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Middle Income Trap

  • Category
    Economy
  • Published
    31st Dec, 2019

Many economists have cautioned that India runs the risk of getting caught in the middle-income trap.

Context

Many economists have cautioned that India runs the risk of getting caught in the middle-income trap.

About

  • Middle income trap: The middle income trap is a theoretical economic development situation in which a country that attains a certain income (due to given advantages) gets stuck at that level. The Middle income countries are not able to move up to the Higher income status due to operation of several adverse factors:
    • A country in the middle income trap has lost its competitive edge in the export of manufactured goods because of rising wages.
    • Also, it is unable to keep up with more developed economies in the high-value-added market.
    • There is failure to build institutional, human and technological capital.
  • Middle-income range: World Bank defines a middle-income country as one with a gross national income (GNI) per capita of $1,000-12,000 at constant 2011 prices.

Case of different countries:

  • Countries that escaped it: Japan, South Korea, Portugal, Poland and Latvia are success stories of transformation to high-income status.
  • South Africa and Brazil: Newly industrialised economies such as South Africa and Brazil have not, for decades, left what the World Bank defines as the 'middle-income range'. They suffer from low investment, slow growth in secondary industry, limited industrial diversification and poor labour market conditions.
  • 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 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.

Case of India

  • Lower middle income country: In 1960, India had a per capita income of $1,033 (in 2011 purchasing power parity terms). This was equivalent to 6% of per capita income of US. India attained lower middle-income status in 2008. By 2017-18, India’s per capita income was $6,538—or 12% of US per capita income.
  • Critics: Critics have cautioned that India runs the risk of getting caught in the middle-income trap. It has been argued that India’s growth has mostly been driven by demand generated by few. India does not have broad income base, and this narrow demand base/market size could act as a growth barrier, resulting in India slipping into a middle-income trap.
    • Even if India reaches $5 trillion in GDP by 2024-25 — Government of India’s objective — it will still be a lower middle-income country.
  • Factors that can hurt India’s growth: 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.
    • Climate change-induced agricultural stress.

How to avoid Middle income trap?

  • New process and markets: Avoiding the middle income trap entails identifying strategies to introduce new processes and find new markets to maintain export growth.
  • Domestic demand: Ramping up domestic demand is also important—an expanding middle class can use its increasing purchasing power to buy high-quality, innovative products and help drive growth.
    • Inequality is a barrier to the broadening of the demand base in an economy.
  • Innovation: The biggest challenge is moving from resource-driven growth that is dependent on cheap labour and capital to growth based on high productivity and innovation.
    • This requires investments in infrastructure and education—building a high-quality education system that encourages creativity and supports breakthroughs in science and technology that can be applied back into the economy.
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