Arun Kumar 
The just-released official GDP growth data for Q2 of FY 2024-25 will heighten concerns about India facing a ‘middle income trap’. If true, India will not become a rich country by 2047.
Many Latin American countries that did well up to a point got stuck in this trap and failed to achieve rich country status. This is not to be confused with the size of the middle class in a country.
But is this issue relevant for India at present when, in the world league in dollar terms, India is a lower middle income country?
Countries are categorised by per capita income (GNI) as low income (less than $1,145), lower middle-income (between $1,146 and $4,515), upper middle-income ($4,516 and $14,005) and high income (above $14,006).
India with a GNI in 2023 of $2,540 is a lower middle income country and is at the 141st rank out of 197 countries. So, the current concern should be, can India become an upper middle-income country soon, given the economic slowdown?
Growth rate story
The data on sectoral growth rates for the first half of 2024-25 compared to that in 2023-24 shows an all-round decline. Primary sector growth has declined from 3.6% to 2.8%, secondary sector from 9.7% to 6.1% and tertiary sector from 8.3% to 7.1%.
This is in spite of the faster growth (half yearly) in private final consumption expenditure (from 4% to 6.7%), exports (-0.7% to 5.6%) and valuables (-5.8% to 9.1%) and the decline in imports growth (13.3% to 0.7%). The negative factor is the decline in the growth of gross fixed capital formation.
The earlier worry regarding the declining share of consumption in the economy pulling down growth has shifted to the slow increase in investment in the economy. But an increase in consumption now can pull up private investment and speed up growth. But this depends on whether the rise in the consumption share will persist.
The rise in the consumption share in the last two quarters is likely due to the elections. Parties have competitively announced ‘concessions’ to the poor. This would have boosted consumption.
But it has also increased budget deficits and set back public investments. Further, with this stress, state governments may prune some of these concessions or withdraw them. Add to that high inflation and unemployment, which reduce the purchasing power of the marginalised sections.
Finally, the pent up demand post-pandemic has exhausted itself so that the well-off segments are likely to pare their consumption. In brief, the consumption share in the GDP may again decline.
The economic slowdown is a result of the differential growth rates in the economy. The organised sectors have been growing at the expense of the unorganised sectors. The latter have been repeatedly hit by shocks administered since the demonetisation announced in 2016.
The result is rising inequality and a decline in the share of consumption. The ‘concessions’ offered do not alter this fact and only provide a temporary respite to the marginalised sections. The loss of incomes due to the shocks is far greater.
Earlier too, this trend was visible in the official data. Pre-pandemic, growth rate of 8% in Q4 2017-18 consistently fell over eight quarters to 3.1% in Q4 of 2019-20. Then it slumped in 2020-21 due to the pandemic.
Over the pre-pandemic GDP in 2019-20, in 2023-24 the GDP was higher in real terms by 18.8%, giving an average growth rate of 4.7% per annum. Again in 2024-25, the rate of growth has declined from 8.2% for 2023-24. So, there is a pattern of decline in the growth rate.
Overestimated growth
Matters are made worse by the overestimation of the official GDP, especially the quarterly estimate. It is based largely on data from the organised sector. It does not have independent data for the non-agriculture unorganised sector, which has been declining by all accounts.
Effectively, a declining sector is proxied by a growing sector and that leads to an upward bias in GDP. This has been the case since demonetisation in 2016-17.
In brief, while the official data points to a slowdown in the economy, if this data is corrected for the methodological problem, then the economy would be found to have stagnated over the last eight years. Is this the middle income trap?
Why does the error in GDP data over the last eight years not show up in errors in say, tax collections and budgetary calculations?
The reason is that taxes are overwhelmingly collected from the organised sector and not the unorganised sector. Most of the incomes of those in the unorganised sector are way below the income tax limit and they do not pay corporation tax. These units are also not in the GST net due to their low turnover.
Also read: How Consumption Slowdown Meets Persistent Inequality
Thus, the non-inclusion of unorganised sector data in the GDP does not impact tax variables. Effectively, this sector gets invisibilised in the data.
Why don’t multinational corporations and foreign investors not worry about this overestimation? They deal only with the organised sector and they are happy that it is doing well. What about the international agencies like the IMF and the World Bank? They are not data-collecting agencies and work with the government data. So, their data reproduces the errors in the government data.
Variables impacted
If the unorganised sector is doing well (over the last eight years), why is unemployment high and there is distress at the lower income rungs? If the average growth rate in the unorganised sector is around 6-7% per annum, then employment should grow rapidly, even if it declines in the organised sector due to rising automation and mechanisation.
The media overwhelmingly caters to the government, the organised sector, international agencies and banks. An echo chamber gets created, which filters out adverse news of the marginalised sections.
The RBI’s data on capacity utilisation is from the organised sector and it has hovered between 70% to 75%. That is why the private investment rate has not picked up in spite of the increase in public investment and tax concessions to the organised sector. The often-quoted purchasing managers’ index data is also from the organised sector.
Consumption growth mostly lagging income growth is a result of rising inequality. The unorganised sector, which employs 94% of the labour force, has low incomes and consumes most of it (consumption propensity is high), but its total consumption is low. As incomes rise, less and less of income is consumed but the total consumption is high.
So, the increase in the share of the organised sector leads to a decline in the share of consumption in GDP and to low capacity utilisation and a low investment rate.
The twin trap
The unorganised sector has remained large because the organised sector generates little employment. It acts as a reserve army of labour keeping wages in check even in the organised sector. Clearly, the vast bulk of the population faces a low income trap and not a middle income trap, which may be relevant for the well-off.
So, India faces a ‘twin trap’. These two are interlinked because the inadequate incomes of the poor lead to a shortage of demand even for the organised sector.
The root of the problem then is the rising inequality. Concessions to the private sector, as the government has done recently, cannot boost investment unless there is adequate demand.
Countries that faced the ‘middle income trap’ also faced rising income inequality. Why have the rich countries not faced this trap? They grew in a different milieu. Many of them had colonies to extract capital from and even had slavery to obtain large surpluses. Later, they became welfare states that effectively boosted workers’ incomes, thereby generating sustained demand.
With Donald Trump taking over as the next president of the US, difficulties in trade are expected. The Indian economy is today far more open, so to boost exports, workers’ wages are likely to be squeezed further, causing inequality to rise and adding to the demand problem.
Conclusion
So, in the Indian context, talk of a ‘middle income trap’ is misplaced. This is perhaps a ploy to extract more concessions from the government in the name of incentivising investment. This is being called ‘reform’ even though it has not delivered in the recent past.
Finally, the real worry should be that the growth of the organised sector will lead to the greater use of AI and more unemployment, and higher consumption and climate change, both of which will set back growth – another ‘twin trap’?
Arun Kumar is author of Indian Economy’s Greatest Crisis: Impact of the Coronavirus and the Road Ahead.