Let a middle-class boom fend off a middle-income trap (2024)

This class is driving consumption growth, which in turn is driving rapid economic growth. India’s economy has been boosted by large investments from global technology majors . These firms are attracted to a large and fast-growing consumer market. New households entering India’s middle class buy more consumer durables than this class does in Europe and the US. Burgeoning demand for all kinds of durables, from cars to refrigerators, can be traced to this class.

Young and dynamic: India’s favourable demographic trend has set the stage for a continued rise of the middle class. India is poised to experience a fast increase in its working-age share of the population. This gain will likely be augmented by greater participation of women in the labour force.

Industrialization has large fixed costs and international trade can be costly, with many developing countries unable to find the capital for it. However, India’s demographic dividend and rising middle class can help enable the country to overcome that problem. The number of people with sufficient income to buy products and also save money is increasing rapidly. This has the potential to create a virtuous cycle of increased incomes, savings, investments and higher economic growth.

Although a massive shift towards a middle-class society is already in the making, there are concerns that we may face a middle-income trap. China, notably, has slowed down and many other East Asian economies have been unable to achieve high-income status after a period of rapid growth.

How to avoid a middle-income trap: Many developing countries have successfully made the transition from low-income to middle-income status, but have then got stuck in a middle-income trap. They get squeezed between other low-wage producers and better developed countries with highly skilled people and fast-moving innovations. Caught between these two groups, many middle-income countries are left without a viable high-growth strategy.

A structural shift from one sector to another or a deliberate rebalancing strategy may also raise the risk of a middle-income trap. This is likely the case with China today, as it shifts from manufacturing to faster-growing services or ‘tertiary’ industries. The risk of falling into that trap is higher in countries that lack innovation capabilities to enable the economy to shift production to higher value-added goods or services. However, a growth slowdown should not be very alarming if it is the result of a strategy to rebalance growth drivers. Many middle-income countries tend to make two common mistakes: either they cling too long to past successful policies, or they exit prematurely from industries that could have served as a basis for specialization. Timing is crucial for a smooth transition.

Another reason for a middle-income trap could be rising income inequality. India has experienced a huge increase in wealth inequality, with the top 1% of the population owning more than 40% of the country’s wealth, and the bottom 50% sharing only 6% of it. India is headed towards a more unequal distribution of labour income and rising wage inequality as technology shifts labour demand from routine low and middle-level skills to higher-level skills. Rising income inequality squeezes consumer spending among the poor, and this can trap countries in a middle-income zone.

What policymakers can do: India is at a point where the rise of its middle class can go hand in hand with its demographic dividend. To capture the benefits, investments in physical and human resources need to be scaled up. India has made heavy investments in its physical infrastructure, but has fallen behind on investments in human capacity, especially education and skill development. India’s youth bulge is not yet fully prepared for the skill demands of the economy.

A key challenge to improve education for all is to ensure that all pieces of the education system fall in place: ready-to-learn students (for which malnutrition and stunting must reduce), prepared teachers and institutions that value learning and align incentives to that effect. Aligning all actors in the system will be India’s toughest challenge. Having well-educated workers who are easy to train for ever-evolving positions is important.

With the rise of the country’s middle class, people will demand improved quality of public services, apart from reduced congestion and pollution. The government may not be able to provide the quantity and quality of services that will be demanded, and more innovative solutions will need to emerge. Public-private partnerships and global solutions could play a valuable role in this.