Can India Escape the Middle-Income Trap?

The middle-income trap refers to a theoretical economic development condition in which a country, after reaching a certain income level due to specific advantages, becomes stagnant at that middle-income stage and struggles to advance to a high-income status.

The World Bank defines the ‘middle-income range’ as countries with a gross national product (GNP) per capita between US$1,000 and US$12,000, measured at constant (2011) prices.

Recently released The World Development Report 2024 underscores the “middle-income trap,” where economic growth slows, causing nations to stagnate. Over a span of 34 years, only 34 middle-income countries have successfully transitioned to high-income status.

How does the World Bank define the threshold for middle-income economies?

• The World Bank classifies middle-income economies as those with per capita incomes between $1,136 and $13,845.
• The middle-income trap occurs when an economy’s growth slows upon reaching roughly 11% of U.S. per capita income.
• In the past 34 years, only 34 middle-income countries have successfully transitioned to high-income status, highlighting the challenge of overcoming this trap.

Key Highlights of the Report:

• Wealthy nations often experience a slowdown in growth when they reach around $8,000 per capita, or about 10% of U.S. GDP per capita. Since 1990, only 34 middle-income countries (MICs) have successfully transitioned to high-income status.
• By the end of 2023, 108 MICs account for 75% of the global population and contribute over 40% of global GDP.
• Key challenges for these nations include aging populations, increasing protectionism, and the need for accelerated energy transitions.
• India, classified as a Lower MIC since 2007, has a GNI per capita of $2,540 and, at the current growth rate, could take 75 years to reach one-quarter of U.S. income per capita.

Reasons for falling into middle income trap

Challenges Faced by Developing Nations: Middle-income countries often struggle to advance due to competition from low-wage economies and a lack of innovation, which hinders growth.
Structural Transition: Shifting from traditional sectors or growth drivers can lead to stagnation in per capita income, particularly if innovation capacities are insufficient.
Widening Income Inequality: Significant income disparities, marked by vast wealth gaps, limit consumer spending and impede overall economic development.

Reasons for India’s Susceptibility to Middle-Income Trap:

Increasing Protectionism

The rise in global protectionism may hinder India from reaping the benefits of hyper-globalization, unlike countries such as China, South Korea, and Japan.

Structural Transformation

India’s heavy reliance on agriculture (with 45-50% of the population engaged in it) and early deindustrialization impede the transition from primary to secondary and tertiary sectors.

State Control

Ongoing state intervention, including retrospective taxation and inconsistent policies, restricts the growth and investment potential of the private sector.

Human Capital Development

The quality of education and the employability of graduates fall below international benchmarks, with approximately 55% of graduates considered unemployable.

Climate Change

Frequent climate-related disasters and dependence on monsoon-dependent agriculture present significant challenges, depleting resources and affecting productivity.

Why is state intervention crucial for breaking the middle-income trap?

Importance of State Intervention

State intervention is essential for coordinating development goals, as demonstrated in South Korea and Chile, where governments actively shaped industries and aligned the private sector with national development objectives.

Role of the State

The state facilitates investment, incorporates global technologies, and fosters domestic innovation, which are crucial for modern economies. This approach is referred to as the 3i strategy (Investment, Infusion and Innovation).

Regulation of Local Elites

State intervention regulates local elites by ensuring that firms achieve success based on their performance rather than political connections. Underperforming firms are permitted to fail, which encourages efficiency and innovation.

Key Recommendations of the Report:

• Implement the 3I strategy (Investment, Infusion, Innovation).
• Foster business dynamism by incentivizing firms that create value.
• Ensure equal opportunities for women, minorities, and marginalized groups.
• Incorporate environmental costs into energy pricing to improve economic efficiency.
• The CEO of Niti Aayog stressed the importance of a comprehensive economic strategy to prevent falling into the middle-income trap, which he termed the “greatest threat” to India’s growth.
• The Niti Aayog CEO advocated for greater openness to free trade and integration with global value chains.
• The government should prioritize transforming urban areas into economic hubs, as this is essential for driving growth.

The End of the Blog: Can India Escape the Middle-Income Trap?