How to avoid the ‘middle-income trap’

India is resisting what should be easy and logical step: Invite Chinese FDI, technologies and manpower openly. Instead, contradictory narratives go hand-in-hand with rising import of machines, finished goods and components.

Before getting into the details, here is a useful lesson from the World Bank’s report of August 1, 2024, “The Middle-Income Trap”. It explains how South Korea escaped poverty and the “middle-income trap” which, the report warns, threatens 108 counties, including India, China, Brazil and South Africa. Countries usually hit this trap at about 10% of US per capita income – or $8,000.

How South Korea escaped ‘middle-income trap’

South Korea’s journey began in 1960s while it was “among the least developed countries” with per capita income of less than $1,200 – which jumped to $33,000 (current USD) in 2023 (India’s per capita GDP in 2023 is $2,484.8). In 1960s, South Korea raised public investment and encouraged private investment; in 1970s and 1980s, its growth was powered by “a potent mix of high investment rates and infusion, aided by an industrial policy that encouraged firms to adopt foreign technologies.” Its family-owned businesses (Chaebols) “took the lead in copying technologies from abroad – primarily Japan”.

As South Korean firms “caught up with foreign firms and encountered resistance from their erstwhile benefactors” its industrial policy shifted toward “innovation”. The need for specialised workforce (engineering and management skills) was fulfilled by its Ministry of Education which provided it “through public universities and the regulation of private institutions” (“setting targets, increasing budgets, and monitoring the development of these skills”). Do you know Samsung was once a “noodle-maker”?

This report also highlights Poland and Chile. Poland raised productivity with “technologies infused from Western Europe”; Chile “encouraged technology transfer from abroad – and used it to drive domestic innovation”. In all, it says, 34 countries since 1990 escaped the trap and shifted to “high-income status” ($13,846 or more), more than a third of which was due to two factors: Integration with the European Union and discovery of oil.

‘3i strategy’: From investment to infusion to innovation

The thrust of this report is why countries hit the trap and how to escape it.

Drawing “lessons from the past 50 years”, it says, too many countries rely on “outmoded strategies” to develop – “too long” dependence on investment or “premature shift” to innovation while the need is “3i strategy”: “First focus on investment; then add an emphasis on infusion of new technologies from abroad; and, finally, adopt a three-pronged strategy that balances investment, infusion, and innovation.”

Here is another warning that needs attention: “At current trends, it will take China more than 10 years just to reach one-quarter of US income per capita, Indonesia nearly 70 years, and India 75 years.”

Let this sink in.

India’s per capita GDP of $2,484.8 (current USD) is at the lower end of the “lower-middle income” countries ($1,146-$4,515) – nowhere close to $8,000 for the “middle-income trap” to apply or the global average of $13,138 (5.3 times India’s). At 6% growth (average for last 10 fiscals), India’s per capita GDP would quadruple in 24 years to touch $9,939 in 2047 – still a middle-income country by current standards.

Why China is important for India’s growth

China is not just Number 2 economic superpower, after the US, it is far more powerful entity than that. Consider the following:

1. Number 1 in manufacturing: Its global manufacturing output (value added) share was 28.8% in 2023 – more than 10 times India’s 2.8%.

2. Number 1 in exports of goods: Its global share was 14% in 2023 – 4.5 times more than India’s.

3. 98% of global production of raw gallium and 67% of global production of raw germanium – two essential minerals for manufacturing semiconductors and other advanced electronics – is by China.

4. Scientific and tech superpower. The Economist recently wrote, China is “scientific superpower” – from plant biology to superconductor physics China is “the cutting edge”. An Australian think tank wrote last year[7], China led the world in 37 of 44 “crucial technology fields spanning defence, space, robotics, energy, the environment, biotechnology, artificial intelligence (AI), advanced materials and key quantum technology areas”.

5. Maximum surplus money to invest: China has (i) largest forex reserve at $3.6 trillion (as in May 2024), plus another $3 trillion of undisclosed forex reserve (India’s reserve is $655 billion) and its (ii) domestic savings at 45% of GDP is way above 26% in the EU and 17% in the US. These two give it more room for investment than any other.

Now four India-specific facts:

6. China is India’s Number 1 trading partner in merchandise goods in FY24 – reaching $118.4 billion. But it is almost entirely due to high imports ($101.7 billion), leading to very high trade deficit (-$85.1 billion or 35.7% of India’s total trade deficit in FY24). Ironically, the fear of Chinese goods was a major factor for India to pullout of the mega trading bloc RCEP in 2019.

7. China controls supply of all the frontline high-tech India needs, like electronics (laptops/PCs), electric vehicles (lithium-ion batteries and raw materials), solar panels and windmills etc.

8. India put a blanket ban on Chinese FDI through automatic route on April 17, 2020 (officially called “Press Note 3 (2020)”) because of the border stand-off (starting with Doklam in 2017 and escalating to Ladakh in 2020). Unlike rest of the world, Chinese firms need prior government approval. As a result, many big Chinese companies, like auto majors Great Wall Motors and BYD (largest EV maker) and others, including Apple's largest Chinese component and finished product makers Luxshare, were disallowed into India.

9. India is not benefiting from western multinationals’ China+1 strategy; it has become a part of the Chinese economic empire.  China, on the other hand, is setting up manufacturing facilities in Mexico and other Latin American countries to access the US market and Turkiye, Nigeria and Morocco to access European market – to overcome tariff and non-tariff barriers against its goods.

The Economic Survey of 2023-24 recognises all this.

It points out that India’s excessive dependence on Chinese goods and the latter’s dominance over many product categories made India “vulnerable to potential supply disruptions” and “risk of economic coercion…for political leverage”.

It argues: “As the US and Europe shift their immediate sourcing away from China, it is more effective to have Chinese companies invest in India and then export the products to these markets rather than importing from China, adding minimal value, and then re-exporting them.” It cites Brazil and Turkey which raised imports barriers on Chinese EVs “but enacted measures to attract Chinese FDI in the sector” – an approach some European countries are following too. This approach, it further argues, would “boost” manufacturing and integrate India with global value chains (GVCs) too.

There is nothing wrong in seeking China’s help for growth. Like South Korea (mentioned earlier), China too took the same path to turn into “the world’s factory”.

The China puzzle

It isn’t really the national pride or jingoism – following the border stand-offs in Doklam (2017) or Ladakh (2020) – which led to restrictions on Chinese FDI. Had that been the case, India’s imports from China wouldn’t have jumped 66% from FY17 or 55.9% from FY20.

It is lack of coherence in policies. How else do you explain the overnight blanket ban on imports of laptops/PCs, just four days after the Reliance launched China-manufactured JioBook on August 3, 2023? Imports of laptops/PCs from China jumped from 76% of all such imports in April-July 2023 (before the ban) to 87.5% during November 2023-January 2024.

How else do you explain 4-6% PLI subsidy to domestic manufacturers after imposing stiff import tariff barriers on electronic and other items India is import-dependent for merchandise exports?

Or for that matter, keeping away from mega trading blocs like RECP, IPEF and unilaterally cancelling 68 bilateral investment treaties (BITs) in 2017 and then, renegotiating BITs and also FTAs all over again?

What happened after the Economic Survey of 2023-24 advocated for Chinese investment and technology is not out-of-character.

The budget promised to simplify FDI rules and regulations policy “to facilitate” FDI but without mentioning China. This step was, apparently, prompted by three consecutive negative growth fiscals in FDI inflows – FY22 (-)1%, FY23 (-)22% and FY24 (-)3% in FY22, FY23 and FY24). But, Commerce and Industry Minister Piyush Goyal ruled out any rethink on Chinese FDI. Later, DPIIT Secretary Rajesh Kumar Singh said Chinese FDI could be considered if it boosted manufacturing but ruled out full-scale opening up.

There is a parallel movement.

Many industries are lobbying for Chinese engineers and technicians to install and run Chinese-made machines they have imported (visa norms for Chinese workers were tightened after the Ladakh incidents of 2020). This includes the Adani group which is keen to kick-start its new solar energy business for which that it had partnered with eight Chinese firms (OEMs and supply chain vendors).

No surprise that both the Ministry of Electronics and Information Technology (MeitY) and Ministry of Commerce and Industry are in favour of visas for Chinese be eased, pleading that production has stalled. An inter-ministerial consultation has started for giving need-based visas to Chinese workers and then it was said that the visas for Chinese technicians in manufacturing had been fast-tracked.

Inevitability of Chinese imports and manpower

Like it or not, the influx of Chinese goods and manpower will keep rising. That is the real challenge: Access to Chinese technologies and manpower for rest of the economy. True, this can’t happen until the political impasse over the border is resolved.