Middle-Income Trap

The World Bank's annual thematic report, the World Development Report (WDR), has this year focused on the concept of the middle-income (MI) trap. The report states that it would take us nearly 75 years to set foot outside the threshold of the middle-income trap, our economy is currently embroiled in.

What is a Middle-Income Economy?

• Since 1987, the World Bank has classified economies into four income categories:
  • High income (HI)
  • Upper middle income
  • Lower middle income
  • Low income
• Over 35 years, the number of HI countries has doubled from 41 to 86, while low-income countries have decreased from 49 to 26.
• The number of MI countries, however, has increased from 74 to 108. As of 2022, HI countries make up 16% of the world population but account for 60% of global GDP.
• As of now, 108 countries are classified as middle-income economies,comprising 75% of the global population and contribute about 38% of global GDP.
• Distinctions between high-income-level countries to those of low/middle income countries.

What is Middle-Income Trap?

• A middle-income trap (MIT)is a situation in which middle-income countries are unable to transition to a high-income economy for a sustained period of time.
• In simple terms, the MI trap refers to a phenomenon where countries reach a certain GDP per capita threshold (about 11% of the U.S. GDP per capita) but struggle to progress to high-income status.
• Rapid growth, closely followed by a period of economic downturn, is indicative of an MIT.
• According to the WDR, only 34 economies have successfully made this transition in the last 35 years.
• India’s condition
  • India transitioned from a low-income to a lower-middle-income economy in 2007.
  • With a per capita income of $2,400 in 2022, India represents about 3.1% of U.S. per capita income ($76,590).
  • As of June 2024, India’s external debt reached $663.8 billion, a $39.7 billion increase from March 2023. The central government’s internal debt was estimated at approximately ?131 trillion, up from ?99 trillion in 2021.
• The systemic slowdown in economic growth characteristic of the MI trap has persisted since 1970, with middle-income countries failing to surpass one-tenth of the U.S. GDP per capita.
• Factors Keeping Countries in the MI Trap: Despite understanding the components necessary for a developed economy—like strong macroeconomic foundations and governance—many middle-income countries struggle to escape the MI trap.
• Research highlights several contributing factors, including:
• Volatile economic growth
• Slowing productivity
• Undervalued exchange rates
• Weakening institutions
• Difficulty in channeling technological innovations
• Reduction in labour participation
• Income inequalities
• As these countries transition from low to middle-income status, they often face diminishing returns on investment, hindering further growth.

What are the solutions to escape the MI Trap?

• The WDR suggests that middle-income countries need to adopt new strategies, termed the "three Is": investment, infusion, and innovation. This approach outlines two crucial transitions:
  • Investment and Infusion: Lower-middle-income countries should focus on investment while imitating and diffusing modern technologies.
  • Innovation: Upper-middle-income countries should integrate innovation into their growth strategies to become modern tech leaders.
• Japan and South Korea exemplify these transitions, initially licensing technologies from industry leaders before evolving into technology innovators. The report also cites Eastern European nations like Estonia, Poland, and Bulgaria, which have managed their transitions at different paces.

Lessons for India

• While the potential for development is high, India must acknowledge the challenges ahead. Currently, there is no clear policy roadmap to becoming a developed nation.
• The WDR emphasizes the need for humility and agility, as it could take India nearly 75 years to reach even a quarter of U.S. GDP at current trends.
• To break past the middle-income threshold, macroeconomic indicators like TFP (Total Factor Productivity), Gross national income (GNI), capital investments, and research and development (R&D) must be prioritised.