Beating the 'middle-income' trap

Around 1990, India and China had roughly the same economic size and per capita income in dollar terms. China’s per capita income was lower than that of India. Both were ranked between 140 and 145 out of 190-odd countries. China had initiated economic reforms in 1978, but growth momentum had yet to kick in. India’s economic reforms started in 1991, some 13 years after China.

Fast forward to the present. These two are now the second and fourth largest economies in the world. China became the second largest economy back in 2010. India attained the fourth rank this past week as per the International Monetary Fund.

This was proudly announced by the chief executive of Niti Aayog on the sidelines of the meeting of its governing council, chaired by the prime minister. The CEO was confident that India would overtake Germany to become the third largest economy in the next three years.

The rise of India and China in the past three decades is nothing short of spectacular. Together, the two giants of Asia represent 40 per cent of humanity. India’s economy is currently valued at about $4.1 trillion. At $19 trillion, China’s is five times bigger. As per the World Bank, India’s economy has grown (in real terms) at 6.3 per cent per annum between 2000 and 2024. This is the fastest growth rate among large economies.

In recent years, India’s average rate of growth has gone up to about 7.3 per cent. As compared to 1990, India’s economy is 11.5 times bigger, while the population is only 1.6 times larger. This means that per capita income has grown substantially: from about $360 in 1990 to $2,700 in 2025.

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The contrast with China is most telling. In 1990, the per capita income in both countries was similar. Come 2025, China’s per capita income has raced ahead to $13,000, almost five times that of India. This is largely due to the fact that China’s economy grew 51-fold over the past 35 years, maintaining an average real growth rate of 10 per cent per year for three decades.

In 1990, both countries had comparable per capita income rankings. However, India now stands at 141 out of 197, while China holds the 70th position. India is firmly within the World Bank’s middle-income bracket, while China has advanced to the verge of high-income status, defined as a per capita income exceeding $14,000.

Countries above this threshold are defined by the World Bank as developed economies. India aims to achieve that status by 2047. For that to happen, India’s growth rate has to accelerate and maintain an average of 7.8 per cent in dollar terms for the next 20 years, i.e., slightly higher than the average (7.3 per cent) achieved in recent years.

Why did India fare poorly as compared to China over the period 1990–2025? Could it be because it overlooked the potential of export-led growth, particularly driven by labour-intensive exports? Was it because of low investment in primary health and education? Or was it because the ‘licence raj’ that was dismantled in 1991 was replaced by the ‘inspector raj’? Has India’s three-tiered system of governance hindered the ease of doing business? Or is it that slower growth is the price India pays for its democracy?

There are many more questions regarding India’s poor performance vis-à-vis China, but instead of dwelling on those, it might be more productive to focus on what needs to be done to sustain high growth for at least two decades — and to chart a growth path that is inclusive so that per capita incomes grow as well. This would mean the growth of productivity, wages, household incomes and high-quality jobs.

If this goal is not met, India may become the world’s third-largest economy by 2047 but could remain trapped in the middle-income bracket, with per capita income stagnating well below $10,000. This has indeed been the fate of most economies in the past 50 years, as documented by the World Bank, whose report shows that only 34 countries have been able to transition from middle to high income, while 108 countries are stuck in the middle-income trap. The trap is to remain stuck at a per capita income of about a tenth of the US or about $8,000 in present terms.

For India, the experiences of countries like South Korea — the most remarkable transition — along with Chile and Poland, offer the most relevant lessons for escaping the middle-income trap. But time is running out. As World Bank research shows, it takes a combination of 3 ‘i’s — investment, infusion, innovation — to ensure that a country transitions from middle to high income.

To meet the prime minister’s demand that all states (and indeed every city and village within them) should strive for developed economy status what we need is rapid, sustained and inclusive growth at every level: states, cities and villages alike. It will involve unlocking the growth potential of small firms (excluding micro-enterprises), which play a key role in generating jobs, output and exports. It also entails freeing the farm sector, predominantly a state subject.

The first ‘i’ in the World Bank’s schema stands for investment, which India must increase to 40 per cent of GDP. It must also increase women’s participation in the labour force from 35 to 50 per cent. The second ‘i’ refers to the infusion of new technologies, by integrating with global value chains, establishing trade agreements and lowering tariffs and barriers to foreign investment.

The third ‘i’ stands for innovation, which involves increased investment in research and development by both the public and private sectors, alongside a substantial upgrade of human capital through skill development, training and enhanced employability. India must accomplish all this while tackling the formidable challenges of achieving net-zero carbon emissions by 2070, keeping income inequality under control and strengthening cooperative federalism, in a three-tiered robust democracy.

Ajit Ranade is a noted economist. Article courtesy: The Billion Press