Middle-income trap — Does India need to change its playbook?

The middle-income trap is a reality that needs to be faced but is equally a reality that has been overcome by some countries.

A recent World Bank study on the way ahead for emerging economies like India has created ripples with its focus on the concept of the ‘middle-income trap’. The terminology, coined nearly two decades ago, has been debated since then by economists while studying the growth path of many countries, including China. Research in this area shows there is no reason to despair as some like South Korea have beaten the odds and reached per capita incomes matching countries like the United States.

On the other hand, the World Bank’s World Development Report 2024 titled ‘The Middle-Income Trap’ presents the rather depressing hypothesis that it will take India 75 years, Indonesia nearly 70 years, and China at least 10 years to reach one-quarter of the US per capita if they stick to current strategies. The income range of the ‘trap’ itself is pegged at about 10% of the annual US GDP per person or about $8,000 today. The report advises that policies need to move away from the old playbook and a new ‘3i’ strategy needs to be adopted by those caught in this miasma of middle income. Investment, infusion, and innovation are the highlights of the new approach.

The suggestions for a new way towards higher growth and development come at a time when a debate is already underway over whether India should drop its efforts to expand the manufacturing base and instead move entirely towards creating a services-oriented economy. The discussion was sparked off by former RBI Governor Raghuram Rajan’s argument that it made more sense to expand the already-vast services sector instead of trying to build up a manufacturing base.

As for the policy approach suggested by the World Bank, it does not appear dramatically different from existing conventional strategies. The thrust on investment and infusion envisages adopting technologies from abroad and infusing them across the economy. South Korea is cited as having done so and thus shortened the path towards high technology output. India is similarly trying to lure foreign investors to set up projects in high-tech areas. This includes semiconductors where a big push has been made to lure firms in this segment. The technical expertise in chip design is available here, but the technological expertise for manufacturing is absent. Drawing on high technology from abroad is the way to go, and the World Bank’s prescription would give an additional heft to policymaking in this area.

This brings us to the third ‘i’ of the 3i formula — that is, innovation. Here there is no doubt that performance has been uneven. World Bank chief economist Indermit Gill has commended the spread of digitalisation throughout the economy, but it will be a long way before India is viewed as a leader in innovation. Yet there is one example of innovation which must be acknowledged as a significant achievement. That is the development of the United Payments Interface (UPI) that has revolutionised money transfers in India.

Having said that, India will have to step up its expenditure on research and development to become a bigger player on the world stage. Even in the arena of computer software and artificial intelligence (AI), this country is not a trendsetter as yet.  To move the economy to a higher plane of development, the process of innovation will have to move faster than ever before.

World Bank economists, however, have described the debate over manufacturing versus services as a ‘vertical’ debate while the thinking should be about the entire economy doing well which implies the need for ‘horizontal’ policies. In other words, it makes no sense to talk only about a services-led or a manufacturing-led economy as both are essential to drive development. This is a valid description of the debate that appears to put the economy into silos.

Any country that lacks a sizable manufacturing base will not be able to push growth to the high level needed to ensure sustainable and rapid economic development. As for services, these already account for over 50 per cent of India’s GDP and are contributing substantially in terms of exports. So, there should be no need to opt for only one or the other sector.

The middle-income trap is thus a reality that needs to be faced but is equally a reality that has been overcome by some countries. The suggested formula for reaching high-income levels is unexceptional but not much different from India’s current economic policies. The only major lacuna is the low priority accorded to research and development by both the public and private sectors. This is where more needs to be done to ensure that India becomes a leader in innovation rather than merely a follower in the long run.

(Sushma Ramachandran is a senior journalist.)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.