We Must Plan Ahead To Escape The Middle-Income Trap

Context: Major challenges need to be addressed for materialising India’s new growth phase of pursuing high-income status and escaping the middle-income trap.

Challenges before India’s transition to high-income status 
     
     

      

• Reality of middle-income trap: Of 101 developing economies that could be classified as ‘middle income’ in 1960, only 13 managed to become rich nations by 2008.
• Low productivity and associated challenges: Annual growth rate of output per worker (Labour productivity) has dipped from 7.9% in 2010 to 3.5% in 2019, as per International Labour Organization estimates. Reasons for low productivity could be understood from:
• Frail growth in India’s manufacturing sector: In 2020-21, it accounted for only 14.5% of India’s gross value added, down from 17.4% in 2011-12.
• High dependence on agriculture: 42.5% of work force still engaged in agriculture. 
• Rigid, complex and archaic labour laws: 

• • • Industrial establishments try to employ less than 100 individuals to avoid falling under the purview of the Industrial Disputes Act, 1947.
    • As per the Annual Survey of Industries 2017-18, nearly 47% companies in India employed less than 20 workers.
    • These labour laws created incentives for firms to remain small and uncompetitive, thereby affecting productivity.
    • The new code, once implemented, would increase the threshold relating to layoffs but above this threshold they still need permissions.s

• Challenges in technology-intensive manufacturing: As per World Bank data, high-tech exports accounted for only 10.3% of India’s manufacturing exports in 2019, only a marginal improvement over its share of 9.7% in 2009.
• Rival countries had a much higher share: 31% in China, 13% in Brazil, 40% in Vietnam and 24% in Thailand.
• Low R&D spending in India, ranging from a mere 0.64% to 0.86% of gross domestic product over the past two decades, has held the country back.

Way forward: “Productivity isn’t everything, but in the long run, it is almost everything.” This aphorism by Paul Krugman should be the guiding principle for the Indian growth story.

• Leverage demographic dividend: India has a nearly 34-year window of opportunity to leverage its human resources and realise its growth potential before a phase of demographic burden sets in.
• Revitalise India’s manufacturing sector: Need to further labour laws reforms in light of falling labour productivity.
• Focus on improving ‘within sector’ productivity: Through, inter alia, research and development (R&D) investments, better management practices and adoption of new technologies.

• • Engendering innovation in higher value-added, tech-intensive activities is equally important.

• Prioritising tech-intensive manufacturing: Moving beyond the production-linked incentive scheme, a further beginning could be reinstating tax exemption on R&D under Section 35 (2AB), even for companies opting for a lower corporate tax rate of 22%.