The Narendra Modi government has set a goal to make India a developed country by 2047, the hundredth anniversary of India’s independence. For that, it has chalked out several short-term, mid-term and long-term plans. But India might run into a roadblock typical of fast-growing economies which aim at a high-income status: the middle income trap.
Niti Aayog CEO BVR Subrahmanyam has called the middle-income trap the biggest threat to India’s growth. “Do nothing, no strategy, and you will fall into the middle-income trap,” he said. The government and NITI Aayog need to work together to formulate an economic growth strategy to avoid such a trap, he said. India’s ambition to become the third-largest economy by 2026-27 necessitates a cohesive grand strategy including prioritising the resolution of the middle-income trap as a critical challenge to our long-term aspirations, he said.
What is the middle-income trap?
Since the World Bank introduced the term “middle-income trap” in 2006, it has become popular among policy makers and researchers. The middle-income trap occurs when countries fail to transition from middle to high-income status and get stuck due to stagnant growth, lack of innovation, and outdated economic models. The trap is defined by policy, income range and benchmarking against an advanced economy. The World Bank defines middle-income trap as “a trap of policy misdiagnosis when countries failed to match their growth strategies with prevailing structural characteristics of their economies”.The World Bank has identified two types of such traps. First is middle-income countries trying to sustain labor-intensive manufacturing export-led growth, despite the competitive disadvantage caused by higher wages, and the second is countries trying to leapfrog prematurely into knowledge economies, with none of the institutional infrastructure in place to accomplish that.
The World Bank defines high-income countries as those whose annual per capita income is more than $14,005. India has the potential and aims to be a high-income country by the centenary of its independence in 2047. India needs to strive to be a $30 trillion economy with a per capita income of $18,000 per annum by 2047, the approach paper by Niti Aayog for vision for Viksit Bharat in 2047 has said.
More than 100 countries, including India and China, are at risk of entering a middle-income trap and failing to become wealthy nations, a recent World Bank report has said. With these countries representing more than 75 percent of the world’s population currently classified as middle-income, tackling the issue will prove key for economic development in the decades ahead.
Since 1990, only 34 middle-income economies have managed to shift to high-income status—and more than a third of them were either beneficiaries of integration into the European Union, or of previously undiscovered oil.
How can India avoid the middle-income trap
As countries grow wealthier, they usually hit a trap at about 10 per cent of annual US GDP per person – the equivalent of $8,000 today. That’s in the middle of the range of what the World Bank classifies as middle-income countries. India may take nearly 75 years just to reach one-quarter of US income per capita, the World Bank report has said.
The road ahead has even stiffer challenges than those seen in the past: rapidly ageing populations and burgeoning debt, fierce geopolitical and trade frictions, and the growing difficulty of speeding up economic progress without fouling the environment, it said. “Yet many middle-income countries still use a playbook from the last century, relying mainly on policies designed to expand investment. That is like driving a car just in first gear and trying to make it go faster,” the report said. If they stick with the old playbook, most developing countries will lose the race to create reasonably prosperous societies by the middle of this century, said Indermit Gill, Chief Economist of the World Bank Group and Senior Vice President for Development Economics.
“First focus on investment; then add an emphasis on infusion of new technologies from abroad; and, finally, adopt a three-pronged strategy that balances investment, infusion, and innovation,” Gill said.
“The stage at which India is is probably the most critical,” Gill told ET in an interview last month. “It would have been easier if India had reached this stage 20- 30 years back. External environment has become harder for India now as compared with what it was 20 years back. Domestic environment, especially demography, is actually better today than it was 20 years back. India is domestically in some sense at its prime potential.”
“In order to avoid the middle-income trap, India needs to be more open to free trade and align itself with global value chains,” Niti Aayog CEO Subrahmanyam said, adding India needs to cut tariffs massively.
The pathway out of the trap, from historical experience, is free markets and tech adoption. Indian companies must grow much faster than they have and become technology innovators to offer jobs to the country’s workforce before it starts shrinking, ET has written. This involves freeing up factor markets for land, labour and capital at an accelerated pace. Alongside, the government must push investment, its own and the private sector’s. The nature of public sector investment should prioritise skilling as industrial demand for labour rises. This is broadly the playbook India has adopted, with limited success. Policymakers are aware of the window of opportunity presented by its demographic dividend, and, so, there is a sense of urgency in pushing the economy to take off during the next quarter-century. Technology transfer can be speeded up by plugging into global manufacturing value chains. An ecosystem for growth is being created through public infrastructure, both physical and digital, for small enterprises. But progress on land and labour reforms has been slow.
