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The World Development Report 2024 by the World Bank has called for attention to the phenomenon of the “middle-income” trap.
The World Bank has estimated that there is, in almost all scenarios, a stagnation of income per capita when economies reach a level of per capita incomes 11% of that of the U.S. This stagnation hinders their journey to high-income status.
Over the last 34 years, only 34 middle-income economies defined as economies with per capita incomes between $1,136 and $13,845 — have transitioned to higher income levels.
The middle-income trap, in development economics, is a situation where a country has developed until GDP per capita has reached a middle level of income, but the country does not develop further and does not attain high-income country status.
The World Bank introduced the term in 2007. As of September 2024, the World Bank estimates that 108 countries are stuck in the middle-income trap, including Brazil, China, and South Africa.
These countries are home to 6 billion people and generate 40% of the world's GDP.
Lack of Innovation: Due to a lack of funding for research and development, nations like Brazil and Mexico find it difficult to advance beyond basic manufacturing. For example, R&D expenditures in Mexico account for approximately 0.5% of GDP, but in South Korea they account for over 2.4%.
Ineffective Educational Systems: The quality of education is low in many middle-income nations. For instance, while having high enrolment rates, only 25% of students in nations like India and Indonesia master fundamental math, which reduces their competitiveness in the labour market.
Political instability: Foreign investment may be discouraged by political concerns. Economic volatility and ambiguous policies have resulted in stagnating growth rates in nations like Argentina, keeping them from rising to the level of high-income nations.
Poor Infrastructure: Businesses are less efficient when there is insufficient infrastructure. For example, Brazil's logistics cost is about 13% of GDP, significantly higher than the global average of around 8%, affecting trade and economic growth.
Weak Institutions: Corruption and weak legal systems can stagnant growth. Transparency International ranks many middle-income countries poorly on corruption perceptions, which makes it difficult for businesses to operate effectively and attract investment.
Most countries that broke the trap were part of the European Union.
However, the EU facilitated growth and mobility of capital and labour for its members.
India can explore ways to create EU-like institutions that aid free factor mobility for whom capital inflows are liberalised.
An important non-European country that managed to escape the trap is South Korea.
The South Korean policy was heavily interventionist, often directing the private sector’s activities promoting their participation in an export-driven growth model.
Successful companies were rewarded with access to new technologies and other supportive measures, while firms that did not perform were allowed to fail.
The presence of powerful business houses such as Chaebols in South Korea can promote growth provided they invest, ensure the adoption and infusion of new technologies, and innovate. South Korean business houses, or chaebols, are among the innovation leaders today.
Chile too, saw state intervention in ensuring the success of natural resource exporting sectors. The salmon industry, for instance, succeeded in Chile due to the targeted intervention of the state on multiple fronts to ensure that the industry flourished.
From South Korea and Chile India should learn that the benefits firms receive from the state must be based on their performance instead of closeness to power.
The power of billionaires in the Indian economy has increased, and they are seen as being close to the state. It is believed that the state cannot or will not guarantee high rates of investment from domestic capital.
The process of structural transformation has reversed and the manufacturing sector has stagnated, although after the pandemic, employment in low-productive sectors like agriculture has increased.
Wages have not kept pace with the government's estimate of a real GDP increase of roughly 7% in recent years.
The PLFS estimates that between April and June 2023–24, the nominal salaries of regular wage workers increased by only about 5%, while the nominal wages of casual wage workers increased by about 7%.
Chile and South Korea’s growth was driven by the authoritarian regime. For instance, South Korea’s export strategy was overseen by a military government that ruled till the 1980s, when the government frequently quelled labour unions.
The challenge for policy is to promote state intervention to ensure growth while maintaining the sanctity of the democratic ethos.
Governments need to spend more money on research and development. For instance, the government of South Korea enacted a provision for R&D funding to more than 4% of GDP, which led to the country's booming technological industry and notable economic growth.
Investing money into high-quality education and career training can improve the skills of the workforce.
Germany's dual education system successfully blends classroom instruction with real-world experience and produces a highly trained labour force and low rates of youth unemployment.
Creating institutions that are responsible and transparent can help to improve the business climate. Singapore has effectively mitigated corruption and optimised regulatory frameworks and has drawn huge international capital.
Increasing the energy and transportation infrastructure can boost productivity. China has made significant infrastructure investments that have boosted connection and efficiency throughout the country and enabled fast economic expansion.
Creating new products and markets can help lessen reliance on a small number of industries. Vietnam, for instance, increased its GDP growth rate dramatically by diversifying its economy from low-cost manufacturing to electronics and technology exports.
Government Initiatives
Atmanirbhar Bharat (Self-Reliant India)
National Education Policy (NEP) 2020
Production Linked Incentive (PLI) Scheme
National Skill Development Mission
Important articles for reference
Sources:
https://www.thehindu.com/business/Economy/can-india-escape-middle-income-trap/article68740618.ece#:~:text=An%20economy%20cannot%20break%20a,question%20of%20democracy%20looms%20large.
https://documents1.worldbank.org/curated/en/965511468194956837/pdf/104230-BRI-Policy-1.pdf
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PRACTICE QUESTION Q.Discuss the key factors contributing to the middle-income trap in developing economies, such as India and highlight the strategies to address the phenomenon. ( 250 words) |
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