India must plan for middle-income trap to become a developed country

In the last eightdecades since World War II, only a handful of countries have transitioned from middle-income to high-income status. A few among them, like Poland, benefited from joining the large European markets, while others, like Saudi Arabia, have been endowed with natural resources. The only successful examples of non-EU and non-resource-endowed countries are Israel, Taiwan, and South Korea, and it looks like China is on the way to the same.

A range of countries, especially in Southeast Asia and Latin America, used commodity exports as their way up the income ladder like Argentina, Chile, and South Africa, while others like Thailand and Vietnam, used manufacturing. Countries like Mexico, Indonesia, and Malaysia tried a combination of the two. They did well for some time but eventually floundered along the way.

So, the question arises: what is the guaranteed way to become a high-income country?

The answer lies in research and innovation.

The countries that transitioned from middle income to high-income countries are the ones with huge spending on research and development as a percentage of GDP. Israel (5.56%), South Korea (4.93%), Taiwan (3.4%), and China (2.43%), all have high gross domestic expenditure on research and development (GERD) spenders. And it is not like they started spending more on R&D when they became a high-income country, they were spending more even at India’s stage of development. For example, South Korea and Taiwan were spending more than 2% of GDP on R&D in the 1980s, when their economieswere equivalent to today’s India in terms of GDP (PPP) and GDP at market exchange rates.

Countries that do not nudge their companies to spend on R&D and come up with products that the world needs get into the middle-income trap. The commodity exporters get into thinking that the boom will last forever until it does not. The Simon–Ehrlich wager shows that betting on raw materials to become a high-income country is a dangerous bet.

Countries like Chile, Argentina, South Africa, and to some extent even Brazil have not recovered since the crash of the commodities boom with the 2008 financial crisis and today they are facing political turmoil and their social compact is on the verge of explosion.

Manufacturing also has moved from country to country. As soon as the Thai economy reached $5000-6000 per capita, manufacturing in the country became uncompetitive for exports. MNCs started looking for other greener/cheaper pastures, and they found Vietnam and Bangladesh as alternatives. The exports of Vietnam have grown exponentially in the last few years but as soon as it will reach$5,000-7,000 per capita, the MNCs manufacturing will start looking for other venues. The MNCs are like mercenaries, albeit they offer manufacturing services to the lowest bidder.

Similarly, as wages rise and China has achieved middle-income status, the MNCs are looking for +1 country that will fill in for low-cost manufacturing along with China. India, Vietnam and Bangladesh are contenders to become the +1 that MNCs are looking for and so far, the Vietnamese are ahead in the race. India needs to sort out the Ease of Doing Business (EoDB) issues and bring down the Cost of Doing Business (CoDB) to become a desirable place to move in for MNCs.

Along with becoming a competitive contract manufacturing option, India has to develop its own products and own the IP in critical areas like Drones, Space, EVs, Nuclear and other sunrise sectors. The East Asian economies did contract manufacturing for MNCs but never gave the domestic market on a platter to them. Along with manufacturing for MNCs, they propped up domestic companies that gained access to technology and IP, often through means that one would look down on, but used that to create a base and built on that to build their own technology and IP.

For example, Foxconn was doing contract manufacturing in China for Apple, but Beijing was not satisfied with that. It propped up Luxshare, which now directly manufactures for Apple. Now Luxshare is large enough to open a manufacturing plant in Vietnam for Apple. Similarly, Chinese electronics companies like Xiaomi, Oppo, and Vivo copied from the innovations of Apple and Samsung and captured the market share in developing countries like India.

With huge R&D investments, now these companies are becoming innovators in their own right. From smartphones, Xiaomi has expanded to backpacks, smartwatches, TVs, and tablets, and most recently, it launched an EV car.

The story is the same for all East Asian economies. Japan initially got technology from the United States and made its improvements. South Korea got technology from Japan and the United States and made improvements. China got the technology from Taiwan, Japan, and South Korea and made its improvements.

The government should nudge companies to leap into technology. Otherwise, the journey from $2,500 to $7,500 may be swift and easy but after that, we will become Thailand, not South Korea. To realize the goal of becoming a developed country by 2047, India needs to learn from the mistakes of the countries that got into the middle-income trap and the experiences of those who escaped it. We have the advantage of hindsight that East Asia, Latin America, and Southeast Asia did not have.

One blessing of starting late is to learn from the mistakes of others and not repeat the same. It would be foolish if we make the same mistakes as countries like Thailand, despite sufficient evidence andalternatives.

(Disclaimer:The writer's views do not represent those of WION or ZMCL. Nor does WION or ZMCL endorse the views of the writer.)