INDIA’S economy and the global economy have tended to move in a see-saw relationship. When one was up, the other was down, and vice versa. Thus, the best period of growth for the world economy was the quarter-century before the first oil shock of 1973, when global growth averaged well over five per cent annually; that period was the worst for post-Independence India, with growth no more than 3.5 per cent. When India began to move up the growth charts to 5.5 per cent, the world went the other way, slowing to barely three per cent. The pattern changed briefly, when both India and the world were up at the same time during the boom years leading to the crisis year of 2008.

But the see-saw relationship would seem to be back – the world has been in serious trouble, as waves of uncertainty and crisis have pushed down growth rates to the lowest levels seen since World War II. The four years to 2015 have averaged a miserable 2.5 per cent growth rate, according to World Bank data, and 2016 will prove to be no better. But India has been chugging along at more than seven per cent, which is higher than its long-term average rate of growth. Why, it has even claimed from China the monicker of the world’s fastest growing large economy; China’s growth rate has plunged from over 14 per cent in 2007 to barely six per cent now (IMF figures); India in comparison has moved down more moderately from 9.5 per cent to 7.5 per cent. The challenge now is to stay up, despite the deadweight of corporate and banking debt, government misadventures like the currency caper, and the many illnesses plaguing the world economy, including the build-up of unsustainable monetary and fiscal imbalances.

The central task is one that India has not confronted before: generating momentum without further dependence on cheap labour as the primary competitive advantage. India is a net exporter of agricultural products, and competitive even in a trade environment where many countries have subsidies for agriculture only because millions of farmers and farm workers are willing to slave away in the sun for precious little by way of return. The average income in the farm sector is a bare one-sixth of that in the non-farm sector, modest as even that is. The stress shows in the number of farmer suicides, often following an inability to repay loans. Those loans were taken to finance wells or other investments to try and improve land productivity and, with that, household incomes.

Some of the successful export sectors are labour intensive too, textiles-garments and gems-jewellery being prime examples where the abundance of a low-cost workforce provides a competitive advantage. Even in the big export segment that comprises engineering goods, cheap labour is a key advantage. One example is provided by the small margin, small car segment: the share of wage cost is barely three per cent of total car cost in India, compared to 30 per cent in some of the advanced economies. And it need hardly be added that in the tech space and the commendable building of a $100 billion, export oriented sector, one of the primary competitive advantages for the country (other than knowledge of the English language) has been an abundant supply of low-cost engineers. They have been called ‘technological coolies’, people who can be used for body-shopping and relatively low value added coding work. Similarly, the secret of India’s ability to do space launches at a cost level that others cannot match is the same: low cost, white-collar technical workers who put in thousands of man-hours of work testing a satellite before launch, at a fraction of the cost in any advanced economy. Recall the story about the Mangalyaan shot to Mars costing less than the film Gravity.

 

The problem is that this particular competitive advantage will start to disappear over the next decade for at least three reasons. First, rapid economic growth raises wages and living standards. India’s per capita income has trebled (in constant dollars) over the last quarter-century, after the launch of economic reforms. If the economy continues on its present growth track of seven-plus per cent, per capita income will double again in a little over a decade. Already, India is no longer the country with the cheapest labour force. Bangladesh, with a substantially lower per capita income, has a significant cost advantage when it comes to wages in its flourishing garment sector. Tomorrow, wages in India may be no lower than in the Philippines, which is the next poorest large economy.

Second, there is an anti-immigrant wave that has swept across many countries, most notably but not only in the US and the UK, which happen to be the two principal English speaking markets. If Donald Trump does clamp down on H-1B visas, on which the tech firms have thrived, it will mean a new wall to be climbed for TCS, Infoys and Wipro, and their smaller contemporaries.

 

The third challenge to the cheap labour advantage is automation. The tech companies are already feeling the heat of changes in the market. Their headcount based business model (each employee costs x but brings in revenue of x plus y per cent; so the more employees you have, the more revenue and profit you generate) is giving way to platform based businesses that depend more on technology than on headcount. Nasscom, the software industry’s lobbying arm, has already lowered the industry’s growth forecast to 8-10 per cent, or less than half what it used to be in its heyday. Inevitably, the hiring of new engineers has suffered a dramatic dip.

The automation challenge confronts the manufacturing sector too. In a recent report, the International Labour Organization (ILO) warned that more than half the factory jobs in the Asean countries of Southeast Asia could disappear over the next few decades because of automation and advanced technologies like 3D printing. The World Bank president has said something similar about India – the figure he used for the jobs at risk, citing his organization’s research, was 69 per cent. These forecasts may be too dire, but ILO says the industrial segment that would be affected most by the new trend is the one that is often viewed as having the maximum growth potential: textiles and garments – where, by way of example, one cutting machine could replace 15 workers.

Anecdotal evidence supports the core truth articulated in these forecasts, if not the macro-numbers. Twenty years ago, Adidas shut its last factory in Germany and moved all of its shoe production to East Asia. Earlier this year, the move was in the reverse direction. The company was back in Germany with a new ‘speedfactory’ – run entirely by robots. Rival shoe companies are setting up their own automated factories in the developed world, and beginning to transfer production out of China. Meanwhile, Apple’s product-maker Foxconn has declared that it is cutting 60,000 jobs (more than half the total) in just one Chinese factory because of automation; Foxconn employs a total of 1.4 million people in all of China, so the larger implications are obvious.

As in India, Asian incomes have been rising virtually across the board, and no labour is so cheap that it can’t be replaced by smart machines. Automation also delivers product flexibility (no need to retrain workers), while factories that are closer to consumption centres bring the advantage of shorter supply lines.

In agriculture too, the old equations are ceasing to operate. Incomes on India’s farms need to grow, but for that the country’s agriculture has to cross its present productivity barrier – land productivity in the country is typically about half of global levels in a range of crops. As in other sectors, the challenge as well as the solution has to do with technology – new seeds (including genetically modified ones), more efficient use of water and improvements in farm practices have to be promoted in an organized fashion to deliver system-wide results. Isolated examples of sharp productivity improvements (cotton in Gujarat, corn in Bihar) show that radical change is possible.

 

The short point is that India has to confront a new set of challenges posed by its own success of the last quarter century, a success that is reflected in higher incomes and wages. Further success with limited reform is possible for perhaps another decade or slightly longer, because there are still low-hanging fruit to be plucked. But if the country is to progress to the next stage of development, after India has become a proper middle-income economy where low labour costs have ceased to be the primary competitive advantage, it must learn some new tricks, adopt new technologies and organize itself differently from the past.

It was nearly a decade ago that India graduated out of the World Bank’s classification as a low-income country. It will move out of its current categorization as lower-middle income, if its per capita income (calculated according to the World Bank’s Atlas method) moves beyond $4,000. It was $1,590 in 2015. If the next decade goes well, then by about 2030 India should be getting ready to make the second transition to an upper-middle income economy. Sri Lanka is nearly there already.

 

The problem which middle-income countries face is that they get squeezed between low-income countries, which have cheaper labour, and the advanced economies, which tend to dominate sectors where there is rapid technological change. Since competition with those lower down the income ladder on the basis of cost becomes less and less feasible for a rapidly growing economy with rising incomes (precisely the reason why India’s garment exporters cannot compete against Bangladesh), middle-income countries have to acquire other differentiators, and also learn how to compete with the advanced economies in their areas of strength. If they fail to do these, their further progress gets arrested and they will remain middle-income countries. Many countries have indeed fallen at this crucial hurdle, leading to the notion of a ‘Middle-Income Trap’.

India does not yet face the challenges of a middle-income trap, because it has some way to go before it becomes properly middle-income. But it will almost certainly start feeling the pressure of new challenges by 2026 or (more likely) by 2030. And it cannot wake up one fine day to start dealing with these new challenges; preparatory work on a wide front has to begin now.

 

China, which is a couple of decades ahead of India on the development curve, has already begun to shift away from its past successes based on the cheap exports of toys, garments and shoes. With the country’s per capita income already approaching $8,000, it has demonstrated its technological prowess in emerging areas like making and operating bullet trains, solar cell manufacture and assembly, and developing cutting-edge technologies that help produce stealth fighter aircraft. China’s priority sectors for the next decade include high-end machine tools and robotics, new materials, aerospace equipment and ‘new’ information technology.

If, a decade or so from now, India would like to demonstrate similar success in its transition to the next stage, what would it take? It will not have the good fortune that China enjoyed: open trading regimes that China exploited to its advantage in labour intensive sectors. The advances in automation and simultaneous rise of trade barriers make a repetition of that performance impossible. Bear in mind that, for the first time in seven decades, global trade is growing more slowly than global GDP, which has slowed down too. India’s transition to becoming properly middle-income has to be along a different path.

Besides, India’s principal social indicators have only now reached the levels that China achieved quite early in its take-off phase. Thus, India’s literacy rate in 2015 (75 per cent) remains short of China’s 78 per cent in 1991; similarly, life expectancy in India is now 68 years, and yet to reach China’s 70 years achieved in 1991. India’s investment rate as a share of GDP, at about 32 per cent, is significantly lower than the 40-plus per cent that China has enjoyed for well over a decade. Also, China’s success in manufacturing has meant that a much larger share of its workforce has made the crucial transition from agriculture to higher productivity manufacturing. In India agriculture still absorbs close to half of India’s workforce, compared to 35 per cent for China. Finally, while India’s GDP and per capita income numbers (on the basis of purchasing power parity, or PPP) today are what China reported in 2005, India is certainly not going to repeat the Chinese mega-achievement of taking up its GDP five-fold (expressed in current dollars) in the space of the 2005-15 decade.

What these numbers drive home is precisely the point that, despite having in 2015 reached China’s level of GDP and per capita income of 2005, India is nowhere near achieving the social, economic and structural transitions that China had already achieved well before 2005, or was in the process of registering at that stage – all of them relevant to graduating to an economy that does not depend on labour cost as the prime competitive advantage. India has some catching up to do.

 

The matter is more than ordinarily urgent because India is well into its demographic transition – a phase when those in the working age (15-59 years) constitute a higher share of the total population and therefore, add to overall labour productivity. A country gets more people in the working age when life expectancy improves, thereby adding to the number of working years, and when the decline in its birth rate causes the share of the pre-working age population to decline. The transition ends when the ageing (post-work) share of the population expands, thereby reducing the share of the working age population.

 

The period between the start and end of the demographic transition could last seven decades and more, during which the working age population could rise from 50 per cent of the total to nearly 70 per cent before beginning its decline. The resulting increase in labour productivity is the demographic dividend. India’s transition started modestly in the 1970s, and gained traction in the 1980s. This was one reason for the acceleration of the economic growth rate in that decade, compared to what went before. Since then, India’s working age population has moved up from about 52-53 per cent of the total by about 10 percentage points. The transition for India is expected to end in or about 2040, when the working age population could peak at 65 per cent or so before starting to decline. (For China, the demographic transition has already ended, as its working age population began declining as a share of the total in or about 2013; this partly explains its shift to a lower economic growth rate in the most recent years.)

India, therefore, has another quarter-century when it must make full use of the one-time demographic dividend. It has already done so by improving literacy and life expectancy rates, but it is common knowledge that educational attainments beyond basic literacy are poor for the majority. While universal enrolment at the primary school stage has more or less been achieved, retention through the secondary school stage, acquiring of work related skills, upgrading the quality of education during the retention phase and improving nutrition levels (critical to improving mental faculties) remain vital challenges. In addition, enough non-agricultural work has to be available so that educated youngsters can be gainfully employed. The usual figure for such employment generation is 10 million annually – a number that the country has never achieved and has no hope of reaching in the foreseeable future.

It is not hard to see the economy doubling its per capita income in the next decade, getting India to a stage when it could look ahead to becoming upper-middle income. But the future could look very challenging at that stage if the country has not by then made some of the key transitions – specifically, the steps needed to develop competitive strengths other than cheap labour. In any case, no country can hope to progress beyond being a middle-income entity if the bottom half of the population lacks the knowledge and other capabilities to deal with the realities of the emerging world.

 

In particular, the absence of enough productive work would mean that the one-time opportunity that is presented by the demographic transition will not be fully exploited. The sober truth is that the first half of the transition phase has already been a period of lost opportunities – precisely because of poor education attainments and suboptimal health standards, and the absence of enough higher value, non-agricultural work. If the next quarter-century repeats this history of only partial exploitation of the opportunity provided by the one-time demographic transition, then the country could find itself locked long-term into functioning at a suboptimal income level that is below the global average, a permanent underperformer who will never graduate out of being middle-income.

 

The issue on which neither Manmohan Singh nor Narendra Modi had/has an answer is jobs. Singh thought up the skill development programme, but that confused a demand problem with one of supply. Skilled workers are scarce because the demand for them is deficient, and the structure of the labour market is unhelpful. Even in the organized manufacturing sector, employers are willing to make compromises in order to get the cheapest options, often by hiring workers through labour contractors. Such a system looks at workers as an undifferentiated mass, and puts no premium at all on skilling.

The heads of two of India’s largest construction companies claimed recently that their biggest constraint was the lack of skilled workers; yet neither was willing to pay a premium for those who had acquired the relevant skills at training establishments. In such a situation, improving supply will not by itself create demand, one reason why workers too have been less than enthusiastic about skilling themselves. The German model that is frequently talked about as the one to copy links skill training directly to apprenticement and future employment. In India, however, the skilling programme has tried to create multitudes of skill development centres that are unrelated to future employment. The strategy hasn’t worked.

Modi has tried to modify the scheme, to no great effect. In his only public comment on job creation, he has argued that making finance available to micro-enterprises will help them grow and create jobs in what he has called the ‘personal’ sector, which he characterized as different from the private and public sectors. At first sight, this argument might seem to hold some water. After all, the 2012 economic census said that India had 58 million establishments that employed 128 million people (about a quarter of the workforce). But most of these were single-person entities, and an overwhelming majority of ‘establishments’ used no electricity.

This suggests that the setting up of an ‘establishment’, as reported by the economic census, looks suspiciously like an unemployed person setting up a roadside tea shop or cycle repair outfit, in the hope of making a living. Drive along the road from Chandigarh to Mohali and you will see dozens of people stationed on the roadside selling fruit. A quick question establishes that most of them have come from Moradabad, because (they say) the pickings outside Chandigarh are better. Are millions of such ‘establishments’ featuring migrant workers, familiar in every urban and semi-urban setting, likely to create the kind of jobs that India needs, in the ‘personal’ sector? One would think not; yet, it is said that more than 10 per cent of the workforce in a large city comprises informal traders like the fruit sellers outside Chandigarh.

 

An earlier economic census, in 2005, had reported that fewer than five per cent of such establishments employed five people or more; of these, the number employing 10 or more people was 1.4 per cent of the total – or fewer than a million establishments. Even that is not a small number, and it is arguable that with financing and perhaps other kinds of support, quite a few of them could grow to significant size. The Modi government has so far organized refinance through its Mudra scheme, but little else. Modi might be well advised to read Abhijit Banerjee and Esther Duflo, who in Poor Economics have argued that such establishments will mostly be unable to acquire scale and grow to economically significant size. To the extent that the setting up of tiny establishments points to the lack of job opportunities, the ‘personal’ sector, if it expands, will be a sign of failure, not success.

 

Debate on the employment-unemployment issue needs to focus on the real challenge, which is to create more productive, higher income jobs in what is called the organized sector. The poor are never fully unemployed, or they would starve; it is more likely that they are partially employed or underemployed. In contrast, large sample surveys done by the Centre for Monitoring Indian Economy show that unemployment is highest among those with more education – going up to as high as 25 per cent.

Neither high paying work nor work for the educated is going to come from Modi’s ‘personal’ sector. That requires other solutions – like the establishment of retail networks that facilitate the setting up of supply chains comprising establishments that can do large volume production, for the domestic and export markets. Notebandi might help, if it ends up encouraging more digital payments and, therefore, a transition from the informal to formal sector, where transactions get recorded and taxed. The laws that hold back or put a heavier burden on organized activity have to go – so that taxes, wages and all other costs are borne equally and fairly. But Mr Modi seems disinclined.

The complexity of the tasks on other key transformation issues – better education, improved nutrition, technological absorption – is only marginally less than in the business of providing enough jobs, but here too the state is struggling to find solutions that work. There are the challenges of encouraging research and innovation, both needed to lay the groundwork for improving productivity and generating the value added work that will sustain a middle-income economy. Also, there is the quite different business of creating the conditions that make India an efficient business base for industry. Simply put, that means setting up efficient infrastructure; there is progress here, but it is patchy and slow.

Agricultural transformation is a no less urgent and demanding task, given the low productivity levels today. Finally, there is the challenge of adding substantially to economic activity without doing further damage to the physical environment – the over-exploitation of water and forest resources, toxic air, the relentless accumulation of waste, and much else. Most importantly, woven through all this must be a strengthening set of properly functioning institutions that are the ultimate guarantor of long-term success (authoritarian leaders usually undermine such institutions because they seek fewer restraints on their power).

 

If all or most of the challenges are met, the results will show in significant productivity gains. Those will become manifest through a strengthening currency – the trend that was demonstrated in the past by Japan, Thailand, China and others during their high growth years. In contrast, India so far has seen a steadily weakening currency (even after adjusting for differences in inflation rates). This reflects precisely the absence of sufficient productivity gains of the kind achieved elsewhere in Asia. It is time that this narrative changed.

Time is not on India’s side, and the global setting has rarely been more unhelpful. The demographic dividend is slipping by, and the middle-income trap beckons. The next decade must prepare the ground for the transition that needs to follow. Fail in the coming 10 years, and we will have missed the tide at the flood.