Middle income trap

Countries in the middle income trap lag behind developed economies in the production of high-value-added products (in theory, middle income trap occurs when a country attains a certain income and tends to get stuck there).

In India, several solutions have been proposed to address this problem. And one of these is through innovating product design and process steps. An obvious hurdle is the efficiency in the supply chain.

Despite the low wages in India, the expenditure related to transportation and logistics has ranged between 15 to 20 per cent of the GDP, whereas other developing countries spend 8 to 10 per cent of their GDP on these activities.

Here are some other suggestions to help firms in this sector.

Several researchers have said that in India, the focus of policy has to be on skills development.

Here, one could learn from the experience of South Korea where firms have achieved major technological breakthroughs by improving the quality of the education system.

The short-term solution might lie in investment in research and development (R&D). The investment in R&D as a percentage of sales is much larger for similar companies in the developed, as well as, developing economies.

Perhaps, developing countries need a different way to conduct R&D — for example, a recent review article not only highlights management practices in the China but emphasises the importance of product development strategies for developing countries.

Some researchers have stressed the importance of the “ease of doing business” for the manufacturing sector.

A favourable regulatory environment results in a high ranking on the ease of doing business.

Other metrics include “starting a business, dealing with construction permits, getting electricity, registering property, paying taxes, trading across border, enforcing contracts or resolving insolvency”.

India has slipped in the ease of doing business rankings from 131 in 2013 to 142 in 2014. Moreover, India ranks the lowest amongst the Bric countries. For example, on the parameters of starting a business, India ranks 179, whereas Russia, Brazil and China stand at 88, 123 and 158.

One might attribute success in sectors such as auto, diamond polishing and information technology to cluster development.

In addition, one major factor that might have helped Indian exporters is the gradual weakening of the rupee (from ₹46.6 in 2010 to ₹61.2 in 2014 against the dollar and, from ₹6.82 to ₹9.98 against the Chinese yuan renminbi during the same time).

If firms could have controlled their internal costs and improved product design during this period, perhaps they could have captured a large share of the global market. India’s share of the international trade in manufactured goods stands at an abysmal low of 1.7 per cent in 2012.

Another possible reason for the predominance of small-scale manufacturers in India is the lack of financial resources, as well as cumbersome bankruptcy laws.

The recent move of the Reserve Bank of India to securitise trade receivables, introduce a bankruptcy code, as well as the thrust by the NSE to help the MSME sector are expected to partly address the problem. The problem of the middle income trap is thus far from resolved.

Understanding how the issues outlined impact the specific sectors and firms and how policy, as well as executive action can help manufacturers gain scale will be the challenge.

The writers are with the Indian School of Business

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