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Business News/ Opinion / Views/  Opinion | It’s still too early to worry about a middle-income trap

Opinion | It’s still too early to worry about a middle-income trap

For now, we are in the Nigeria zone and should confront reality if we are to do something about it

Over this period, India’s per capita income grew at an annual rate of about 5.6%. (Photo: Mint)Premium
Over this period, India’s per capita income grew at an annual rate of about 5.6%. (Photo: Mint)

The Indian economy is in deep trouble. Gross domestic product (GDP) growth for FY20 is likely to come in at 5%, an 11-year low. Nominal GDP growth will likely be at more than a four-decade low. Grim statistics abound. A debate about the nature of the slowdown, whether it is cyclical or structural, is ongoing. A bigger issue, however, occupies my mind. Does the public appreciate the full extent of India’s long-term economic challenges? Eminent economists and scholars are issuing regular warnings about the economy’s future. The clearest such warning has come from economists who argue that India is heading towards a middle-income trap. That is a purgatory in which middle-income countries languish as they are unable to catch up with wealthier nations. Frankly, India would be lucky to be close to the middle-income trap threshold. The reality, in my view, is far grimmer.

There is much academic literature about whether or not there is in fact a middle-income trap. For our purposes, we stick with the original intention behind the coining of this term. In 2006, economists Indermit Gill and Homi Kharas at the World Bank coined the term “middle-income trap" while working on growth strategies for East Asian economies. Simply put, low-income countries with cheap labour and access to ready-made technology grow fast and start becoming wealthier. However, as they reach middle-income status, they tend to slow down as they lose some of their advantages. They fail to converge with wealthier nations and do not get beyond middle-income status. Mexico and Brazil are classic examples of such countries. A few, such as South Korea, have escaped the trap. China is at the cusp.

Several eminent economists have warned that, without reforms, India is in danger of ending up in a middle-income trap.

Rathin Roy, a former member of the Prime Minister’s Economic Advisory Council, argued in an interview that India’s growth since the 1990s was on the back of consumption by the top 100 million Indians. He asserted that “India is heading, unless we do something about it in the next five years, towards a middle-income country…" He went on to suggest that “we will be a middle-income country" and “…in short, we will not be Korea, we will not be China, we will be Brazil, we will be South Africa".

Noopur Sen and Michael Walton at the Centre for Policy Research have added to this stark warning in a July 2019 paper. They argue that “…unless there is a comprehensive agenda of policy and institutional change to create a dynamic capitalism, there is a risk of a Latin Americanization of India’s path that will consolidate a middle-income trap of low productivity growth and entrenched inequality". In a 2015 paper by economists Maria A. Arias and Yi Wen at the Federal Reserve Bank of St. Louis, countries such as India received a grim warning: “…the cases in which low- or middle-income countries have successfully caught up to high-income countries have been few".

While these warnings are scary, India’s situation is worse. If India had any chance of getting to Brazil’s level or even South Africa’s in the foreseeable future, that would make for excellent progress. Economist Ajay Chhibber holds similar views and stresses the importance of getting out of India’s “policy muddle". I use the World Bank’s country income classification system to illustrate this point. This system separates countries into four categories—“low income", “lower middle-income" (India), “upper middle-income" (Brazil, South Africa, Mexico, China), and “high income" (US, Germany, Japan, Korea). Using 2018 data, the World Bank classified countries with gross national income (GNI) per capita of up to $1,025 (current dollars) as low income countries. Those with income per capita from $1,026 to $3,995 are lower middle-income. Countries between $3,995 and $12,375 are upper middle income. Per capita income above $12,375 makes a country high income. India’s per capita income in 2018 was $2,020, at the halfway point for the lower middle-income category.

The way the World Bank’s income classification system works is that as economies grow, the thresholds for these four categories also change. The threshold for the low-income category in 1988 was only $545. In 2018, the latest year for which data is available, it was $1,025. Overall, the lower and upper middle-income thresholds have increased at 2% per year over the last three decades. Over this period, India’s per capita income grew at an annual rate of about 5.6%.

If we assume that World Bank thresholds and India’s income per capita grow at the same pace as they have in the past 30 years, it will take India until 2038 to reach the lower end of the upper middle-income threshold. Similar data crunching reveals that even in 2050, India would be well below Brazil and South Africa. Korea and China would be in a different league altogether.

Well-intentioned as India’s middle-income trap warnings are, the reality is substantively bleaker. For now, India is in the Nigeria zone. This may shock some people, but that’s what the data shows. The important thing is to confront reality and then do something about it.

It is amply clear that countries do not uniformly go from low middle-income to upper middle-income status. Some even fall into low-income status. That is how brutal life can be in the field of development. Sustained economic growth is not automatic.

Salman Anees Soz is an author, commentator and vice-chairman of the All India Professionals’ Congress. These are the author’s personal views

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Published: 13 Jan 2020, 10:38 PM IST
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