Economy

Middle Income Trap– Can India Avoid It?

PM Narendra Modi’s return as the Prime Minister of India with an even greater majority for the BJP, clearly demonstrates people’s reinstated faith in his vision, abilities and intent. It also reflects the mass approval that Modi has received for the various initiatives and projects undertaken during the first term (2014-19). Streamlining the focus to the economic realm, the NDA-I government boasted of India’s status as the fastest growing economy, with the GDP constantly remaining above 7. Renowned economists in the country and abroad, however, have been presenting an alternative picture of the supposedly flourishing economy. While the government has always denied any such impending concern for the Indian economy, a few recent remarks by a celebrated economist Mr. Rathin Roy, member of Prime Minister’s Economic Advisory Council (PMEAC) and the Director of National Institute of Public Finance and Policy, have stirred a discussion on this. Mr. Roy believes that the economy is heading towards a structural crisis, which may push it into a middle income trap.

What is the middle income trap?

It is an economic development stage where a country attains a considerable growth out of a situation of extreme poverty through structural changes and industrialization. But the growth then gets stagnated at the middle-income category and the country fails to grow further to the high-income category and fully-developed status. These income categories mentioned correspond to the World Bank’s Atlas method of classification of countries on the basis of their Per Capita Income Gross National Income (GNI), into lower-income group, lower middle-income group (between $996 and $3,895), higher middle-income group (between $3,895 and $12,055) and higher income group (above $12,055) [As per the 2018-19 standards]. This trap has engulfed countries like Brazil and South Africa, and as per economists, threatens to attack India now.

India, ever since globalisation, has always been a consumer economy with an unfavourable tilted balance of payments. It has had relatively low levels of exports, and therefore, consumer demand has been the real driver of the economy. However, various survey reports on micro and macro consumption trends depict multi-quarter lows in several sectors, including auto, air travel, FMCG, etc. Reasons could be decreasing money supply, high unemployment levels, government policy uncertainties or a plunge in income growth in both rural and urban areas. A low consumption level will be detrimental to the GDP and a falling general level of growth will slow down the pace of the economy, a typical characteristic of economies trapped in the middle-income trap. World Bank data reveals that only 13 out of the 101 countries deemed to be in the middle-income category in 1960 could achieve high-income status by 2011.

What can be the causes of the middle income trap?

Well, every country and economy has a set of socio-economic, demographic and political realities that differ from circumstances prevalent in others. Therefore, there is no well-defined, rigid reasoning that could be laid out to explain a country being caught in the middle income trap. However, there are certain possible causes that contribute to the crisis depending on their intensities and the prevalence of other factors.

One of the primary factors could be an uncontrolled population expansion, where despite a country showing growth in the National Income, its per capita GNI remains bound to low levels. This is a major factor in the Indian case. With the second largest population in the world, our per capita income falls drastically even when a small portion of the population remains poor.

Lack of sufficient investments in the education, healthcare and skill development training sectors for improving human capital becomes detrimental to productivity, and thus, leads to the slowing down of the economy. It could also be that early growth from low-income group to middle was more input-driven than productivity-driven, and now that the former cannot be a sustaining option, growth levels fall. If focusing on output and productivity, advanced and sophisticated technology with a dedicated research wing is another important necessity. Advancement needs to be measured not merely by aping the West or adding a little to something that has already been done. Instead, efforts need to be made to invent new technologies that have the potential of causing a positive change, because new innovations receive higher prices in the world market.

While a large population is a problem, an aging population is another significant issue for a country that is trying to sustain itself in the global competitiveness. If a large portion of the population is above the middle age, the supply of energetic labour decreases and an efficient workforce is absent. Therefore, the country may age before it gets rich. The most prominent factor of all is macro-economic stability, that involves a well regulated price level keeping inflation in check. The political and economic institutions that occupy pivotal decision-making positions must be responsible and far-sighted in making monetary, fiscal and popular policies. The government is one of the most central institutions in this.

Having pointed out the various political and economic factors, another key factor is the socio-cultural scenario. It is important that while traditions and roots be kept alive, developing societies learn to discard unreasonable and discriminatory traditions that become hindrances for the members of the society. Women have for long been restrained within the domestic boundaries. The entry of women into the mainstream economy and workforce is a very recent development and is, in fact, still under process. Socio-cultural practices shape the community and its people, and in turn, have a significant impact on the outlook and attitudes people develop. These attitudes have the potential to make or break a society, and impact its economy. These are some of the factors that in different combinations affect a country’s economic growth.

The Indian economy advanced by 5.8 percent in the first quarter of 2019, slowing from the 6.6 percent in the previous quarter and missing market expectations of 6.3 percent. This was the lowest number since 2014, and is being attributed to weak consumer demands and fixed investments. The Indian economy has, in fact, seen a few ups and downs in the last few years due to the improper implementation of policies like Demonetisation, the GST, decreased money supply done to keep inflation in check, and high unemployment rates. The GDP has also seen a somewhat slow down. These are factors owing to which economists are predicting an impending danger for India in the form of a middle income trap. However, outlining a problem is only the first step towards solving it, the more important act being strategizing and formulating policy to solve the issue at hand.

Expectations

Experiences around the world show that once caught in this trap, the chances of growing out of it are little. Therefore, the best way is to be vigilant and avoid it. One of the important things to take note of is the need to balance demand and supply policies so that per capita income goals are achieved and sustainable growth is ensured both domestically and through international trade.

Further, the growth model followed to uplift an economy out of the low income category cannot be carried forward to raise the same economy to the high income status. It is central to ensure a shift from low value-added industries to high-value added ones. The advantages of low cost labour disappear and greater investments must be made to improve the quality of human capital. Innovation becomes important as global competitiveness needs to be dealt with. If one aspires to be a part of an affluent league, one must also have the strength to contribute and lead. There must be a shift from input-driven to productivity driven growth as well.

While economists might be putting forth the dangers of India approaching the middle income trap, there is certainly time and scope for avoiding it.

Picture Courtesy- The Economist



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