What is a middle-income trap?

In a recent interview with Business Standard, London School of Economics professor Nicholas Stern had rejected the fears of some experts that India might be caught in the middle income trap. Stern said that India was nowhere close to it.

A middle-income trap is a scenario where the country’s economy is unable to transition to the higher per-capita income levels. Low-income countries often tend to transition faster to middle-income levels, driven by low wages, cheap labour and basic technology catch-up. However, only a few countries manage to achieve high-income status.

There is no consensus around the theory of middle-income trap. It was and is still hotly debated among many economists and policymakers around the world as to whether such a trap really exists.

Historically, some evidence suggests that Latin American and Middle Eastern countries suffered middle-income traps for at least four or five decades. According to a World Bank report, out of 101 middle-income countries in 1960, only 13 countries achieved high-income status by 2008 based on per capita income level relative to the United States.

The most recent examples being Brazil and Mexico, which were touted to transition to developed economies, but failed to achieve the same success as Japan or some countries in the Eastern Europe.

If indeed a middle-income trap exists, economists argue that, after rising to a matured middle-market economy, policymakers need to be innovative, strengthen institutional capacities and look for renewed sources of growth rather than depending on the traditional growth engines to avoid such traps.

In India's case, a few years ago, top economist Rathin Roy had warned that growth is sluggish at lower-middle-income levels, with per capita income stuck between $1,000 and $3,800. He had warned that India’s growth was primarily driven by the demand generated by top tier 100 million people and the same is not sustainable going forward. But Nicholas Stern says sustainable infrastructure, energy transitions will invoke strong investment and drive India’s growth going forward.