The challenge is to escape the middle income trap

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: There is much cause for celebration in India today: a successful democratic election, growth rates for 2009 and 2010 averaging 5 percentage points more than the world, and a stock market up 77% in the last three months. For a country that graduated from low income status only in 2007, these are heady statistics.

For the first time in many years, a single party emerged as a clear winner in national elections. The size of the Congress Party victory has raised hopes that, despite India’s complex coalition politics, serious reform is possible. If growth can be sustained or even accelerated to reach its potential, India could be transformed into an affluent country within one generation. The prize is huge: the elimination of poverty in one of the world’s largest countries, and an economy that could be one of three largest in the world at market exchange rates-a global economic leader.

But the challenges are also enormous. Few countries have grown from low income to affluent in a single generation. Most have floundered and seen growth slow considerably when they reach middle income. Only a handful of East Asian economies have sustained rapid growth once they reached middle income. The great challenge for the new Indian government is whether it can lay the policy and institutional foundations that will allow the country to become affluent. The temptation will be to move cautiously. After all, cautious reforms generated India’s current economic success, and caution in financial reform insulated India from the recent global turmoil. With a solid mandate in hand, why risk political capital on an accelerated reform agenda?

The answer lies in a hard-nosed look at what happened to Brazil, Morocco, the Philippines, South Africa, and Syria in the past. Only Brazil and Morocco from this group had higher per capita incomes in 2005 than in 1975 in constant dollars. In Brazil, this was due entirely to a commodities boom that started in 2005 (its 2004 per capita income was lower than in 1975), and in Morocco the annualized growth over 30 years was less than 0.1 percent a year.What is striking about these examples is that all the countries grew rapidly in the previous decade, 1965-75, and were considered development success stories in 1975, much as India is today. Brazil had grown by 10 percent per year per capita, more than doubling incomes during these years.