Avoiding the middle-income trap

Unless substantial reforms are undertaken to improve India's freedom rankings, it may remain stuck within the Upper-Middle-Income range beyond 2030

In 2018, the government set a target of achieving a gross domestic product (GDP) of $5 trillion by 2025. The GDP was then approximately $2.7 trillion, implying a target growth rate of over 9 per cent. The most optimistic guesses for India’s GDP circa March 2024 are around $4.1 trillion, with the $5 trillion mark looking likely to be crossed circa 2027.

The World Bank assessed GDP at around $3.4 trillion in 2022, and some estimates indicate the 2024 GDP is closer to $3.9 trillion. This looks reasonable with a growth rate of about 7 per cent ($4.1 trillion would imply a growth rate of near 10 per cent in FY23 and FY24).  

The target was unrealistic but that’s not necessarily a bad thing when it comes to setting targets. In per capita terms, a $5 trillion GDP works out to $3,600-3,700 per capita, which is categorised as “lower-middle income” by the World Bank definition since it falls in the bucket between $1,136 and $4,465. “Upper-middle income” is $4,466-$13,845, and anything above is considered “high income”. For comparison, China is close to $12,700 — upper-middle and closing in on high income.

There are some optimistic projections from many in the government that the economy will hit $10 trillion by 2030. It won’t, barring a severe collapse of the US dollar. Nonetheless, barring Black Swans, India should cross into upper-middle income territory by around 2030.

But the upper-middle income band is wide. A lot of nations get stuck within that income band for decades, and some never break out to high income. The reasons for getting stuck in upper-middle income territory are manifold.

One is simply the base effect, which leads to the usual arithmetical slowdown as the denominator gets larger. Growth also tends to slow since productivity gains become more difficult. There’s also demographics. By the time countries hit the high end of upper-middle income, population growth is low and the workforce is older and smaller.

Large countries that make it past the upper-middle income barrier to achieve high income tend to have some things in common. They have highly educated populations and excellent educational systems, which improves the odds when it comes to productivity gains. They have good laws and law enforcement, which leads to a safe physical and legal environment. They have easily understood, moderate tax codes, applied even-handedly by honest officials. Many high-income nations also have reasonably good social security and many have freely convertible currencies.

Almost all are high-end democracies. By Freedom House Rankings, out of some 195 countries under coverage in 2023, a batch of 84 were accounted “Free”, with the rest classified as “Not free” or “Partially Free”.  Comparing that list of free nations with the World Bank’s high income list, only the West Asian cluster of Saudi Arabia, Oman, the UAE, Kuwait, along with Singapore, qualify as high-income while not making the grade in terms of being free. That’s due to oil in the case of the Arab nations and Singapore is tiny, and super-efficient, with a free port, low taxes, honest government, etc.

India does have very low female labour force participation, so there’s an upside provided social attitudes change enough to induce more women to work and expand the workforce.  India is classified as “Partially Free” and rankings have deteriorated. 

Moreover, it has a continuous undercurrent of violence. Kashmir, Manipur, Chhattisgarh —    there is some violent conflict going on, somewhere or the other, at any given time. Apart from anything else, this means internet shutdowns, which cripple the digital economy. India also has complicated tax and commercial codes, and corruption is an endemic issue.

Lower population growth rates are already visible. Most of the workforce has less than 10 years of schooling. Perhaps new modes of distance learning and edtech will help? There is some welfare outreach but low spends on healthcare. Given tight currency controls, we can’t expect a freely convertible rupee.

It would require a huge legislative and administrative effort to change the business environment, and an even greater effort to push India back up to a “free” status in democracy rankings. More likely, India will just get stuck somewhere in the upper-middle income range.