[op-ed snap] The middle income illusion

Mains Paper 3 : Effects Of Liberalization On The Economy, Changes In Industrial Policy and their effects on Industrial Growth |

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing Much

Mains level : Why middle income trap might only be a hypothesis and not a reality.


CONTEXT

The World Bank has a definition of middle income. It is a range of per capita income between $996 and $12,055, with $996 to $3,895 defined as lower-middle income and $3,895 to $12,055 defined as upper-middle income (the thresholds are often changed, these are 2019 levels).

With a per capita income of around $2,000, India is still a lower-middle income country and $12,055 is a long way off.

The issue with the estimation

Numbers are based on nominal exchange rates

  • These numbers are based on official exchange rates, the so-called nominal per capita GDP or Atlas method figures.
  • But a country’s per capita income is in local currency, that is, rupees.
  • Typically, when economists use the trap idea, they at PPP (purchasing power parity) dollars, using PPP exchange rates, not official exchange rates. India’s PPP per capita income is now around $7,000.
  • The grist to the mill is usually provided by empirical research, documenting the development experience of a diverse range of countries.

Reasons for such a trap

  • On the one hand, as countries attained middle-income status, they would be squeezed out of manufacturing and other dynamic sectors by poorer, lower-cost competitors.
  • On the other hand, they would lack the institutional, human, and technological capital to carve out niches higher up the value-added chain. Thus, pushed from below and unable to grasp the top, they would find themselves doomed to, well, middle-income status.

Faults in this assumption

  • Middle-income countries as a group continued to grow as fast or faster than the convergence standard demanded.”
  • First, a trap cannot be defined without referring to a time-frame.
  • The time series on PPP per capita is a bit more difficult to get than the official rate per capita.
  • With that caveat, take a look at the time series of any relatively more advanced country. Until a few decades ago (a cut-off in 1960 or 1970 will suffice), all these countries were stuck in middle-income traps.
  • Second, the middle-income trap is sometimes defined not with respect to an absolute threshold level of per capita income, but with per capita income expressed as a share of US per capita income.
  • Even if one uses this relative notion, the case of a middle-income trap existing has not been proven.

Conclusion

  • Does this mean there are no issues with the Indian economy? Certainly not. After the elections, with a new government in place, plenty of people have come up with agendas for reform. In most instances, these are not short-term quick fixes, but medium-term changes.
  • Therefore, they can rightly be called structural reforms, and the suggestions should be debated, accepted and implemented.
Economic Indicators-GDP, FD,etc
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