The way out of the dangerous trap

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India, celebrated as the world’s fastest-growing economy, has become the world’s fourth-largest economy, and is expected to be the next engine of global growth.

Yet beneath these numbers lies a grim reality: India is drifting toward the middle-income trap, in which countries exhaust their gains from cheap labour and rapid catch-up and fail to transition to an innovation-driven, productivity-based economy.

Weak job creation, stagnant wages, sluggish private investment, and low productivity are reinforcing one another, threatening to stall the country’s rise before it reaches high-income status.

Many countries in the Global South are caught in this trap.

India’s structural crisis is unique and more serious than not just a consequence of wars in West Asia disturbing its supply chain or premature automation from AI.

The signs of distress are visible in the youth protests across the country.

Private investment remains sluggish, wage growth is stagnant, and household consumption is weak.

Manufacturing has failed to generate enough jobs, while post-pandemic recovery has favoured large corporations and the digital economy, leaving the informal sector barely touched.

Jobless growth emerges because productivity gains stay concentrated in narrow, capital- and skill-intensive enclaves that create little employment.

This simultaneous rise of rising inequality and low productivity is a dangerous trap.

Economists are typically divided in explaining this trap.

Those trained in pro-market orthodoxy argue India needs another set of market reforms — no less than what occurred during the 1991 moment — more labour flexibility, agricultural reform, deregulation, and infrastructure investment.

Those on the left and typically in the Keynesian mould argue that the economy suffers from weak aggregate demand and needs more public spending, redistribution and social protection.

Both arguments hold a kernel of truth, but miss the larger point: India’s current situation stems not only from supply and demand constraints but from institutions shaped by social norms, which decide both how markets set incentives and prices, and how the State allocates resources and provides public goods.

It is no surprise, then, that both the State and the market operate suboptimally.

Private capital, more freer from regulation than ever, does not do well on productivity and innovation.

Its competitiveness comes from cutting costs rather than innovating.

It couldn’t even absorb knowledge that comes with FDI.

It couldn’t increase productivity that results from both inter-sectoral movements and innovation within sectors either.

On the other hand, capital is heavily subsidised, lowering its relative price vis-à-vis labour in a labour-surplus economy.

India’s innovation is skewed, with R&D spending at a paltry 0.65% of GDP, while technology adoption remains weak and far from spontaneous.

Despite the government’s growing size, India’s capacity to intervene — even to provide basic services like health centres or schooling — remains among the lowest anywhere.

The Left–Right debate focuses on the size and quality of government expenditure, but the problem lies elsewhere.

The same social norms that shape resource allocation also drive its inefficient use.

For instance, India has historically underfunded mass education while subsidising higher education for elites, tilting spending toward the privileged.

That same elite bias later drove the service-sector-heavy growth of post-reform India, letting upper castes monopolise better occupations while relegating low-productivity work to others.

India’s social norms are distinctive: they decide how State and market function while producing durable inequality and legitimising it.

Having long undermined mass education, India’s vocational training system remains poorly managed and chronically underfunded.