Middle Income Trap – Can India Escape?

First, we need to understand what middle income trap is. Middle income trap is a situation when middle
income economies find it difficult to make the climb from being a middle-income country to achieve
high-income fully-developed status due to several adverse domestic factors. According to World Bank,
Middle income countries are those whose per capita income lies between from $1000 to $ 12000
approximately. So basically, middle income incomes countries are those countries which dream of
becoming a high income country but are not able to become due of the failure of these economies to
bring some structural changes in their policies or actions.

So what causes economies to fall into this trap? The answer is very simple, still complicated. Some of the
causes, which area also relevant in current scenario, are Institutional Failures and Social Capital
weaknesses, rising inequality, slow or no growth in manufacturing and Labor migration.

Let’s talk about Indian economy now. India has gained middle income status in 2008 and since then, the
economy is finding it very difficult to raise per capita income of individuals and consequently, inequality
is on upward trend henceforth. According to Rathin Roy, a member of an economic panel advising Prime
Minister Narendra Modi, India’s growth has mostly been driven by demand generated by 100 million-
odd people at the top of the country’s socio-economic pyramid. Wealth inequality and the hierarchical
distribution of income in developing countries has long been identified as a growth barrier. However, in
recent time, the demand for goods and services, even by these wealthy population, has begun to shrink
which is paving the way for Indian economy to fall into this trap.

But this is not the only cause. There are several other factors which has been negatively impacting the
economy since 2011. Investment spending and private consumption expenditure has never been
reached at that level which it is used to be in the golden period of indian economy that ended in 2010.
The reasons for continuous fall is the lack of confidence among consumers and investors, including
foreign investors. In addition, there is rapid increase in the prices of basic goods and services such as
clothing, housing, healthcare, food and education due to which middle income consumers were
increasingly finding it difficult to purchase these goods. Further, the textile industry, India’s largest labor
employing industry, has been facing difficulties ever since economy opened up to foreign countries.
Textile manufacturing industries are heavily concentrated in the regions where labor is expensive such as
south Gujarat. Ironically, labor working in these manufacturing units migrated from poor parts of the
country such as Uttar Pradesh, Bihar etc. to work. Lastly there is lack or credible and autonomous
institutions in country and since 2014 the situation has even worsened as we can see many cases of that
such as collapse of NSC, tussle between RBI and the Government etc..

So, can India escape? Yes, but no. Yes, in the sense that there are many doors to escape the trap, but the
government is not doing its part to open that doors of healthy growth. There are many ways in which we
can achieve high growth and data manipulation is not one of them. Firstly, government need to
understand farmers were in distress since a very long time and they need to be lift out of poverty to
provide a stimulus to consumption expenditure, a major part of aggregate demand. Agricultural output
growth has dropped from somewhere around 4% in 2017-18 to 2.7-2.9% in 2018-19. Moreover, MSP for
many crops were not raised due to which the rate of farmers suicides are increasing day by day. So, we
need to address the problems that the agricultural sector is facing currently, otherwise we are not very
far away from becoming a poor country. Secondly, we need to locate industries in those regions where
we have abundance of labor resource such as Uttar Pradesh, Chhattisgarh, Bihar etc. as it will solve the
problem of both unemployment and inequality and would raise industrial output in the long run. Thirdly,
government need to provide autonomy to institution to work properly and to gain confidence of
consumers in the coming years. This is a very significant issue that need to be addressed immediately as
economy can sustain long term growth only if the institutions are credible enough to gain consumers
confidence. Lastly, we need to solve the issue of high pricing of basic goods or needs such healthcare,
education, food etc. in this case government need to understand that by giving subsidy only they can
help some section of population to purchase those goods and services, but the problem could not be
solved by this. Government needs to regulate the pricing of aforementioned goods so that problems like
illiteracy rate, malnutrition rate, infant mortality rate etc can be solved in the long run.

According to Rathin Roy, we have 5-10 years, or maybe a last chance, to increase our per capita income
but only if government understands the severity of the current situation and take all the necessary steps
that are needed to get out of the trap.

Prashant Bhatia, research associate at 6Wresearch and an economics graduate.