India lost the manufacturing race to China. Here’s why it can still succeed

Today is election day in India. Well, technically, it is the day when the official results from the Indian elections are expected to be announced. Voting has been going on for the last six weeks. Apparently it takes a long time for 900 million voters to cast their ballots.

The economy is a major concern for Indian voters. And, if they were to compare the long-term trajectory of their economy with their neighbor to the northeast — China — they might have a lot to complain about.

In 1980, India and China were roughly equal when it came to making money. Both countries’ GDP per capita—or, more casually, their average per capita income—was about $300 a year.

However, in the decades since 1980, Chinese wealth has grown dramatically ahead of Indians. The average Chinese resident now earns over $13,000 a year. The average Indian earns only about $2,700. In other words, China’s economy has grown almost five times faster than India’s.

The main reason for China’s economic success: manufacturing. China now produces about 35 percent of the world’s manufactured goods. Manufacturing has also been central to the economic success of almost every other nation that has moved from rags to riches.

India is lagging far behind in manufacturing. Despite representing almost 18 percent of the world’s total population, India produces only about 2 to 3 percent of the world’s manufactured goods. This number has barely decreased since the 1980s.

So it makes sense that Prime Minister Narendra Modi, who is widely expected to be re-elected today for a third term, has made manufacturing the centerpiece of his development strategy for India. The Modi administration has protected and subsidized strategic manufacturing sectors such as textiles and electronics to the tune of billions of dollars annually.

All this is wrong, argues Raghuram Rajan. And he’s not just some random dude. Rajan is the former governor of the Central Bank of India, the former chief economist of the International Monetary Fund and now a professor at the University of Chicago Business School. Along with Rohit Lamba, he has brought out a new book titled Breaking the Mould: India’s Uncharted Road to Prosperity.

Mother The money of the planet He recently spoke with Rajan about India’s challenges and opportunities in getting rich, why the manufacturing-led path China blazed may not be open to India, and the path Rajan believes India should take instead.

Time is ticking for India’s economic development

While India’s economy has fallen dramatically behind China’s in recent decades, it has been doing better recently. India’s GDP is projected to grow over 6.5% this year. That’s more than double the United States and many other rich countries. Companies like Apple have shifted manufacturing to India. Under the Modi government, the country has seen a burst of investment in infrastructure, such as roads, railways and ports. The stock market is booming. And it looks like India is marching steadily towards becoming the third largest economy in the world soon.

However, Rajan expresses a lot of concern about India’s economy. Of course, he says, it may be growing fast compared to many rich countries. But, he says, it must grow much, much faster to have any chance of eradicating the extreme poverty and unemployment plaguing the world’s most populous country (over 1.4 billion people!)

When Rajan looks at the Indian economy, he sees a ticking clock. India, he says, is currently experiencing what social scientists call a “demographic dividend.” There are many young people entering the workforce and relatively few seniors. This golden boom period, Rajan predicts, will only last about 25 years in India. After that, the country’s population will skew older, fewer people will work, and more people will look to the government for help to meet their needs. The economy will predictably slow down (as seems to be the case with an aging China lately).

“So the question is: what level of growth does India need over the next 25 years to get rich before it gets old?” says Rajan. “And the answer is much higher than 6.5 percent. If you look at China in the early 2000s, it was growing at 10, 12, 14 percent.”

Rajan argues that India is squandering the golden opportunity of its demographic dividend. Despite having this huge economic advantage of having a large number of young people, “these young kids coming into the workforce are not getting jobs,” says Rajan. Lacking good job opportunities, some of the brightest graduates of India’s elite engineering schools tend to migrate abroad. The current government’s strategy of trying to reverse the path of China and many other manufacturing-led countries to greater wealth, Rajan argues, is not working.

The main reason why: manufacturing has become much more competitive. When earlier developers, such as China, entered the market, they were competing against “expensive Western labor,” says Rajan. This gave them a huge competitive advantage: cheap labor.

“Today, when India comes in, it’s not competing with Western countries, it’s competing with Bangladesh, Vietnam and still China,” says Rajan. This means that India has much less room to make money in manufacturing.

If not production, then what?

While India’s manufacturing sector has faltered, it has been doing better in services. For those of us who have dealt with the customer service or IT departments of large American corporations, you are probably familiar with communicating with someone based in India on the phone. However, India also specializes in higher skilled services. Rajan says companies such as Boeing, Victoria’s Secret, Goldman Sachs and JP Morgan are increasingly turning to Indians for high-skilled services. “JP Morgan, for example, has 3,000 lawyers in India, doing contracts for the rest of JP Morgan’s functions around the world,” says Rajan.

Even when it comes to physical products, like the iPhone, the money tends to be services, like design and marketing. “Apple hasn’t produced anything since 2004,” says Rajan. It outsources its production to Foxconn. Apple is worth about $3 trillion. Foxconn is only worth about $80 billion.

With the explosion of telecommuting since the pandemic, Rajan believes outsourcing services in India could be overwhelmed. To borrow from the title of his book, Rajan now believes that India can break away from the manufacturing-led form of development and jump into the service sectors that tend to be dominated by rich country workers. He envisions Indians providing many more services to Westerners and others around the world, in areas such as telemedicine, design, consulting, even yoga instruction.

To achieve this vision, Rajan believes India needs to shift strategies “from the body to the brain”. Right now, the country is pursuing industrial policies like pouring billions in taxpayer subsidies into manufacturing. But, argues Rajan, they should be more flexible and open-minded about the country’s development path.

The money currently pouring into manufacturing construction, Rajan argues, would be better spent on improving underfunded public schools, building world-class universities and training workers to thrive in the growing service sector. Indian leaders should also, he says, create a more business-friendly regulatory environment and invest in social programs like childcare, which would allow more Indians to enter the workforce.

India may have “missed the manufacturing bus” but, says Rajan, it can still get rich by jumping on the utilities train. Of course, we haven’t really seen a poor country dance like this before. But Rajan believes that India is well suited to do so. There is a massive population of English speakers. The Internet has enabled more services to be performed remotely. And Indian service providers are willing to work for much less than their Western counterparts.

And India is still a democracy. Of course, says Rajan, it can be argued that China’s undemocratic authoritarianism may have helped it suppress opposition and solidify its path to becoming a manufacturing powerhouse. But, he argues, democracy is an asset for India moving forward because, he argues, democracy holds leaders accountable and political freedom empowers citizens to challenge orthodoxies, challenge the establishment, and be more creative and innovative. He is concerned that, under Prime Minister Modi, India has taken a more authoritarian turn.

In the future The money of the planet we will dive deeper into the question of whether democracy is an asset or a liability for economic growth. Stay tuned.