature of the experience of East Asian countries in the aftermath of the Second World War (see, for instance, Commission on Growth and Development (2008)). But over time, capital accumulation becomes subject to diminishing marginal effects. The growth benefits therefore get eroded over time.

_Exhaustion of cheap labor and imitation gains_ . During an initial phase of rapid development, low‐cost labor and imitation of foreign technology are critical to generate high growth. During that phase, countries can compete in international markets by producing labor‐intensive, low‐cost products using technologies imported from abroad. Large productivity gains can be achieved at first through a reallocation of labor from low‐productivity agriculture to higher productivity manufacturing. Because producers of nontraded goods must compete for labor with exporters, wages tend to increase, thereby contributing to expand the domestic market. However, once middle‐income status is reached, the pool of underemployed rural workers shrinks while wages continue to rise, thereby eroding competitiveness. Productivity gains from sectoral reallocation and technology catch‐up are eventually exhausted, while rising wages make labor‐intensive exports less competitive on world markets. The productivity slowdown translates into a growth slowdown.

_Poor quality of human capital._ Poor quality of human capital acts as a constraint on the ability to absorb more advanced foreign technologies and on the expansion of innovation activities, thereby preventing the productivity growth that may allow a country to sustain high levels of economic growth, after the gains from cheap labor and imitation are exhausted. The inability to improve the quality of the labor force as countries get closer to the world technology frontier is an important factor in understanding not only the emergence but also the persistence of middle‐income traps.

_Misallocation of talent._ Individuals with potential ability to be highly productive in innovation activities may end up working in sectors that are less beneficial in terms of growth, because wages there are higher or less uncertain. High wages in the financial sector, for instance, may induce individuals with highly technical skills, capable of doing very well in innovation‐based activities, to work in that sector instead. The issue therefore is the (sectoral) _distribution_ of human capital, rather than the accumulation of human capital _per se_ .

_Lack of access to advanced infrastructure_ . Advanced infrastructure, which consists of advanced information and communication technologies (ICTs) in general, and high‐speed communication networks in particular, is essential to increase productivity in production and innovation activities. Access to broadband, in particular, has been shown to facilitate the buildup of domestic and international knowledge networks, thereby promoting dissemination and research as well as innovation and growth. Conversely, lack of access to this type of infrastructure can be an important cause of a middle‐income trap.

_Finance constraints_ . Access to finance represents a major constraint on innovation and growth in developed and developing countries alike. A key reason for that is the inherent difficulty for firms engaged in innovation to resort to external finance. Without innovation, countries may be unable to move along the world production possibility frontier and engage in high‐productivity activities.

Early empirical evidence on these various causes emphasized the productivity slowdowns that occur after the exhaustion of gains from low‐cost labor and technological catch‐up (Eichengreen et al., 2012). In a more recent study, Lee (2018) found that countries that were successful in the transiting from middle‐income to high‐income status (as documented in Table 2.3) were able to maintain strong human capital, a high working‐age population ratio, the effective rule of law, low prices of investment goods, and high levels of high‐tech exports and patents. Those that were unable to make that transition, and ended up “stuck” in a middle‐income trap, faced unfavorable demographic, trade and technological factors, excessive investment expansion (which can be related to the diminishing marginal returns to capital alluded to earlier), hasty deregulation and hurried capital account opening.

35