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Middle income trap

  Mar 13, 2020

Middle income trap

What is it?

The middle income trap is an economic development condition, in which a country that attains a certain income (due to given demographic, technological and resource advantages) is unable to move higher. The World Bank defines as the 'middle-income range' countries with gross national product per capita that has remained between $1,000 to $12,000 at constant (2011) prices.
Why does it happen?

According to the idea, a country in the middle income trap has lost its competitive edge in the export of manufactured goods because of rising wages. For example, newly industrialised economies such as South Africa and Brazil have not, for decades, left what the World Bank defines as the 'middle-income range’.  

What features characterise it?

They suffer from low investment, slow growth in the industry, limited industrial diversification etc.
How can we avoid it?

Avoiding the middle income trap requires identifying strategies to introduce new processes and find new markets to maintain export growth. 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. For example, the tax slabs have been reworked in India and upto Rs.5 lakh of income is non-taxable. It will boost durable consumption and investment

What structural reforms are needed?

The big challenge is moving from resource-driven growth that is dependent on cheap labor 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 fed back into the economy. 

What about India?

Shri. Rathin Roy, a member of an economic panel advising Prime Minister Narendra Modi recently said that India could be headed for a “structural crisis" as India’s growth that was mostly driven by demand generated by 100 million-odd people at the top of the country’s socio-economic pyramid has begun to exhaust itself, and so India could slip into a “middle-income trap". This is a risk that fast growing large emerging economies are said to be vulnerable to. As a country runs out of new sources of growth after an initial run of rapid expansion, it finds itself unable to break into a higher-income league. In India right now, the relatively weak offtake of white goods, consumer goods, apartments etc points to a slowdown in consumption. 

But what is structural about it?

Wealth inequality and the steeply hierarchical distribution of income in developing countries has long been identified as a growth barrier. The greater the gaps between strata, by this analysis, the slower the upward mobility of families that are at lower levels. Such economies typically experience lopsided expansion, with the positive fallout of an economic boom on top often failing to reach those below. 

What should be done?

Sustaining growth requires the mass mobilization of financial as well as human resources, and if inequality is acute, growth sows as demand does not exist adequately. This phenomenon is exemplified by Brazil and South Africa, among a few others. These countries increased their economic output at a fast rate for several years at a stretch, but large sections of their population did not see their lives get better. They got left behind.  

Spell out more details of the threat of a middle income trap in India

India appears to have undergone something similar. Opening up to global capital in the early 1990s gave the economy a big boost, transforming upper-crust and middle-class lifestyles beyond recognition. Their prosperity also generated enough demand for goods and services for India’s have-nots to get slightly better off, and it’s clear that poverty levels did fall. Yet, growth impulses seem to have slowed. 

What policies are required to reverse it?

Reforms can help the economy regain pace and achieve its potential. Investment in social sector; infrastructure; export sectors; structural reforms in agriculture are recommended. The best insurance against the risk of slipping into a middle-income trap, however, would be to address mobility restraints at lower levels of the socio-economic pyramid. This would mean sharply increasing the quality of healthcare, education and skill development for the deprived masses. These are long-gestation projects and could take time. But the economy needs to rise as a whole, not in parts.