India’s Wake-Up Call

Making the growth case for India involves answering one key question: How can India differentiate itself from China? In this episode of The Active Share, Hugo and Raghuram Rajan, a professor of finance at the University of Chicago’s Booth School of Business, discuss what it would take for India to evolve into a global economic powerhouse.

Comments are edited excerpts from our podcast, which you can listen to in full below.

How can India achieve its growth potential?

Raghuram: In the 20th century, countries such as Japan, Korea, and China followed a development path that focused on low-skilled manufacturing (with the intent of exporting goods), using global markets and higher-value-add items to achieve scale and grow into developed countries.

But that wasn’t the case for India. Its manufacturing sector never focused on exports, and the portion of its workforce in the sector has seen little growth over the last four decades. While the Indian government has been expanding its infrastructure, it’s unclear how India can grow without a strong manufacturing sector, as that avenue of growth is much harder today.

But there could be an entirely different path that no country has tried before—moving up the services ladder. India has a particularly strong services sector across industries such as information technology (IT), retail, legal, consulting, logistics, and security, with services exports having grown tremendously since the pandemic.

In today’s services landscape, does India have what it takes to produce world-class services?

Raghuram: Competition in the services sector is low, but many countries have yet to take advantage. And there are two reasons why.

One is the English language—many developing countries don’t use the English language. Two is the proliferation of remote work post-COVID. A consultant in Seattle who provides services in Chicago could be sitting in Bangalore.

In addition, there is a massive shift toward increasing the workforce in emerging markets. Many companies are starting global capability centers in India, for instance, because of cost efficiency. A consultant in the United States, fresh from business school, costs about $250,000, while the same consultant with the same education only costs $40,000 in India.

But the key to India’s success in services will be based in human capital. Top graduates from elite Indian universities tend to complete higher-education programs elsewhere. Retaining these graduates will require an improvement in the quality of education in India.

This will take time, but it can be done. For example, China has created a higher-education establishment that’s increasingly second to none in the world.

The key to India’s success in services will be based in human capital.

In India, we send many students abroad and bring some of them back to help seed new universities. Not only will we need to work to attract more of these students back to India—much like China has done—but we need to improve the quality of faculty across establishments, as faculty is one of the key resources in higher education.

Overall, the labor arbitrage is shifting to services today, and I think India could easily expand on their presence in the sector.

Agriculture is still a large employer in India, and many people leave school in their teens to go and work in agriculture. Is this a challenge to India’s economic growth?

Raghuram: Agriculture is not a barrier, but people in the sector want to leave because it's low productivity and low paying—agricultural wages haven’t increased in the last decade by more than one percent.

In Breaking the Mold: Reimagining India's Economic Future, I write about a young boy, Mustafa, who was stuck on a farm. He didn’t have support at home, and he failed the sixth grade, eventually dropping out of school. This is the case for many Indian children.

But Mustafa was pulled back into class by his teacher who told him, “School is the only way out.”

Mustafa ended up working hard and graduated at the top of his class. Eventually, he started a company that makes fresh idli batter. That company now employs 2,500 people and distributes product in urban cities throughout India.

It’s a formidable story of New India that we’d like to see repeated. But the barrier is good education. How can India mass produce quality education?

Another example is an entrepreneur who started Orchids International Schools, which is an organization that offers innovative, high-quality education in multiple cities throughout India. Orchids utilizes scripted learning, where every class and lesson plan has been pre-planned.

With this method, you don't need a great teacher, just a reasonable teacher. Scripted curriculums have allowed Orchids to scale up from small private schools to teaching 300,000 students in a year.

In addition, poor parents desperately want their kids to get out of agriculture, and they're willing to pay private school tuition. This guarantees the teacher shows up, which is an advantage over government-funded schools.

Another problem is that India has many lower-quality universities that view education as profit but haven't invested in better-quality teachers or facilities. These universities are often set up by politicians.

But quality is emerging, albeit slowly. Our elite universities are good, but not great. The closest comparison to China’s Tsinghua University is the Indian Institute of Science, which still needs substantial upgrades to be similar in quality.

Competition in the services sector is low, yet many countries have yet to take advantage.

Does India have strong democratic institutions?

Raghuram: India became a democracy well before the United Kingdom or the United States but did so when it was extremely poor. Roads, airports, and railway lines were unable to be built, and some people have argued that democracy held India back.

But today, democracy is one of India’s growing strengths. It’s helped create institutions that have enhanced the capabilities of India’s population, giving them room to be creative and to innovate.

One way India can expand its services growth is by implementing strong privacy protections. Because services are hugely data intensive, no country would want another country’s government to have access to its citizens’ data.

India needs to focus on making many of its democratic institutions more independent, which will allow it to expand in areas such as services. If India ever eliminates these protections and checks and balances, and if its democracy ever becomes less sound, its economic future will be in jeopardy.

What kind of influence, if any, does China have on India?

Raghuram: I think there is China envy in India. We want to be where China is. But while a strongman led us into the 20th century, we need a more democratic structure to lead us into the 21st century. Thinking that a strongman-type leader will get us to where we need to go is misreading history in many ways.

China looms large for any country, but particularly one as populous as India. How can India make sure it wisely uses its soft power dividend?

Raghuram: I think the world is looking for an alternative to China. Countries are looking for new markets that they can access without fear of conflict, as well as a workforce that can provide cheap labor. India fits the bill in many respects.

The concern that some have is that India is very strong. If India moves toward an authoritarian structure, it could become less desirable to other democracies of the world.

I think India needs a strong opposition to ensure that there are checks and balances on the government in power. India also needs to revisit some of the decisions that gave its central government tremendous power. A country like India requires far more decentralization.

Though there may be a period of potential authoritarianism, my hope is that India finds within itself the ability to reverse that path. And in the longer run, I hope it becomes a country that stands by its democratic values and is trusted by the democracies of the world.

Can you expand on the kind of decentralization India requires to succeed?

Raghuram: If you look at the China decentralization model, many local authorities were able to redefine the rules—and sometimes even break them—for local businesses. That kind of competition between local authorities is known as competitive cronyism. Competition keeps the cronyism down.

But cronyism is effective in creating a path through the thicket of rules that hamper business. While we’d prefer to have no cronyism, we’d also prefer to have more sensible rules. The notion of local authorities helping businesses is something India should be inspired by and is one of the benefits of decentralization.

The other benefit, which India already experiences from the few states that are decentralized, is that local authorities have an incentive to improve the quality of healthcare and education, as citizens can hold them responsible and protest if things aren't going well. In addition, if local authorities properly serve their communities, they can easily get reelected and reappointed.

India is capable of so much, but it needs to recognize that there is still work to do.

Is India capable of identifying and executing the necessary changes to achieve its economic goals?

Raghuram: I think India needs to guard against excessive complacency and thoughts such as, “India’s time has come. It’s done everything it needs to do and has the ruling party that will take it across the finish line.”

This is where I see a lack of vision. India shouldn’t strive to be the next China since China is already there, sitting on the ladder. That would quickly lead nowhere—and lead to disillusion.

For India to become rich before it gets old—and it will be considered old by 2050—it has a window of about 25 years in which it needs to accelerate.

In Breaking the Mold, I discuss many examples of how India can achieve its economic goals. But that is not to say those examples reflect the norm. They reflect the outliers, and what could be possible.

So, what India must do is make the outliers the norm. For example, there are states in India that have healthcare systems operating at near first-world levels. But there are also states that have healthcare systems that are the equivalent of those in sub-Saharan Africa.

What India needs to do is win business and ensure best practices are in place across the board. But how does it do that? How can India shake itself up and say, “We need a new path?” It won’t happen unless India can recognize where it needs to go, and what it will take to get there.

Breaking the Mold is, in some sense, a wake-up call. India is capable of so much, but it needs to recognize that there is still work to do. Going forward, the greatest challenge for India will be its chest-thumping nationalists who say, “We've arrived, and all we need to do is collect the rewards.”