Lower-middle-income trap

Without structural transformation in India's workforce, growth will necessarily sputter in the future

Much has been written about a recent report issued by the International Labour Organization (ILO), together with the Institute for Human Development (IHD), about India’s employment situation since 2000. The report, which uses publicly available government data but takes it a step forward by comparing the results from surveys that had been conducted with different methodologies, makes for disheartening reading. The report writers’ interpretation of the data can be starkly summarised: any structural transformation of the Indian workforce has run into severe problems. Indeed, in some aspects — such as those dependent on agriculture — there are signs the country is moving backwards.
 

What is meant by a structural transformation? Both economic theory and economic history teach us that poorer countries have a significant amount of “reserve labour” in agriculture — individuals who are relatively unproductive because of the unmodernised nature of that sector. When employment opportunities open up in the formal sector, particularly in mass manufacturing, those soak up some of agriculture’s reserve labour. This creates greater output in manufacturing while not notably reducing output in agriculture — since the excess labour there was unproductive. In the aggregate, wages and incomes increase and over time the country stops being poor and becomes rich.
 

The ILO-IHD report argues that “the process of structural transformation has been slow in India” and even quotes it as being “stunted”. It points out two relevant facts about this process in India. 
 

First, any transfer of labour out of agriculture was primarily to construction and services. The share of manufacturing employment remained at 12 to 14 per cent. Second, even this movement “reversed after 2019, with a substantial rise in agricultural employment”.
 

The absorption of excess agricultural labour into the “services” sector is not something we should be comfortable with. The services sector varies in nature from roadside one-man street food stalls to high-end information technology companies. But it is the former that is demonstrating absorptive capacity for labour, not the latter. Construction is another matter: it has been widely understood that it is the first port of call for migrants from rural India to the cities.
 

Work by the economist Amit Basole, the head of the Centre for Sustainable Employment at Azim Premji University, has compared India’s performance at absorbing agricultural labour with other countries’. At least till 2019, Prof Basole concludes that “the performance in pulling workers out of agriculture is as expected given its level and growth of GDP per capita, but the same is not true for pulling workers out of the informal sector”. More precisely, he finds that “the proportion of the workforce in agriculture [in 2019] is around 8.8 percentage points higher than expected [based on a cross-country comparison],” while “for construction, India is a large outlier with its employment share being nine percentage points higher than predicted”.  In other words, excess labour in India was shifting to informal jobs in the non-agricultural sector, particularly in construction — but not particularly fast.
 

The ILO-IHD report’s concern that this has since reversed is based on data that “the share of employment in agriculture experienced a significant reversal, rising from 42.4 per cent in 2019 to 46.4 per cent in 2021 and then falling marginally to 45.4 per cent in 2022”. Whether this is entirely due to the effects of the pandemic remains to be seen.
 

Where and how India’s working-age population is employed is not relevant merely for sectoral shares. This lack of transformative structural shifts is reflected in broader measures including productivity and wages. Between 2012 and 2022, according to the government data analysed in the ILO-IHD report, the monthly real earnings of salaried workers and of the self-employed actually declined. (Casual labour saw wage increases.) Wages that decline reflect a formal sector that sees no great demand for additional workers. It is a natural corollary of a development model that does not seem to be able to create a formal sector that attracts the surplus labour in agriculture.
 

Such a development model has built-in limitations. If manufacturing and, more broadly, the formal sector do not attract and absorb workers, then average productivity will not increase. If it does not increase, wages and thus demand will not increase. But India’s appeal to investment and its entire growth model in recent years have been built on demand. Given our apparent unwillingness to trade freely, we need at least to see rapid growth in demand domestically in order for there to be investment in manufacturing to meet that demand. But that growth in demand will not materialise without a structural transformation in the workforce.
 

If this appears circular, that is because it is circular. Those countries that have successfully developed have broken out of such a vicious cycle through boosts provided by, for example, export markets. There are other possible measures that could be taken. Rathin Roy has argued on these pages that regulatory and institutional “structural barriers” limit aggregate demand for “the things consumed by the next 300 million” consumers in India who are just above subsistence level. These structural barriers keep these items at a higher cost than they need to be, and low wages limit how many of them can be purchased.

There has been much talk in recent years of a “K-shaped recovery”, of “rural distress”, and other such phrases. The data behind such assertions can be read in several ways. But the wage and employment data is less ambiguous than most. The data suggests that, whatever the headline numbers, India’s economic growth has far too narrow a base, with limited sustainability and low potential to transform the lives of the vast majority of the country’s people.

For some reason, these basic questions of wages, growth, and employment are not central issues in the current elections. This is unfortunate as it allows politicians to proceed with unimaginative economic policies. Instead of being in a middle-income trap, India might wind up being in a lower-middle-income trap — which is a degree of magnitude worse. Even if these are not hot-button political issues, they should thus be at the top of the agenda for the next government. 

The writer is director, Centre for the Economy and Growth, Observer Research Foundation, New Delhi