The article suggests focusing on improving productivity and thereby the manufacturing sector to avoid the middle-income trap.

What is the middle-income trap and why it matters for India

• This trap was first conceived by World Bank economists.
• They found that of the 101 developing economies that could be classified as ‘middle income’ in 1960, only 13 managed to become rich nations by 2008. 
• There is little consensus on why some countries succeed in making the transition to high-income status.
• But a distinctive attribute of those that succeed in the transition to high income is productivity improvement.
• India could use its demographic dividend to avoid this predicament and achieve the critical velocity needed to move into the high-income bracket.

How can India avoid the middle-income trap

1) Improve productivity

• Re-allocation of labour from low-productivity agriculture to high-productivity sectors, such as manufacturing, has been a primary channel through which today’s advanced economies raised their living standards.
• In India, growth in labour productivity has consistently declined over the past decade.
• The annual growth rate of output per worker has dipped from 7.9% in 2010 to 3.5% in 2019, as per International Labour Organization estimates.
• This was also a period of low 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.
• An essential first step in improving productivity would be strengthening this sector.

2) Strengthen manufacturing sector

• Industrial labour relations is among the most critical elements to revitalize India’s manufacturing sector especially in the context of labour productivity.
• 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 and retrenchment in industrial establishments to 300 workers.
• Other countries, such as China, Vietnam and Bangladesh, with whom India competes for foreign investment and export markets do not require the approval of administrative or judicial bodies for dismissals.
• Therefore, in spite of recent reforms, India’s labour laws stay rigid in comparison with those of its competitor countries.

3) Technology intensive manufacturing

• Engendering innovation in higher value-added, tech-intensive activities is important for economies before they reach that juncture.
• If exports are taken as a proxy for the manufacturing capabilities and competitiveness of an economy, the present status of tech-intensive manufacturing in India leaves a lot to be desired.
• As per World Bank data, high-tech exports accounted for only 10.3% of India’s manufacturing exports in 2019.
• Rival countries had a much higher share of the same: 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.

Steps to improve tech-intensive manufacturing

• The government has introduced a production-linked incentive scheme to ensure a greater share of local value addition.
• While this would attract foreign investments in tech-intensive manufacturing, there is also a need for greater incentives for R&D investments by firms in India.
• A first step in this direction could be reinstating the tax exemption on R&D under Section 35 (2AB), even for companies opting for the lower corporate tax rate of 22%.

Conclusion

We need appropriate interventions to improve productivity—both economy-wide and within the sector. And we must do it now.

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