India should be wary of middle income trap

Many economists believe that countries that grow from low-income to middle-income levels tend to get stuck in a trap that prevents them from graduating to high-income status. India runs the risk of getting caught in that trap. Mint explains the pitfalls in India’s path.

What is the middle-income trap?

World Bank defines a middle-income country as one with a gross national income (GNI) per capita of $1,000-12,000 in 2011 prices. Those below the $4,000 mark are “lower middle-income” countries, and those above it “upper middle-income” ones. The middle-income trap refers to the phenomenon where rapidly growing economies graduate to the middle-income tier but then stagnate. They get squeezed from below by intense competition from lower-cost competitors while failing to transition to high-income levels for a variety of reasons—especially a failure to build institutional, human and technological capital.

Which countries have escaped it?

In the history of development, the success stories of transformation to high-income status include Japan, South Korea, Portugal, Poland and Latvia. Countries such as Brazil, South Africa, Egypt, Thailand and Turkey also tried to develop but could not transition to the high-income level. These countries failed to develop and remain stuck below their potential. Argentina, Mexico, and Russia, meanwhile, have been trapped in the upper middle-income category for a long time. China, with a GNI per capita of around $9,800, is most likely on its way out of the middle-income trap—unless it stumbles.

How has India moved up the development ranks?

In 1960, India had a per capita income of $1,033 (in 2011 purchasing power parity terms). This was equivalent to 6% of the per capita income of the US. India attained lower middle-income status in 2008. By 2017-18, the country’s per capita income was $6,538—or 12% of the per capita income of the US.

Is India caught in the middle income trap?

Rathin Roy, a former member of Prime Minister Narendra Modi’s economic advisory council, has cautioned that India runs the risk of getting caught in the middle-income trap. According to him, the country’s growth has mostly been driven by demand generated by the richest 100 million Indians. However, as this demand cannot keep growing infinitely, a failure to broaden the income base—and, therefore, the demand base or the market size—could act as a growth barrier, resulting in India slipping into a middle-income trap.

Is India’s market too small?

Inequality is a barrier to the broadening of the demand base in an economy. Even at $2.7 trillion, India’s GDP is relatively small—it’s about the size of California’s GDP. China’s is over 4 times as large. The 2017 Economic Survey warned that four factors could hurt India: hyper-globalization repudiation, thwarted/impeded structural transformation, human capital regression due to technological progress, and climate change-induced agricultural stress.

Puja Mehra is a Delhi-based journalist