Will India face middle income trap

People Issues

“The main idea behind a middleincome trap is getting caught in low productivity growth,” says Jehangir Aziz, India chief economist at JP Morgan. “The initial surge in productivity which drove growth begins to recede, causing growth to slow down, and is not boosted later.

Importantly, there is little push from within the economy to reinvent itself” Another major factor affecting middle-income countries in Asia is demography and slowing population growth.

As the population begins to age, new additions to the workforce begin to slow. This pushes wages up, making the country less able to compete purely on labour costs alone.

“At this point you need a completely new production structure driven by technology and innovation,” points out Pronab Sen, former chief statistician of India and currently chairman of the National Statistical Commission. Countries such as South Korea or Taiwan made that transition to high-tech manufacturing, from competing purely on labour costs. It’s less clear whether countries like China, India, or Malaysia can do so.

The India story

India is less at risk from an ageing population, at least for now — indeed over the next decade or so, it is one of the few countries whose average population will actually get younger, thus providing a potential demographic dividend. But the IMF research identifies a set of other factors — among them re infrastructure weaknesses and macroeconomic problems, as potential causes of a growth slowdown in India.

“Infrastructure is not much of a factor behind growth slowdowns in high income economies,” points out Aiyar. “Neither is it a major constraint in low-income economies,” he says pointing to other, more pressing problems such as even basic institutions, and a functioning state. “But it is an important factor affecting growth in middle-income economies.”

The broader picture that emerges from the research is one of different factors affecting growth at different stages. For low-income countries, just maintaining minimum law and order and a functioning state is a major achievement.

Beyond this, for a country to move to middle-income status, and beyond, a much larger set of conditions needs to be fulfilled — everything from allowing entrepreneurs to flourish, to ensuring adequate credit and well-functioning infrastructure. As Aiyar points out the idea can even be applied to individual states within India. “A good example is Bihar under Nitish Kumar,” he says.

“His most immediate priority was to put in place a functioning state and that led to an immediate burst of growth. But to sustain that, Bihar needs to focus on building other aspects of its economy such as infrastructure.” While India does not face a ‘demographic time-bomb’ like China, there is hardly any room for complacency on this front either.

While the decreasing age of India’s population might make us believe that there isn’t much to be worried about, when it comes to supplying
labour to feed demand, skill shortages in a number of sectors have already pushed wages up.

This makes the picture more complicated and puts the emphasis on education and even health. “That’s clearly a risk that we will face in the years ahead,” says Aziz, referring to the lack of an adequately skilled workforce.

Cautious Optimism

Interestingly, though, Aziz is sceptical that the term ‘middle-income’ fits India at all. The country has a per capita income of about $3,600 (in ‘international dollars’), technically bringing it within the ambit of the IMF’s definition. “It’s difficult to apply the definition of ‘middleincome’ to a country where around 300 million live on less than a dollar a day,” he argues.

But his argument goes deeper. “The very idea of a ‘trap’ suggests a situation from which a country cannot extricate itself. If India does face serious economic problems, there will be pressure from within for change,” he says.

In fact, he points to the experience of the last few years. “For three years we had a policy freeze, but we continued to coast along since we had reasonable growth. There was no urgency to fix problems. But only when we ended up with a 5-6% growth rate, did the government move with urgency to fix outstanding policy problems.

The impact of this will play out in the months ahead,” Aziz adds Scaling It Up Middle-income trap or not, India will eventually have to deal with the problem of how to move to a higher growth path.

This isn’t merely a problem of numbers. Sen points to the example of largescale labour-intensive manufacturing in the textiles sector. “We are nowhere when compared with a country like Bangladesh when it comes to scale of factories,” he says.

India, he points out, has moved to a segment in the textiles sector which is focused on more highvalue garments, vacating the basic garments space to its neighbour to the East and countries like Vietnam. “The problem is that the segment we operate in faces a limit to demand beyond a point. That limit is not there in basic garments.”

While Bangladesh’s textile manufacturing model comes with its own set of critical problems — witness the over 900 deaths from fires in two textile factories in a span of two weeks — the concern for India is whether it can create an environment where large-scale labour-intensive manufacturing facilities can be built.

Ironically, while China has built factories of enormous scale, that country’s main concern is whether, over the next decade or two, it can find enough workers, cheaply enough, to staff them. India seems to have exactly the opposite problem.