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.
Two failing engines
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.
Undervaluing useful skills
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. Fewer than 3% of the workforce has any formal vocational education. Of roughly 14,000 ITIs offering about 25 lakh seats, actual intake is only about 48%, and even among graduates, the employment rate is just 63% — far below the 90%-plus seen in many other countries.
Societies set up institutions based on their interests and norms. Economists often take self-interest as central to economic motives. Yet social norms determine the kind of institutions that take shape, which in turn decide how individual efforts are channelised into productive activities. These institutions work as the taproot of entrepreneurial success. As this year’s Nobel Prize winner Joel Mokyr has argued, modern growth depends on the accumulation and diffusion of “useful knowledge,” the practical skills that enable societies to innovate, adapt and raise productivity.
For Mokyr, sustained growth rests on the coevolution of science, technology and the spread of useful knowledge, something that failed to take strong root in India. India has historically privileged abstract education over vocational and technical knowledge. University degrees command prestige while technical courses training electricians, welders, machinists and carpenters do not. This hierarchy is not accidental. It reflects centuries of caste-based occupational stratification, where manual and artisanal work has been systematically undervalued despite its indispensable role in industrial development.
The result is a chronic shortage of skilled manufacturing workers even as millions of educated young Indians struggle to find decent jobs. Ironically, India’s Chief Economic Adviser, V Anantha Nageswaran, recently urged the youth to pursue trades such as welding and plumbing instead of chasing software jobs or MBAs.
But it won’t happen unless India changes its social valuation of skills. Take the marriage market: some skills and occupations carry a premium over others. These social valuations shape educational choices, occupational aspirations and ultimately the allocation of labour.
Data show a persistent and steady decline in the labour intensity of production technology across sectors. Even in traditionally labour-intensive sectors, the trend is likely to accelerate with the advent of AI. India therefore needs to recalibrate not just production and distribution, but also their valuation. Without changing the cultural valuation of skills and the way production itself is organised. India may fall into a low-income, low-productivity trap.
Diffusion of useful knowledge
Countries that escaped the middle-income trap — from South Korea to China — did not simply build factories but built institutions capable of creating and diffusing useful knowledge across domains. China’s interventions in education and health laid the foundation for its later productive capacity. Its early state-led industrialisation was accompanied by massive investments in technical education, local manufacturing capability and technological learning. By contrast, countries such as Brazil, Argentina, Thailand and the Philippines, which failed to build or sustain such institutions, became stuck in the middle-income trap. Like India, large sections of their populations remain dependent on public transfers and handouts to secure the basic requirements of a prosperous existence.
As an alternative to this trap, Harvard Economist Dani Rodrik has recently proposed what he calls productivism — an approach that shifts attention from ex-post redistribution to creating productive employment. It calls for the dissemination of economic opportunity and differs from free market orthodoxy in giving the government an important role over the markets in shaping economic opportunities. It emphasises the real economy over finance, jobs over redistribution and production over consumption. A truly inclusive economy, according to him, gives people dignity and social recognition as productive members of society. It can happen not just by recalibrating the policy framework but by overhauling the institutional framework and changing the norms that underpin those institutions by moving beyond the matrix of state-market binaries.
For India, this means combining industrial policy with investments in vocational education. It also means restoring dignity to skilled manual work and creating institutions that spread technology beyond a handful of elite enclaves. Without transforming how the country values skills, builds productive capabilities, and expands access to good jobs, India risks being locked into a low-productivity economy.
(Kalaiyarasan A. is Associate Professor, Madras Institute of Development Studies)
Published – September 11, 2026 08:30 am IST
