PART – I
I was going through a statement of the Reserve Bank of India the other day on international education costs and the numbers seemed to be staggering. The spending on tuition and hostel fees by Indian students studying abroad has shot up with a compounded annual growth rate (CAGR) of 44% from $1.9 billion in 2013-2014 to roughly around $2.8 billion in 2017-2018 and this is not just the case with the education sector. The 100 million strong middle class are now breaking their banks on international travel, healthcare and imported luxuries. Now, on the flip side, domestic consumption and private investment have suffered massively due to the macro economical headwinds and the economy has a whole is facing severe liquidity crises.
THE PROBLEM:
India, as an economy has never been an export oriented economy unlike its South East Asian counterparts namely, Japan or South Korea. Consumption and domestic spending had been the fuel for the growth of the economy since the 1991 reforms. It is interesting to also note that this consumption was largely driven on the basis of what the richest 100 million Indian wanted to consume. Spurred by liberalization, the 100 million strong middle class went on a purchasing rally, acquiring everything from Rolex to Rolls-Royce. With creature comforts met, the next level in Maslow’s hierarchy is being attained by a largely imported pool of consumption. This has put a downward pressure on domestic consumption and the Indian economy is still trying to find the answers as to how and from where would the next 100 million segment come from.
The Indian economy is still the fastest growing economy in the world but is the growth sustainable enough to make it an economic superpower or is it just an illusionary trap set known as the middle income trap?
WHAT IS A MIDDLE INCOME TRAP?
Middle income trap is a theoretical economic phenomenon, in which a country that attains a certain income level gets stuck at that level. The World Bank defines as the ‘middle income range’ countries with gross national product per capita that has remained between $1000 – $12000 at constant (2011) prices. Historically studies point out that only 13 countries out of 101 middle-income countries in 1960 had become high income countries by 2008.
To add to the misery, studies also point out that a country once stuck in the middle income trap has never been able to come out of it. The threat is now looming over India after China knocking around these doors and countries like South Africa, Brazil and most of the Latin American countries have fallen as a prey to this theory witnessing large scale poverty with rising crimes, low investment, limited industrial diversification and poor labour market conditions.
SO NOW WHAT LIES AHEAD:
For India to avoid this trap, inroads need to be made as soon as possible into the skewed income and wealth distribution problem and find measures to prevent it any further. The Paris School of Economics had released the World Inequality Report adopted by the World Economic Forum showing India in the top five countries with the most income disparity. Therefore, a mechanism is to be devised to create the next 100 million earners through a win-win strategy. The country must shift its focus from being an imitative economy to an innovative economy and inclusive economic growth. Tailwinds should be removed and sectoral transformation should be the focus rather than focusing on a top down approach. Such a transformation requires the liberalization of the regulatory and bureaucratic obstacles that gag entrepreneurial activity. Government should hence become a key driver of the economy with latent private consumption and spend enough to sustain the growth. Subsidies, stimulus and waivers could aid to be a short term remedy but in the long term the focus should shift on increasing the disposable income within the next set of earners whose increasing consumption could help the economy bypass this trap.
The choice is up to the country itself whether to continue with the interventionism of the state capitalism of the past or to move to entrepreneurial capitalism. The verdict from the standpoint of sound economics is crisp and clear: only those countries would achieve high income status that is able to make the shift to entrepreneurial free market capitalism.
The single engine fuelling India’s growth is running out of fuel and alternative measures are the need of the hour or else the Indian economy is heading for a plateau. India can still grow at 5-6%, but a time would come when this growth would be halted.
For India, the toughest crossroad decision has to be made now, or else the future would remember it as an economy with a lot of promise but falling prey to the same old middle income trap.
To be continued..
Read PART II of this article