World Development Report 2024: Middle Income Trap- Timely for States setting Vision 2047
Mehul Gupta
Director @ PwC India | Economics, Public Finance, Financial Inclusion, Impact Assessment
Government of India has set the vision to be ‘Developed (or Viksit)’ by the centenary of India’s independence in 2047. States have been instructed to develop respective vision to be developed by 2047. But what does status of ‘developed state’ mean?
There is no single definition of a developed state. United Nations refers to Human Development Index to classify countries as ‘developed’. Countries with high HDI scores are classified as developed. Similarly, International Monetary Fund classifies countries based on per-capita income, export diversification, and degree of integration into global financial system. Last, World Bank classifies countries based on Gross National Income per-capita into four categories, low-income, lower-middle income, upper-middle income, and high-income.
As per latest classification, World Bank defines countries as:
Out of 20 large states, 17 states fall under the category of lower-middle income status and three states fall under the category of low-income (Figure 1). Per-capita NSDP is used as proxy to GNI per-capita. None of these 20 major states fall under the category of upper-middle income status. Goa and Sikkim could be potential contender.
Figure 1: Per-capita income of major states, 2022-23 (IN USD)
There is a strong positive correlation between per-capita income and various other development indicators (life expectancy, educational outcomes etc.). High income states also report high performance on other metrics of development. For the sake of simplicity, a developed state could also mean achieving current levels of per-capita for high-income countries i.e. USD 14,005. This metric is also subject to change overtime to control for price increase.
Table 1: State-wise past growth and gap to achieve high-income country classification
States like Bihar, Uttar Pradesh, Jharkhand given their past growth face significant gaps between required growth to achieve high-income status and past growth path. Southern states or already top-five per-capita income states are relatively in comfortable zone. But does that mean some of the states could actually attain the high-income status by 2046-47 reflecting on past growth trends.
World Bank’s 2024 World Development Report has raised doubts on middle-income countries’ ability to grow rapidly in the coming decades. Some of the key points are:
1.????? Out of 108 countries classified as middle-income countries, only 34 countries have managed to transition to high-income countries. Therefore, it is easy to enter middle-income country status but difficult to exit and be high-income and thus are subject to middle-income trap.
Figure 2: GNI per-capita in 1990 and 2022
2.????? The growth environment for countries which managed to transition from middle-income country status to high-income status was different than in current times. World economy is facing polycrisis. We are living in a:
a.????? Fragmented world: Advanced economies are moving towards inward oriented policies, protectionism is on the cards. This is restricting ability of middle-income countries to benefit from transfer of technologies through FDI, knowledge exchange, talent mobility and move up the technology frontier.
b.????? Debt levels remain elevated and cost of debt is considerably high with increasing sovereign bond yields (difference between bond yields issued in international markets by the concerned country and AAA rating countries). India has sovereign rating of BBB-[1].
c.????? Advanced economies of current times took more time to age than the pace at which middle-income countries are aging. This means middle-income countries’ demographic dividend would be short-lived.
Figure 3: Time period between aging (7% of population >65) to aged (14% of population >65)
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a.????? Climate change: Middle-income countries contribute nearly 2/3 of global emissions and more susceptible to climate change effects. Energy transition capital is expensive and may be challenging for middle-income countries.
3.????? Key feature of middle-income countries is their lack of persistence in economic growth. Republic of Korea managed to achieve sustained growth and achieve high-income status. This was possible due to subjecting domestic firms to foreign competition and sharing of new ideas, building foundational skills and then transitioning towards advanced education, shifting from incentivizing large conglomerates to smaller firms, and building digital infrastructure. Other middle-income countries have not be efficient enough to deliver.
Figure 4: Growth periods for select middle-income countries
4.????? Growth slowdowns occur more frequently in middle-income countries than in low or high-income countries. Underlying structural deficiencies in middle-income countries restrict their ability to sustain growth overtime:
a.????? Middle-income countries do not set right incentives for firms which create value. Both entrants and incumbents can create value (or bring efficiency/produce innovative products). Incumbents given their scale and access to networks can foster innovation only if these are subject to competitive pressures. Country’s anti-trust regulatory environment needs to promote competition. Similarly, entrants given their agility can introduce new ways of production or introduce new technologies but are constrained by access to finance, collateral, requisite support (network etc.). But in middle-income countries, too few entrants disrupt and too few large incumbents innovate or infuse global technologies. Micro and small enterprises remain small and follow flat and stay approach than up or out approach followed in advanced economies. In India, priority sector lending targets for MSMEs consider size as parameter than firms which create value.
b.????? As economies grow, demand for high-skilled workers goes up. Countries need to have sizeable pool of highly skilled workers. However, middle-income countries currently report poor performance on foundational skills such as upper secondary or tertiary education enrollments. These need to be addressed urgently.
c.????? State’s direct participation in productive sectors restricts ability of private enterprise to bring efficiencies. Some of the leading sector under discussion is ‘electricity’ which due to state’s active participation crowds out private sector.
d.????? Middle-income countries are subject to social immobility due to networks, neighborhood, and norms. Gender norms restrict women to attain education, participate in labor markets, earn equal or better pay, invest in human capital development. Networks restricts ability of small firms to exchange ideas, raise scarce capital. Neighborhood keep people stuck in places, hinders migration, block small firms to be large and productive firms.
5.????? Middle income countries given their stages of development needs to follow specific strategy. A low income country needs to prioritize 1i strategy focusing on investment (building physical and financial capital). A lower-middle income country needs to follow 2i strategy both investment and infusion (imitating and diffusion of technologies of advanced economies) rather than spending precious resources to innovate at low levels of technology frontier. As economies transition toward upper-middle status, countries need to add innovation layer to development strategy (3i). Countries by this stage have matched technology frontier of advanced economies and thus need to invest to move the tech frontier.
World Development Report 2024 is timely for many of the states in India who are setting a long-term development strategy. Given that majority of the states are lower-middle income, states would need to follow 2i strategy (investment plus infusion). Lower-middle income countries are subject to diminishing returns to capital and thus needs to be supported by infusion of modern technology (imitation as well as diffusion of modern technologies).
[Many of the figures and tables are directly taken from World Development Report 2024].
Views are personal.
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