Innovating For Prosperity

India has to expand its production-possibilities frontier to achieve population-scale prosperity

Speaking at the Observer Research Foundation in August 2019, Chairman of Dalmia Group Holdings Gaurav Dalmia, recounted a discussion from 1990, where an analyst remarked to him that after independence, India was aiming to catch up with Europe’s level of development. With the rise of Japan through the 1970s and 1980s, India set its sights on matching that country. Immediately, in the post-liberalization period after 1991, India’s objective was to catch up with the South East Asian tiger economies. At this rate, the analyst observed in 1990, India would be playing catch up with Vietnam in 2020. Dalmia then cited statistics to show this is where India stands today – since 1990, India’s GDP has increased in absolute terms by 8.37x, while Bangladesh’s GDP rose by 8.67x and Vietnam’s GDP rocketed by 37x. Vietnam’s per capita income also grew much faster over these three decades, and had surpassed India by 2020.

At one level, the numbers are damning. India faces a huge task – how should it become rich and prosperous if only meandering progress is possible? While India is often compared with other Asian emerging markets, the country’s sheer size presents a unique governance and economic growth challenge. On metrics such as geographic footprint and population, countries like Vietnam and Bangladesh are about the size of one or two major Indian states. Comparable Indian regions have experienced a transformation in the same time frame – Andhra Pradesh (from which the state of Telangana was created in 2014) has seen a sea of change over the last 25 years, with a largely poor, rural and agrarian region now more urbanized and home to some of India’s key knowledge industries. Today, Andhra Pradesh and Telangana both have per capita incomes substantially higher than the all-India average.

There are incipient regional and persistent sectoral imbalances in the Indian economy. While some states and regions have outperformed by liberalizing and adopting market-friendly policies, the manufacturing and agriculture sectors even within those better-performing regions continue to trail due to inadequate sectoral reform. The introduction of the Goods and Services Tax (GST) has made a measurable impact on the formalization of firms, and the war on corruption and black money. Alongside a number of measures that make high-value cash transactions difficult, there is now a greater incentive for the financialization of savings. India has recorded a notable rise in the World Bank’s ease of doing business ranking, improving from 142 in 2014 to 63 in 2019. But a lot remains to be done on factor market reforms for land, labour, capital and long pending direct tax reforms. The union government along with state governments need to retrench from activities that are best left to the private sector. There has been a robust debate on the liberalization measures required in various areas. Scholars such as Columbia University economists Jagdish Bhagwati and Arvind Panagariya have expounded at length on policy measures that are required to accelerate economic growth.

Comprehensive reforms are necessary for India to attain prosperity, but they are not sufficient. As of 2019, US GDP per capita (constant 2010 US dollars) was $55,809, whereas GDP per capita in India was $2,169. The US, an archetype of a wealthy nation, had output per capita that was more than 25 times that of India. China has output per capita nearly four times that of India. Closing this gap and achieving national scale transformation will require India to make a technology-driven productivity leap in business and government. In economics jargon, India has to expand its production-possibilities frontier to achieve prosperity, so that we can have more from less for more, to use eminent scientist-technologist Dr Raghunath Mashelkar’s quip.

The US, an archetype of a wealthy nation, had output per capita that was more than 25 times that of India. China has output per capita nearly four times that of India. Closing this gap and achieving national scale transformation will require India to make a technology-driven productivity leap in business and government

The Solow-Swan model, formulated by economic theorist Trevor Swan and the 1987 Nobel laureate in economics Robert Solow, posits that growth in output comes from three sources, namely population increase (which in turn raises demand), savings (which are reinvested) and productivity gains. Looking at the population factor of the Solow-Swan growth model when assessing the different experiences of Vietnam, Bangladesh and India is revealing. Building on Dalmia’s example, since 1990, Vietnam’s population has increased from 67.9 million to 97.3 million, a compounded annual growth rate of 1.20%. India’s population increased from 873.3 million to 1.38 billion, a materially higher growth rate of 1.54%. Bangladesh’s population rose from 103.2 million to 164.7 million, clocking a growth rate of 1.57% and matching India. An analysis of Vietnam’s relative outperformance over the last three decades indicates that its growth has been driven by raising capital and labour efficiency and relying on capital stock accumulation. Elements of this should be part of the playbook for Indian states and regions, but more is necessary for a national-scale transformation.

Where Swan and Solow viewed technology as an exogenous factor, the 2018 Nobel laureate in economics Paul Romer integrated it as an endogenous factor – in a seminal 1990 paper, Romer wrote that growth was driven by “technological change that arises from intentional investment decisions made by profit-maximizing agents”.

Aadhaar and the India Stack infrastructure have demonstrated what digitalization can deliver for governance, welfare delivery and payments. They stand out as trailblazing exemplars of govtech innovation globally. The endogenous role of technology in driving economic growth is relevant for India’s private sector too, especially if the government retrenches from business activity as has been committed under the Atmanirbhar Bharat reforms package, whereby public sector enterprises in specified non-strategic industries will be privatized. This is where entrepreneurs and investors should step up and deploy risk capital to fund innovations harnessing novel general-purpose technologies.

Aadhaar and the India Stack infrastructure have demonstrated what digitalization can deliver for governance, welfare delivery and payments. They stand out as trailblazing exemplars of govtech innovation globally

General Purpose Technologies (GPTs) make a horizontal, economy-wide impact, transforming entire value chains rather than just particular industries. Commercializing such technologies, which entails mainstreaming new knowledge and pioneering business models, is perhaps the most challenging style of entrepreneurship. But the market is primed for such innovation in India given the need for doing things differently for economic transformation on a national scale. We are seeing glimpses of what this entails – and the wealth creation opportunity it offers to investors and entrepreneurs – with technology’s impact on the financial services, education, entertainment and media industries.

Take financial technology. The combination of Aadhaar, GST electronic records, along with India Stack-enabled payments and electronic Know-Your-Customer (eKYC) identity verification has made it possible for digital-first lenders, financial intermediaries and asset managers to emerge. Where govtech has reduced the cost and speed of compliance, private entrepreneurs and investors are trying to capitalize on the wealth creation opportunity offered by financializing India’s savings through new digital conduits. The innovation is delivering results – the number of new demat accounts in India rose 22.5%, from 4 million in 2019 to 4.9 million for the financial year 2020, and with the total number of such accounts at about 40 million, there remains enormous headroom for growth. The advent of India Stack-based Sahamati and Sahay, for consent-based financial information aggregation and cash-flow based lending respectively, will help catalyze a transformation in how households manage wealth and savings, and in how small enterprises access credit.

India faces significant supply side challenges in health and education. In health, the shortage of trained medical professionals and doctors will have to be partially bridged by virtualization and digital tools. In education, new edutech platforms have tapped into massive latent demand, accruing tens of millions of users and delivering better education on a scale that would simply not be possible through physical modes alone.

India faces significant supply side challenges in health and education. In health, the shortage of trained medical professionals and doctors will have to be partially bridged by virtualization and digital tools

In manufacturing, rigid, antiquated labour laws as well as low labour productivity are among the issues that have stymied potential. Where the promise of automation and robotics for advanced economies lies in alleviating the challenge of an ageing population, for a country like India the promise of robots and “cobots” is in raising productivity. In agriculture, biotechnology, digitalization and automation can transform what has traditionally been subsistence activity in India into a corporatized, profitable industry.

A customer-centric and combinatoric application of GPTs is required for raising India’s economic output 40-50x over the span of a few decades. Artificial intelligence, augmented and mixed reality, intelligent machines and advanced materials are other GPTs that herald a new productivity dawn. Unlike smaller countries, the productivity jump that India needs for national-scale prosperity will require invention and innovation, for importation of technologies and business models alone will not suffice. There is an opportunity for Indian industry, venture investors and entrepreneurs to don the mantle of Romer’s “profit-maximizing agents”, rewrite playbooks and forge new paradigms using technology to create wealth.

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Part II:

Enabling India to lead in the development and deployment of critical emerging technologies

For India, there are clear economic and strategic payoffs to investing in critical emerging technology (CET) development

The global turmoil precipitated by the pandemic and subsequently the military confrontation in Europe is not limited only to the macroeconomic domain—geoeconomic considerations and supply chain security have come to the fore. Attaining industrial and technological self-reliance and sustainability, especially for critical emerging technologies (CETs), is now a high priority for both established and emerging powers. The security challenges in our neighbourhood, coupled with the dual-use nature of CETs, make self-reliance in this domain a special priority for India.

The Chinese threat complicates the picture, given its status as the world’s manufacturing hub, contributing 28.7 percent of global manufacturing output in 2019. Additionally, as Deng Xiaoping had observed with perspicacity in 1992, what Saudi Arabia is to oil, China is to the rare earth metals, the elements that are indispensably important for the modern electronics and communications-filled world that economies rely on. When it comes to futuristic CETs, such as autonomous machines, unmanned aerial vehicles, new energy vehicles, and advanced materials, China’s control of rare earth materials and preponderance in manufacturing represents a significant challenge.

Attaining industrial and technological self-reliance and sustainability, especially for critical emerging technologies (CETs), is now a high priority for both established and emerging powers.

How can democracies compete with China? 

The process-driven, rules-based, consultative approach of liberal democratic republics creates long-term resilience but exacts short-term costs when up against an authoritarian, single-party state. Even for non-hardware-oriented CET areas, such as artificial intelligence and biotechnology, the latter has more latitude to make mistakes and course correct than the former, where a safety-first approach can tend to hamstring policymakers.

Thus, competing effectively requires a two-pronged approach, harnessing both internal reform and external cooperation. This effort on two fronts will have to be impactful across the value chain – from sourcing input materials, making intermediates and components, and finally manufacturing end products. Succeeding demands shedding many shibboleths, so that CETs—which are essentially vanguard, sunrise sectors in manufacturing and services—can be both developed indigenously and regulated appropriately.

The road ahead for India

Much of the internal reform effort broadly necessary for India’s economic transformation to become a US $10 trillion+ GDP economy is especially crucial for achieving global leadership in CETs. India has always had high quality human capital and munificent natural resources to make a major global impact, but homegrown innovators were hamstrung by dearth of capital and a litany of red tape. While the latter has seen improvement, policymakers need to do a lot more to deepen equity capital markets in both the public and private spheres. The government has done well to financialise retail savings and incentivise investment in modern financial instruments through a raft of measures over the last eight years, but a structural shift is necessary so that long-term domestic institutional capital, including in insurance and pensions, contributes its share to the risk capital pool. After all, one should not rely on foreign capital to step up to enhance Indian capacities in CETs, especially for those with dual use—that is, both commercial and military—applications. Alongside such equity capital market reforms, direct tax reforms and administrative reforms on the domestic front are the need of the hour. Finally, tapping expertise available outside of government officialdom, through lateral entry or other mechanisms, can be especially impactful when it comes to designing policies for CETs.

Additionally, the country’s scientific research establishment needs to be reoriented and rejuvenated. The National Research Foundation, announced in 2021 to oversee and coordinate research activities across disciplines, is yet to be established. In the context of the transformational industrial, economic and defence sector reforms that have been implemented, leaving the country’s higher education and scientific base relatively untouched is not an option. Bringing together teaching and research rather than keeping them separated in siloed institutions, injecting more competition in different industries by implementing the aforementioned set of broadly applicable reforms so that businesses invest more in R&D, and positioning India as a destination for global scientific talent would be some measures that would unlock potential.

While India has enormous potential in the mining and minerals sectors, it has not delivered on its potential due to several constraining factors, the most obvious one of which has been disruption of mining businesses by environmental activists.

In the external cooperation domain, India needs to work with trusted partners that can help bridge gaps in the value chain. This would entail, for example, a closer partnership with resource-rich Australia, which is also seeking new export avenues for its mining industries now that relations with China are strained. While India has enormous potential in the mining and minerals sectors, it has not delivered on its potential due to several constraining factors, the most obvious one of which has been disruption of mining businesses by environmental activists. Through a combination of internal reforms and international partnerships, whether through bilateral initiatives or multilateral forums like the Quad, the materials deficit must be bridged.

The second aspect of external cooperation is in trade policy. By adopting a regime of tariff protections—much to the consternation of free trade ideologues—and boosting domestic manufacturing through targeted production-linked incentive programs, India has shown it will not be hidebound by received economic wisdom which may not be as universally applicable as the ideologues claim. Some promising results have already been achieved, with electronics assembly gaining significant traction and companies now integrating backwards in the value chain, and manufacturing intermediates and components. The same playbook is likely to deliver results in sectors such as pharmaceuticals, specialty chemicals, and advanced materials. But while trade defense instruments, as some European think tanks like to call tariffs, are gaining acceptability with more countries taking cognizance of the Chinese mercantilist model, it remains imperative for India to close bilateral trade agreements with friendly countries, thus linking trade policy to foreign policy.

Through a combination of domestic and external-focused policy interventions targeted across elements of the materials, intermediate and product segments of the value chain, India will create space for its globally sought-after engineering talent to excel at home and build up high-value export industries and national capabilities in CETs. There are clear economic and strategic payoffs to investing in CET development, and without the right enabling measures, both sustained economic growth and national security would be under a cloud.

[Originally published as two essays by New Delhi-based think tank ORF:

Part I - https://www.orfonline.org/expert-speak/innovating-for-prosperity/

Part II - https://www.orfonline.org/expert-speak/enabling-india-to-lead-in-the-development-and-deployment-of-critical-emerging-technologies/]