The middle-income trap4 min read . Updated: 02 Jul 2011, 01:37 PM IST
The middle-income trap
The middle-income trap
Achild born just before the 1991 economic reforms is likely to retire in an India where living standards are on par with those seen in Europe today.
Average income in India in 2050 will be around $41,700 based on purchasing-power parity or a little less than half of average incomes in the US, according to a new study by the Asian Development Bank (ADB). Right now, US incomes are about 15 times those in India. Sustained economic growth over the next four decades would help India close the income gap with the rich countries of today.
Also See | Asia And India In 2050 (PDF)
The big question is whether India can indeed continue to expand its economy rapidly over the next four decades. Too many countries have taken off the blocks with gusto, but were then left panting on the track. Latin American countries such as Brazil and Argentina were among those that lost their way; Brazil was as rich as South Korea in the mid-1980s, but has since been outpaced by the East Asian nation.
Also Read | Niranjan Rajadhyaksha’s previous columns
ADB has done well to avoid Asian triumphalism and the view that a sustained economic boom is written into our destiny. It has alerted policymakers about the risk of falling into the “middle-income trap", as economic growth tapers off in the next five or 10 years. High growth in the initial years is relatively easy because a young population and high investment rates allow a country to put more resources to use. Trade and investment flows allow poor countries to access the best technology and move closer to the global productivity frontier. However, at some point of time, innovation rather than inputs has to become the main driver of growth. Many countries fail to make the switch and land in the middle-income trap.
Economist Barry Eichengreen and his colleagues recently published a provocative paper in which they argued, based on data starting from 1957, that economic growth slows by around 2 percentage points once per capita income reaches $17,000 a year. They add that China will be at that income level by 2015.
Eichengreen and his co-authors identify two main forces at work. Both weigh down on productivity growth. One, the potential to keep shifting people from low-productivity agriculture to high-productivity manufacturing keeps diminishing. Two, the gains from importing technology run their course. A fall in the proportion of workers to total population as part of an inevitable demographic transition also plays a part.
The economists also point out that countries with undervalued exchange rate are more likely to be hit by such growth slowdowns. Why? “It may be that real undervaluation works as a mechanism for boosting growth during the early stages of development when a country relies on shifting labour from agriculture to export-oriented manufacturing, but not in subsequent stages when growth becomes more innovation-intensive, but governments are reluctant to abandon the earlier policy strategy, leaving the economy increasingly susceptible to slowing down," the Eichengreen paper says.
Taking an annual per capita income of $17,000 as a benchmark, it would seem that India has at least another 20 years before it is hit by a growth slowdown. A younger population and a fairly valued exchange rate could also help. In fact, the recent Chinese census data suggests that the working-age population in China has already peaked. Those are some of the reasons why several forecasts about how India will grow faster than China after 2015 seem realistic.
But it would be foolish to either wish away the proven ability of the Chinese government to adapt to new challenges or to believe that India will also face similar problems at some point of time. Sustained growth will also have to overcome other roadblocks such as rising inequality, lack of skilled labour, chaotic urbanization and broader issues such as social stability, climate change and pressure on natural resources.
Just consider the current set of problems. The finance ministry had raised hopes about sustained double-digit growth in 2009, both in the budget speech and in the Economic Survey. Policymakers are now busy snipping around 2 percentage points off that target, at least for the current fiscal year. But they also need to ask whether India can sustain double-digit growth without sparking off double-digit inflation. The evidence is not encouraging. Two percentage points may not be a big deal if it is a cyclical setback; but a secular drop in the growth rate could mean a lot when compounded over several decades, something this column has pointed out earlier as well.
Let’s get back to the ADB study. Two scenarios are considered—an optimistic one (called the Asian century) and a more sober one (the middle-income trap). Look at what a huge difference it can make to the life of the average Indian if we fail to sustain growth and end up in a trap.
Niranjan Rajadhyaksha is executive editor of Mint.
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