The "middle-income trap" refers to a situation where a country that has experienced rapid economic growth and has reached a middle-income level finds it challenging to progress further and advance to a high-income level.
In other words, countries in the middle-income trap struggle to transition from being moderately developed to achieving a higher level of economic development and prosperity.
The World Bank introduced this concept in 2007. It applies to countries with a gross national product (GNP) per capita that remains between $1,000 to $12,000 at constant (2011) prices.
Economists Indermit Gill and Homi Kharas coined the term while working on strategies for East Asian economies. These countries lose their competitive edge in low-wage manufacturing exports but struggle to compete in high-value-added markets.
Let’s explore the causes of this phenomenon:
Competitive Edge Erosion: A country in the middle-income trap loses its competitive edge in exporting manufactured goods due to rising wages. However, it struggles to keep up with more developed economies in the high-value-added market.
Limited Industrial Diversification: Newly industrialized economies, such as South Africa and Brazil, often remain in the middle-income range for decades. They suffer from low investment, slow growth in the secondary sector of the economy, and limited industrial diversification.
Poor Labor Market Conditions: Countries caught in the trap face poor labor market conditions. These conditions hinder productivity growth and prevent a smooth transition to high-income status.
Aging Populations: Increasingly, countries in the middle-income trap grapple with aging populations, which can impact economic growth and development.
Structural Problems and Inequalities: Sociologists and political scientists argue that the middle-income trap is also a “political trap”. Structural problems and inequalities generated during early development play a role. Wealthy elites may prioritize a strong currency, leading to a shift in the economy toward luxury goods consumption and low-wage labor laws. This prevents the rise of mass consumption and mass income.
Strategies to break out of this trap:
Invest in Infrastructure: Prioritize physical and human infrastructure. Modern transportation, communication networks, and education systems are essential for sustained growth.
Enforce Social Policies: Implement policies like higher minimum wages to stimulate domestic demand. A strong domestic market can drive growth.
Currency Management: Consider maintaining a weak currency to make exports competitive. A favorable exchange rate can boost employment and economic activity.
Innovation and Technology: Embrace the third industrial revolution, characterized by globalization of services. Invest in innovation, research, and technology to stay competitive.
Smooth Transition: Avoid clinging too long to past successful policies. Transition smoothly from declining industries to emerging competitive sectors.
Timing Matters: Recognize when prior strategies are no longer effective. Adapt to changing global, institutional, and structural environments.
New Growth Drivers: Identify new sources of growth. Services, especially tradable services, are becoming crucial in the global economy.
Education and Skills: Invest in education and skills development. A skilled workforce drives innovation and productivity.
Industrialization and Diversification: Accelerate structural changes and industrialization. Diversify the economy to reduce reliance on specific sectors.
Strategic Active Policies: Adopt a comprehensive, innovation-focused strategy. Active policies can drive growth and help escape the middle-income trap.
Timing and a well-executed transition are key to success. By embracing these strategies, countries can break free from the middle-income trap and achieve sustained high-income status.
Argentina, Bulgaria, Colombia, Croatia, Greece, Laos, Nigeria, Slovakia, Trinidad & Tobago, and Uruguay are some of the nations struggling in the middle-income trap.
India is often cited as a country at risk of falling into the middle-income trap. India's per capita GDP is currently around $3,570, placing it in the low-middle-income category.
To escape the middle-income trap, India must focus on increasing productivity, investing in research and development, manufacturing efficiencies, logistics, and human capital development. The country needs to maintain its current growth momentum for an extended period to escape the middle-income trap.
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