MIDDLE INCOME TRAP – ECONOMY

MIDDLE INCOME TRAP – ECONOMY

NEWS: India is a middle income country despite being the world’s fifth-largest economy by nominal GDP, highlighting the issue of Middle-income Trap.

 

WHAT’S IN THE NEWS?

India is classified as a middle-income country despite being the world’s fifth-largest economy by nominal GDP, which underscores the challenge of the middle-income trap. This phenomenon refers to the situation where countries experience economic growth and achieve middle-income status but struggle to transition to high-income status due to structural and systemic barriers.

Key Points and Elaboration:

India’s Economic Aspirations

  • Current Status: India is currently the fifth-largest economy in the world by nominal GDP, but its per capita income remains low, placing it in the middle-income category.
  • Future Goals:
    • The Finance Ministry projects that India will become the third-largest economy globally, with a GDP of 5trillion in the next three years and 7 trillion by 2030.
    • By 2047, India aims to achieve a $30 trillion economy, coinciding with its centenary of independence.
  • NITI Aayog’s Vision: The government think tank, NITI Aayog, has outlined a roadmap called "Viksit Bharat @ 2047", which aims to elevate India to high-income status by 2047. This requires a ninefold increase in GDP (from the current 3.36trillion) and an eight fold rise in per capita income).

Structural Challenges

  • Manufacturing and Logistics: India needs to enhance its manufacturing capabilities and improve logistics infrastructure to compete globally.
  • Rural-Urban Divide: Bridging the income gap between rural and urban areas is critical for inclusive growth.
  • Energy Transition: Balancing energy security, affordability, and sustainability is essential for long-term growth.
  • Industrial Competitiveness: Transforming the agricultural workforce into an industrial one requires improving industrial competitiveness and creating higher-value jobs.

 

World Bank’s Income Classification

  • The World Bank classifies countries into four categories based on Gross National Income (GNI) per capita:
    1. Low-Income Countries (LICs): GNI per capita of $1,145 or less.
    2. Lower-Middle-Income Countries (LMICs): GNI per capita between 1,146and1,146and4,515.
    3. Upper-Middle-Income Countries (UMICs): GNI per capita between 4,516and4,516and14,005.
    4. High-Income Countries (HICs): GNI per capita of more than $14,005.
  • India currently falls into the lower-middle-income category.
  • The classification is updated annually on July 1 using the Atlas Method.

What is the Middle Income Trap?  

  • A Middle Income Trap occurs when a country that has successfully moved from low-income to middle-income status gets "stuck" and fails to transition to high-income status.  
    • According to the World Bank, this typically happens when a country reaches about 11% of US per capita income levels.  
    • At this point, countries find themselves in a challenging position: they become too expensive to compete with low-wage economies in manufacturing exports, yet lack the technological sophistication and innovation capabilities to compete with advanced economies. 
  • The trap manifests when traditional growth drivers begin to lose their effectiveness. Countries in this situation often face rising wages that make labor-intensive exports less competitive, while simultaneously struggling to develop the innovation and productivity levels needed for knowledge-based growth.  
    • To escape this trap, the World Bank recommends a "3i" approach: Investment in physical and human capital, Infusion of new global technologies, and fostering domestic Innovation capabilities.  
  • The challenge is significant - over the last 34 years, only 34 middle-income economies (defined as those with per capita incomes between $1,136 and $13,845) have successfully made the transition to high-income status, demonstrating how difficult it is to break free from this economic plateau. 

How has India's Income Level Evolved Over Time? 

  • 1950s-1970s (Post-Independence Era): India started with a per capita income of just ₹ 265 in 1950-51.  
    • The period saw slow growth at around 3.5%. Agriculture dominated the economy. Poverty rates remained high at about 45%.  
    • The period was marked by heavy state intervention, license raj, and emphasis on public sector enterprises. 
  • 1980s-1990s (Pre & Early Liberalization): Per capita income growth accelerated to 5.6% in the 1980s.  
    • The 1991 liberalization marked a pivotal shift, opening up the economy. Services sector began its rise, surpassing agriculture's share in GDP. 
    • The middle class started expanding. Foreign exchange reserves grew to USD 5.8 billion in 1991.  
  • 2000-2010 (High Growth Phase): India achieved its high growth phase with GDP growing at 8-9% annually.  
    • In terms of constant (1999-2000) prices, the per capita income was Rs 16,173 in 2000-01 and rose to Rs 24,295 by 2007-08. 
    • The services sector became dominant. Software service exports increased from US $0.50 million in 1990 to $5.9 billion in 2000-01 to 23.6 billion dollars in 2005-06  
  • 2010-2020 (Mixed Growth Phase): Growth became more volatile but averaged 6-7%. Per capita income reached ₹1,08,645 (2019-20, constant prices).  
    • Middle-class expanded significantly, with about 400 million people joining this segment.  
    • However, inequality widened - the top 1% owned 40.5% of national wealth by 2021. 
  • 2020-Present (Post-Covid Recovery): Despite Covid setback, India's GDP reached $3.75 trillion.  
    • Per capita income recovered to ₹1,72,000 (2022-23). However, K-shaped recovery is evident. 
    • Gig economy expanded with 7.7 million workers. Digital payments hit a record with Unified Payments Interface (UPI) processed ₹80.8 lakh crore ($964 billion) in April-July 2024, marking a 37% year-on-year increase. 
      • Unemployment remains at 8.1% (CMIE, April 2024). 

Middle-Income Countries (MICs)

  • Global Significance: MICs account for 75% of the world’s population and 66% of the world’s poor. They contribute one-third of global GDP and 40% of global economic output.
  • Transition Challenges: Over the past 34 years, only 34 middle-income economies have successfully transitioned to high-income status. Most of these were European Union members, along with countries like South Korea, Saudi Arabia, Latvia, and Bulgaria.
  • Middle-Income Trap: The World Development Report 2024 highlights that 108 countries, including major economies like China, Brazil, Türkiye, and India, are stuck in the middle-income trap. This trap occurs when countries fail to develop domestic innovation capabilities, leading to economic stagnation.

Factors Contributing to the Middle-Income Trap

  • Rising Labor Costs: As wages increase, industries reliant on cheap labor (e.g., textiles, manufacturing) relocate to lower-cost countries, leaving the economy without a new competitive edge.
  • Declining Competitiveness: A lack of investment in high-value industries (e.g., technology, advanced manufacturing) results in economic stagnation.
  • Insufficient Innovation: Without robust innovation ecosystems, countries fall behind in global competition.
  • Global Competition: Emerging economies like Vietnam, Bangladesh, and Indonesia are competing for the same low-cost manufacturing opportunities, intensifying pressure on India.

Challenges Faced by India

  • Low Investment in R&D: India’s spending on research and development (R&D) is significantly lower than that of high-income countries, limiting technological advancement and economic diversification.
  • Agriculture Dependence: A large portion of India’s population remains dependent on low-productivity agriculture, which contributes less to GDP compared to its share of employment.
  • Slow Wage Growth: According to the Periodic Labour Force Survey (PLFS), nominal wages for regular and casual workers grew by only 5% and 7%, respectively, in 2023-24. With inflation at 5%, this implies negligible real wage growth, reducing purchasing power and limiting economic mobility.
  • Global Competition: India faces stiff competition from other emerging economies in attracting foreign investment and expanding exports.

Way Forward

  • Innovation-Focused Strategy: A comprehensive strategy focused on innovation, technology adoption, and industrial diversification is essential to escape the middle-income trap.
  • Human Capital Investment: Investing in education and skills development is critical to creating a workforce capable of driving high-value industries.
  • Industrialization: Promoting high-value manufacturing and services (e.g., IT, pharmaceuticals, renewable energy) can help India move up the global value chain.
  • Infrastructure Development: Improving infrastructure in underdeveloped regions can reduce regional disparities and boost economic growth.
  • Sustainable Growth: Addressing challenges like ageing populations, geopolitical tensions, and environmental sustainability is crucial for long-term growth.

Broader Global Challenges

  • Middle-income countries face additional challenges such as:

·         Ageing Populations: Increasing dependency ratios and healthcare costs.

·         Geopolitical Frictions: Trade wars and supply chain disruptions.

·         Environmental Sustainability: The need to balance economic growth with environmental conservation.

Conclusion:

India’s ambition to become a $30 trillion economy by 2047 and achieve high-income status is achievable but requires addressing structural challenges like low innovation, agricultural dependence, and slow wage growth. By focusing on innovation, industrialization, human capital development, and infrastructure improvement, India can overcome the middle-income trap and achieve sustainable, inclusive growth.

Source: https://indianexpress.com/article/india/govt-marching-india-into-middle-income-trap-congress-9808322/