Adding-Up Problem and Wage-Productivity Gap in Exports of Developing Countries: A Source of the Middle-Income Trap

The possible causes of the middle-income trap phenomenon are diverse, and the difficulty in sustaining export growth, particularly in small open economies in the South (developing countries), can be one such cause. Exports from the South tend to be subject to the adding-up problem, which several studies have argued to happen because of the limited market size in the North (developed countries). The present study revisits the adding-up problem by dealing with diverse factors as determinants of export growth. It considers the following variables: undervaluation to represent the exchange rate effect, the top five trading partners' weighted GDP growth to represent the market demand effect, and wage-productivity gap to represent the price-cost effect. This research introduces this new variable of wage-productivity gap as a factor, and finds that the adding-up problem occurs not because of the limited market in the North but because of the wage-productivity gap (i.e., low productivity relative to the ever-increasing wage rates) in the South. Moreover, undervaluing currency does not significantly improve the aforementioned condition.