World Development Report 2024: The Middle-Income Trap

13-09-2024

In Aug 2024, the World Bank published report titled "World Development Report 2024: The Middle-Income Trap".

Middle-Income Trap

The middle-income trap occurs when a country, after attaining middle-income status, faces difficulty in progressing to high-income levels.
This happens when economic growth slows down after a period of rapid advancement, leaving the country stuck at a middle-income level.
According to the World Bank, the middle-income trap is characterized by economic stagnation when a country's GDP per capita reaches approximately 10% of the US level (currently around USD 8,000).
Low-income countries often grow quickly when moving toward middle-income levels, driven by factors like low wages, cheap labour, and basic technology adoption.
However, middle-income countries may struggle due to the exhaustion of initial growth drivers, institutional weaknesses, inequality, and a lack of innovation.

Current Global Status:

As of the end of 2023, 108 countries were classified as middle-income, with GDP per capita between USD 1,136 and USD 13,845.
India was classified as a low-income nation until 2006. In 2007, India moved to the lower-middle-income category, where it remains today.
Economists note that India’s growth has been slow at lower-middle-income levels, with per capita income ranging from USD 1,000 to USD 3,800.
They emphasize that India's growth has primarily benefited the top 100 million people, raising concerns about the sustainability of this model.

Key Highlights

Middle Income Trap:

India is one of over 100 countries that may struggle to break free from the "middle income trap," where nations find it difficult to progress from middle-income to high-income economies.
India stands at a crucial moment, enjoying demographic advantages and progress in digitalization, but faces a more challenging global environment than in the past.
Achieving the goal of becoming a developed country by 2047 requires a broad-based approach to improving economic performance, rather than focusing on isolated sectors.
Since 1990, only 34 middle-income countries have transitioned to high-income status, often due to factors such as European Union integration or oil wealth.
Middle-income nations encounter difficulties in maintaining growth due to declining returns on physical capital investment.
In the past, low-income countries like India in the 1980s could boost their growth by building physical capital and improving basic education.

However, middle-income countries experience diminishing returns (doesn't lead to the same level of growth) as they continue to invest.

Increasing savings and investment isn't enough to drive growth. Even though these countries already have a good amount of physical capital, they face challenges in productivity.

This shows that physical capital alone isn't the key to further economic growth.

Despite significant capital resources, middle-income countries face productivity challenges, showing that physical capital is not the only hurdle to growth.
The World Bank criticizes outdated economic models in many middle-income nations, which highlights increasing investment without considering broader productivity issues.

Global Economic Impact:

Middle-income countries are home to six billion people, accounting for 75% of the global population, and contribute over 40% of global Gross Domestic Product (GDP).
Their ability to achieve high-income status will play a key role in global economic growth.

Per Capita Income Disparity:

India is currently the fastest-growing major economy, but if current trends continues, it will take 75 years for India's per capita income to reach 1/4^th of the US levels.
China would take over 10 years, Indonesia about 70 years, and India 75 years to achieve this milestone.

Challenges and Risks:

Middle-income countries face major challenges, including aging populations, increasing debt, geopolitical tensions, trade disputes, and environmental concerns.
If current trends continue, these countries risk falling short of becoming reasonably prosperous societies by the middle of this century.

Strategic Recommendations

3i Strategy: A Three-Phase Approach for High-Income Status

The report suggests a phased strategy for countries aiming to achieve high-income status:

Phase 1: Focus on investment for low-income nations.
Phase 2: Combine investment with the adoption of foreign technologies for lower-middle-income countries.
Phase 3: Add innovation to investment and technology infusion for upper-middle-income countries.

The case of South Korea serves as an example. In 1960, with a per capita income of USD 1,200, South Korea reached USD 33,000 by 2023 through the gradual adoption of this 3i strategy.

Policy Recommendations: Path to Development for India

To reach developed nation status, India needs a holistic strategy aimed at improving its overall economic performance rather than concentrating on specific sectors.
Focus on broad-based policies rather than debates about specific sectors like manufacturing versus services.
Prioritize education and skill development to better incorporate technology and promote innovation.
Strengthen university-industry linkages to promote effective knowledge transfer.
Technology preparedness: India has a strong foundation in digitalization, but there is a need for businesses to become more dynamic in adopting and utilizing these technologies.
The report points to the dominance of microenterprises in India, suggesting that policies favouring small firms may inhibit the growth of more productive enterprises.

Challenges India Must Overcome to Improve Income Status

Income Inequality: India faces continuous consumption inequality, with the Gini index remaining around 35 for the past 20 years. This restricts broad-based economic growth and hampers inclusive development.

Despite reducing extreme poverty between 2011 and 2019, progress slowed, particularly after the Covid-19 pandemic, reflecting ongoing economic disparities.

Balancing Growth and Inflation: Higher interest rates, aimed at controlling inflation, can curb demand and slow economic growth. India must carefully manage its monetary policy to strike a balance between growth and inflation.

Fiscal management is key to ensuring growth while avoiding inflationary pressures.

Income Per Capita: India’s per-capita income remains below the upper-middle-income mark of USD 4,256. Substantial growth is needed over the coming years to improve this figure.

Projections suggest that by FY31, India could become a USD 7 trillion economy, but maintaining a 6.7% average annual growth rate is essential for achieving upper-middle-income status.

Labor Force Participation: Employment indicators show improvement, but challenges continue regarding job quality, real wage growth, and women's low labour force participation.

These issues affect economic productivity and the inclusivity of growth.
The Economic Survey 2023-24 indicates that India needs to generate 7.85 million non-farm jobs annually until 2030 to accommodate its growing workforce.

Economic Diversification: Mining, manufacturing, construction, and services are key growth sectors, but India must continue diversifying to prevent over-reliance on any one sector.

India aims for manufacturing to account for more than 20% of GDP by FY31, requiring improvements in global competitiveness, value chains, and green transitions.

Environmental and Climate Resilience: India aims to achieve high-income status by 2047 while reaching net-zero emissions by 2070.

Balancing economic growth with climate resilience demands investments in green technologies and sustainable practices. India's growth must also be climate-resilient while benefiting the broader population.

Factors Supporting India's Improvement in Income Status

Global Offshoring: There is increased outsourcing of services like software development and business process outsourcing to India.

The rise of work-from-home and work-from-India models could double employment in outsourced jobs to over 11 million by 2030.
This is because the global spending on outsourcing is projected to grow from USD 180 billion to USD 500 billion annually by 2030.
Offshoring is the practice of relocating business processes or work functions to another country in order to cut costs and increase efficiency.

Digitalization: India’s Aadhaar program and IndiaStack (Digital Public Infrastructure) are driving a digital transformation, enabling greater financial inclusion and credit access.

The credit-to-GDP ratio may rise from 57% to 100% in the next decade, and consumer spending could more than double, from USD 2 trillion to USD 4.9 trillion, particularly in non-grocery retail.

Energy Transition: Significant investments are being made in renewable energy sources such as biogas, ethanol, green hydrogen, wind, solar, and hydroelectric power.

Daily energy consumption is expected to increase by 60%, reducing reliance on energy imports and improving living standards.
This transition creates demand for electric solutions, driving investment growth, job creation, and income.

Manufacturing Sector: Corporate tax cuts, investment incentives, and infrastructure development are fuelling capital investments in manufacturing.

The share of manufacturing in GDP is expected to rise from 15% to 21% by 2031, potentially doubling India’s export market share.
India is opening its economy to global investors by raising Foreign Direct Investment (FDI) limits, removing regulatory barriers, and improving the business environment.
The 14 Production Linked Incentive (PLI) schemes could significantly boost production, employment, and economic growth, transforming the country’s manufacturing ecosystem.

Services Sector: The services sector is expected to grow at an average rate of 7% between FY25 and FY31, continuing to be the dominant driver of India’s growth.
Economic Size: India’s GDP could potentially double from USD 3.5 trillion to over USD 7 trillion by 2031.

The Bombay Stock Exchange is projected to grow by 11% annually, reaching a market capitalization of USD 10 trillion by 2030.
By 2031, India is expected to become the 3^rd-largest economy globally.

Consumption and Income Distribution: Rising income levels are expected to significantly boost consumption. Growth in per capita income and economic expansion will drive domestic consumption.

Consumer spending is forecast to more than double, from USD 2 trillion in 2022 to USD 4.9 trillion by the end of the decade, with gains in non-grocery retail, leisure, and household goods.

Strategies India Should Adopt to Avoid the Middle-Income Trap

Address Income Inequality: Implement policies to promote fairer wealth distribution, such as progressive taxation, increased social welfare spending, and targeted subsidies for lower-income groups.

Strengthen social safety nets to minimize income disparities between various income groups and regions.

Enhance Economic Diversification: Broaden the economy by investing in emerging sectors like technology, renewable energy, and advanced manufacturing, reducing reliance on traditional industries.

Support the development of economically lagging regions to ensure more balanced economic growth and reduce concentration in specific areas.

Increase Productivity and Innovation: Promote innovation by investing in research and development, with a focus on tech-driven industries to boost productivity.

Improve education and skills training, particularly in vocational and higher education, to meet the evolving needs of the modern economy.

Support Local Manufacturing and Production: Promote local manufacturing through initiatives like the PLI (Production Linked Incentive) scheme to make essential goods more affordable and competitive.
Foster Inclusive Growth: Prioritize the production and distribution of essential goods such as food, healthcare, and education, ensuring they are accessible and affordable for all.

Implement policies that create employment opportunities and enhance living standards across different regions and communities.

Strengthen Economic Institutions and Governance: Enhance the efficiency and transparency of economic institutions to reduce corruption and ensure resources are allocated effectively.

Pursue structural reforms to simplify regulations, improve the business environment, and attract investment.

Focus on Sustainable Development: Align economic growth strategies with environmental sustainability by investing in green technologies and ensuring that development is environmentally responsible.

Develop strategies to mitigate the impacts of climate change and increase resilience in vulnerable sectors.

Promote Financial Inclusion: Improve access to credit and financial services for small businesses and individuals, particularly in underserved regions, to enhance financial inclusion.

Use digital platforms to expand financial inclusion and improve the efficiency of financial transactions.

World Bank

The World Bank was established in 1944 during the United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire.
Initially created as the International Bank for Reconstruction and Development (IBRD), it later became known as the World Bank. It works in partnership with the International Monetary Fund (IMF).