This paper analyzes the reasons for the middle income trap in Latin America, where countries have been at the middle income level for decades, and draws out lessons for Asia. The middle income trap captures a situation where a middle income country can no longer compete internationally in standardized, labor-intensive goods because wages are relatively too high, but it can also not compete in higher value added activities on a broad enough scale because productivity is relatively too low. The result is slow growth, stagnant or falling wages, and a growing informal economy. Insufficient development of domestic innovation capabilities is at the heart of the middle income trap. In Latin America, it is the result of a market-led strategy which generated dismal productivity growth, rapid de-industrialization, a decline in export sophistication in many countries, poor innovation performance, and underinvestment in the requisite social capabilities. The current globalization context provides a challenging context for middle income countries to narrow the capabilities gap, because they have less time to do so, with more players competing in the innovation space and technological innovation changing faster. A comprehensive innovation-focused strategy with strategic active policies is the only way to escape the middle income trap. The nature of the production structure, already existing elements of an innovation eco system, and the possibilities for creating political coalitions in support of a systemic advancement of innovation capabilities are critical factors conditioning the escape from the middle income trap.
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