Opinion | India’s premature tryst with the middle income trap?

Almost exactly a year ago, the Asian Development Bank (ADB) published a report, ‘Asia 2050: Realising the Asian Century.’ The multilateral lender presented two scenarios for 2050 – an affluent Asia producing half the world’s output or getting stuck in the “middle income trap.”

Most rapidly growing countries are susceptible to a loss of economic momentum or even stagnation after the middle income point. They are trapped in an impasse: they are no longer low-income, low-wage economies but have failed to make the transition to high-income, high-innovation economies. Growth tapers off. This is the middle income trap from which they need to quickly innovate themselves out of low productivity sectors like agriculture onto high productivity manufacturing and services.

The World Bank classifies India as a lower middle income country, with its gross domestic product per capita of just $3,200 (on purchasing power parity basis) as opposed to our upper middle class fellow BRICS, whose incomes average at around $10,000 per capita. However, the trap has plagued countries like Brazil, which have been stagnating at the upper middle class level for more than a decade.

Despite having similar growth levels until 1983, South Korea surpassed Brazil to graduate to a high-income status. South Korea managed a stellar transition from a labour-intensive economy to a skills and innovation economy, through investments in human capital and technology. Contrastingly, unable to sustain its high growth trajectory, Brazil grew at an average of only 1% per capita in the last 30 years. Mired in a mix of inflation and high interest rates, it was extremely difficult to pay off debts accumulated through imported technology on one hand, and coping with bureaucracy, protectionist industries, poor educational system and lack of innovation on the other.

In India’s case, the ADB report shows that if the country slows down to a per capita income of $17,800 – which should be in 20 years’ time considering the 2005-2010 growth trend – it will be in the middle income trap.

However, there is much speculation if India’s high growth trajectory of 8-9% will continue onto the next two decades. The economy grew at 5.3% last quarter, its slowest pace in a decade. While some economists argue that this may just be a cyclical low due to externalities from the troubled Euro zone, it could also be that actual growth trend is below that of high growth yesteryears. RBI governor, Duvvuri Subburao, recently estimated the 2012-2013 fiscal growth to be at 7.5%. However, Goldman Sachs estimates a growth trajectory of 6.3% for the rest of the decade.

Estimates show that more than 75% of the total middle class still belong to the lower middle class earning between $2 - $4 a day. With slower growth and second generation reforms on the backburner, the state will be more inclined to kowtow to demands for massive welfare schemes, like the National Rural Employment Guarantee Scheme (NREGS). While the intentions of the scheme are good, it costs a hefty $9 billion annually and is riddled with heavy corruption. Workers reportedly learn no new skills that could help them move to the manufacturing sector – a step closer to boosting incomes.

However, quite paradoxically, the government’s year-old New Manufacturing Policy aims to increase the share of GDP from manufacturing from 16% to 25% and add 100 million jobs by 2022. With the absence of a proper skills programme to link the NREGS to this policy, the good intentions could be cancelled out. Moreover, there are no signs of the modernising reforms needed to encourage a flexible labour market.

Unlike China, we still have time to capitalize on our young workers by investing in human capital, research and innovation, to boost our GDP levels with a stronger manufacturing and services base. However, with our unimpressive educational quality, and only 0.9% of GDP allocated to research and innovation, we could be at a danger of letting away that potential untapped. With the ongoing ‘policy paralysis,’ especially our vacillating stands on curtailing foreign investments to protect our industries, a low growth trajectory could very well invite a premature middle income trap.

Let us hope that we can strike while the iron is hot – because unlike the last-minute economic reforms of 1991 that led to the country’s economic turnaround, we can’t wait for things to get much worse and expect to get lucky again.

Hemal Shah is programme coordinator of economic studies at the Legatum Institute in London.