85 percent, or 3 percentage points, of the absolute reduction in the growth rate of GDP per capita–and that the peak probability of a growth slowdown occurs when manufacturing accounts for about 23 percent of total employment in the economy.

A common explanation of growth slowdowns is based on a Lewis-type development process. In that perspective, factors and advantages that generate high growth during an initial phase of rapid development–low-cost labor and imitation of foreign technology–disappear when middle- and upper-middle-income levels are reached, thereby requiring new sources of growth to maintain sustained increases in per capita income. Indeed, during a first phase, low-income countries can compete in international markets by producing labor-intensive, low-cost products using technologies imported from abroad. These countries can achieve large productivity gains initially through a reallocation of labor from low-productivity agriculture to high-productivity manufacturing. However, once these countries reach middle-income levels, the pool of underemployed rural workers drains and wages begin to rise, thereby eroding competitiveness. Productivity growth from sectoral reallocation and technology catch-up are eventually exhausted, while rising wages make labor-intensive exports less competitive on world markets–precisely at the time when other low-income countries get themselves engaged in a phase of rapid growth. Put differently, growth slowdowns coincide with the point in the growth process where it is no longer possible to boost productivity by shifting additional workers from agriculture to industry and where the gains from importing foreign technology diminish.<sup>5</sup> This process is well supported by the evidence on productivity slowdowns provided by Eichengreen et al. (2011), as indicated earlier. It is also consistent with the results in Perez-Sebastian (2007), where imitation is the main source of productivity growth at early stages of development, whereas broadbased innovation–defined as the application of new ideas, technologies, or processes to productive activities–becomes the main engine of growth as the economy approaches the technology frontier.

The implication then is that to avoid falling into a middle-income trap, countries must address its root structural cause early on and find new ways to boost productivity. The main sources of higher productivity are a shift to high-value services and the promotion of home-grown innovation, rather than continuing to rely on imitation of foreign technology. Put differently, the key issue that needs to be addressed is how to switch from “imitation” activities to a broad-based innovation strategy.

This paper offers an alternative view on the cause of a middle-income trap. Although it fundamentally agrees on productivity slowdowns as being a source of these traps, it differs from the existing literature in terms of the reasons why productivity growth may be constrained, and what type of public policies can be implemented to promote a broad-based innovation strategy and escape a middle-income trap. We emphasize interactions between three determinants of productivity growth: individual

> 5A related consideration is that by specializing initially in low-skilled intensive activities, lowincome countries may have diminished incentives to invest in education–hence reducing the rate of accumulation of human capital needed to promote broad-based innovation.

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