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The Elements of a Policy to avoid Middle Income Trap

Author : Aditi Bairolu

Few countries are expected to grow tremendously in the near future. The pandemic has slowed down the growth rate a bit but, looking at how the markets are moving, a steep upsurge is expected soon and everything will stabilize with economies reaching high GDP percentages.

The current market in India (for example) speaks a lot for itself. There is an expected shift in the economy where technology drives the entire country and makes India a hub to latent opportunities. These opportunities will ensure more foreign investments in the country creating more job opportunities and acting as a centre for services that companies stationed outside India will outsource from. Imagine the kind of revenue that will be generated. Not only will the foreign investments will drive the economy but the recent “Atma Nirbhar” movement by the government of India has increased the scope for Indians themselves driving the economy through domestic production. This too will add to the economy eventually increasing the GDP. This is just one initiative. Taking into consideration all the initiatives possible either active or yet to be launched, the result will be positive.

But will there be a limit to this increase in growth? It is very similar to how markets move and growth is cyclical in nature. It reaches a peak and then falls with staggering values. Remember, everything that reaches a peak either crashes or stays stable for long before hitting a new peak or will crash. In the past a few countries have shown an upward trend depicting progression on the economic front but after a period, remain at the same level for long until they figure out a strategy to come out of the loop. This is called the Middle Income Trap.

According to Asian Development Bank, ADB, the definition of this term is:

The middle-income trap refers to the phenomenon where rapidly growing economies stagnate at middle-income levels and fail to transition into a high-income economy.The word trap reflects many factors and ideologies of a country or a government. This term was first coined by Indermit Gill and Homi Kharas while observing the regions of Latin America and the Middle East showing a possibility of slowdown in 2007.

In one of the documents provided by World Bank by Greg Larson, Norman Loayza, Michael Woolcock, when growth of a country is fueled by cheap labour, catching up with technology, the reallocation of labour and capital from low productivity sectors or traditional sectors like agriculture to becoming an export driven, high productivity manufacturing hub, it is often followed by lower growth. This is further fueled by migration of the rural population to the urban counties in the expectation to earn better. Ergo,as the rural labour force decreases and wages rise, the phenomenon that once propelled the growth reduces its ability to sustain. This eventually leads a country to lose its strength to compete with its peers while it is trying to optimize its current resources leading to a saturation point.

Any amount of growth reflects the quality of public and government policies, private sector contribution and entrepreneurial scalability, ability of a government to fathom risks, abiding by the economic principles, law and institutional stability. Any imbalance in any of the mentioned factors, causes disruption in the economic trajectory of a country. Middle Income stagnation reflects a deadlock in the mentioned factors or forces of policy and economy. Taking examples of the historical data of any civil unrest or economic downfall, the prima-facie cause is the policy in action. Any economic activity is driven by fiscal, monetary and social policymaking. These control the inflation rates, avoid crises and strengthen the ability to combat risk, maintain volatility and have a robust infrastructure to reflect the ideology of - “too big to fail.” Further, diligent and disciplined institutions and laws become essential to keep policies intact and lead the country towards prosperity. Governance of the state or corporates play a major role in enforcing growth which involve efficiency of the governing bodies, efficiency of public sectors, degree of corruption, prowess of the legal bodies, timely execution of policies and laws, rights of the citizens. These decide the growth of any economy.

Also, private sector companies should be given the leeway of exercising some control in the market. Governments cannot and should not overburden the markets with heavy taxation norms, limited partnerships and should further promote public private partnerships to full capacity to have capitalism play its part. Burdening of any system, saturates and drains an economy and any country would become risk-averse. Heavy policies reduce the capability and probability for foreign companies to invest in projects in a country. Looking at the current scenario where technology is the niche and root of everything that's around, investment in the education sector and human resources becomes crucial to keep everyone abreast with the development taking place in the field of technology. To remove the deadlock mentioned before, open and competitive markets should be exercised by optimal resource allocation, productivity, knowledge penetration, hyper-innovation. These will further boost economic growth.

According to most economists there is a so-called virtuous cycle where trade results in productivity enhancement which propels trade further. Economies try their best to synergise all factors to make a country grow. Macro and micro economic or external and cyclical disruptions in international trade and capital inflows and outflows can affect the growth prospectus and policy reforms. Capital is one thing which adds to the development of a country but an economy should be fundamentally strong.

Mentioning India seemed appropriate as it has become the epicenter of global business. But, Middle Income Trap is not restricted to just one country. In the past a few countries have fallen into the trap and it's getting challenging for the policy makers to remove them out of the trap. There will be a point in time when consumption of goods and commodities will stop because consumers will no longer feel the need to spend. They will be content with whatever they have. If this happens, the economic cycle will pause, globalization will hit rock bottom and there will not be circulation of capital to keep businesses alive.

So, what are the elements that will help device better policies to avoid the stated phenomenon? Most of the elements have been already described. The promotion of structural transformation, entrepreneurship, building social enterprises, innovation, integration of cheap labour and knowledge into skilled labour, expanding secondary, tertiary education and skill development system and including the concept of ‘Gig Economy’ will make a robust policy. Skilled human capital is an innate aspect for value addition in modern services (digitization and technology driven) and manufacturing.

On a final note, to stop this conundrum from happening, a red flag is raised here, for future leaders to take a calculative approach while making policies, to deviate from the traditional way of policy making, to hyper innovate and to grasp the sentiments of the citizens. It has been seen that this trap occurs in every economic cycle, the only difference is its impact. Few countries are able to sense it and are able to raise the early warning sign while a few fail to comprehend. Only a dynamic policy-making approach can survive any challenge and hopefully the world economy will scale a new height.

References :

  1. Definition retrieved from https://www.adb.org/adbi/research/middle-income-trap-asia.

  2. Larson G, Loayza N, Woolcock M. “The Middle-Income Trap: Myth or Reality?”. Research & Policy Briefs From the World Bank Malaysia Hub, World Bank Development Research, March 2016. (http://documents1.worldbank.org/curated/en/965511468194956837/pdf/104230-BRI-Policy-1.pdf)

  3. Ghani E, Flaeen A, Mishra S, “How to Avoid Middle Income Traps?”. August 13, 2013. (https://blogs.worldbank.org/developmenttalk/how-avoid-middle-income-traps)

The Elements - Aditi Bairolu
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