Hugo Scott-Gall: Today, I am delighted to have with me Raghuram Rajan, Professor of Finance at the University of Chicago’s Booth School.

He has served as Chief Economist at the International Monetary Fund, Chief Economic Adviser to the Government of India, the Governor of the Reserve Bank of India, and Vice Chairman of the Board of the Bank for International Settlements. Dr. Rajan’s research spans banking, corporate finance, and economic development. His acclaimed books include Fault Lines and The Third Pillar, and most recently, Breaking the Mold: Reimagining India’s Economic Future. Welcome to The Active Share. Thank you very much for joining us.

Raghuram Rajan: Thanks for having me.

Hugo Scott-Gall: Well, big picture question, which I really think is the thread that runs through your most recent book, which is your growth algorithm for India. What is your growth prescription for India? How does India achieve its growth potential? I think the argument you’re making is that it’s not the classic growth path that emerging countries followed in the 20th century. It’s something different. So, I’ll hand it over to you to describe your prescription, how India should grow in the 21st century.

Raghuram Rajan: Well, thanks for having me on the show. Many East Asian countries, in the 20th century, followed a path which became tried and tested as a way from poverty to riches. Basically, focus on low skilled manufacturing, usually assembly, with the intent of exporting goods, use global markets to achieve scale, and keep moving up the production chain to higher value-added items until you have become developed.

And at that point, you start slowly switching into services for the domestic population. But really, manufacturing is the sector that absorbs all the people who leave agriculture, and you move up the manufacturing ladder. And if you look at Japan, if you look at Korea, if you look at China, they all followed that path.

Problem, in our view, is multifold today. India sort of never really took off on that path. It certainly has a reasonable manufacturing sector, but never one that focused significantly on exports. And so, for India, the manufacturing share of the workforce has remained fairly constant for the last four decades or so. And what’s really grown is services. Now, this is not just IT services that everybody is typically familiar with, but also the usual services that countries have, such as retail, people working in retail, people working in logistics, people working in security.

But the point, however, is how does India grow from here without a strong manufacturing sector? And most people say, “Well, let’s rebuild manufacturing. Let’s focus on the things that need to be done to get manufacturing up and running.” And that’s what the government has been doing, building out infrastructure, but also focusing on trying to improve the manufacturers who have sites in India, sometimes by subsidizing them usually. What we’re arguing is that avenue for growth is really much harder today.

Because when these East Asian countries started out, they were competing with the West, with rich industrial country workers. Now those workers have been displaced. What is left to compete with are other emerging markets with cheap labor, such as Bangladesh and Vietnam. And move a little bit up the value chain, you encounter China, which still hasn’t moved up the value chain in every part in manufacturing.

The other huge problem is growing protectionism in the West. Every country wants its own manufacturing sector. And they’re willing to give up a little bit in terms of cost efficiency in order to bring it back home, to reduce the political clamor against the exporting of manufacturing jobs, and, of course, to build resilience in their own supply chains. So, the extent of manufacturing protectionism, it’s been growing. It’s still not made a huge dent, but it suddenly changed the direction of trade. In this environment, for India to expect that the world will be as open to another China, so finding its way up the manufacturing ladder, is perhaps very optimistic.

On the other hand, India has a really strong services sector. It’s much larger in terms of its services exports. And this is not just IT services. What has grown tremendously since the pandemic is a whole variety of other direct services. Such as consulting. Such as, you know, telemedicine picked up a little bit. But also, things like legal services.

So, the point that we’re trying to make is, let’s not get fixated on all paths of roads. There may not be that much political rule. There may not be that much economic rule to follow that path. But there could be an entirely different path that no country has tried before, which is to move up the services ladder. Which you already do a fair amount of. India has 300,000 engineers doing chip design today, without a single chip boundary in India. So, can we move up that ladder? Let’s think about what it takes.

Hugo Scott-Gall: So, what does it take to do that? I guess you’re going to say it’s human capital. And it’s easy to say, I think, at a headline level, it’s education, education. But it’s quite hard to change, even in a generation, a country’s human capital, its skills, its skill base. So, I think your prescription, go for services. Miss out manufacturing from that agriculture to manufacturing to services. Miss out the middle bit of manufacturing, go straight to services.

But to do that, you’ve got to have demonstrable competitive advantage in services, given that you’re doing that not just for domestic, the domestic market, you’re doing for export as well. So, how does India produce world class services in what is a competitive landscape?

Raghuram Rajan: We’re a little hesitant to prescribe services. We’re saying look at services because you’re already pretty good at it. But pain of India, and I think increasingly pain in many countries, is the notion that government knows which direction to go. And so, we’re hesitant to prescribe industrial policy. Because then it becomes what’s the favorite toy of the bureaucrats currently? And currently, across the world, it seems to be, “Let’s build chips.” Many billions are being invested there, even in India.

And so, the first answer to your question is, let’s stop doing stupid things which waste resources, when in fact, the resources are much better used in building your human capital. And you have to build human capital regardless of whether you’re going to go into manufacturing or to go into services. India needs far better educated and trained people across the board. That’s number one.

Number two is the low hanging fruit in the world today are services. Competition in services is much lower. And you may say, “Well, why hasn’t it been taken advantage of?” Two reasons. One, English language. Many developing countries don’t have the English language. India has that. And second, work at a distance was much much harder pre pandemic. Now it’s become much more acceptable. So, that consultant who’s sitting in Seattle is providing services in Chicago, that same consultant could well be sitting in Bangalore and providing services in Chicago. And increasingly, firms are finding that out.

So, you’re seeing a massive move towards increasing the workforce in emerging markets, certainly in India. Many companies now are starting what they call global capability centers in India. Hiring people to provide, not back office, but even semi front or front office services. To give you an example, I mean, a consultant in the United States, fresh from MBA school, costs about $250,000. The cost in India from the best business schools is $40,000. And they’re not that different. So, in that sense, the labor arbitrage is shifting to services today. And I think, certainly in high skilled services, India has already a presence and could expand that.

Now, the key however, which you correctly see, is we need much broader based improvements in human capital. That elite fringe of universities that produce the top graduates, those graduates can work in the best jobs in India or across the world. Many of them go on to do master’s and Ph.D degrees elsewhere. What we need is the average to come up substantially. And that requires an improvement, not in the numbers, but in the quality of education.

And that’s harder, of course. It takes more time. You have to start focusing on that. You have to see that’s the issue that you need to fix. And just as an example, you offered $2 billion in subsidies to Micron to set up a packaging plant in India because chips are the new flavor of the month for bureaucrats. And that’s more than one third the higher education budget of India. So, what we’re trying to do is change the focus.

Now, can it be done? Yes. I mean, look at China. China has created a higher education establishment, a university establishment, which is increasingly second to none in the world. Tsinghua University is one of the best in the span of one and half to two decades because they focused on doing it. And what we’re saying is, focus on the right things and it can be done. India has a massive diaspora across the world.

Some of them can be attracted back, much as the Chinese did. To seed new universities as faculty, we send a lot of students abroad, bring some of them back. The key resource in higher education is faculty, and we need to improve the quality of faculty across sized establishments. We have plenty of establishments. We train one and a half million engineers a year. But only a fraction of them are up to snuff. And we need to do far more to improve the average quantity. And it can be done if there’s a way.

Hugo Scott-Gall: Is part of the challenge that agriculture is still a big employer, and that people leave school in their teens rather than going to tertiary education, or even before, to go and work in agriculture? Is that something that holds the country back? And second question is, do you think tertiary education needs disrupting? That the elite universities have a vested interest in staying elite, and so they just don’t—as demand expands, or they don’t even know how big demand is, but they don’t really scale themselves because they want to keep the badge scarce?

So, there’s two questions really. One about agriculture. Does that soak up a lot of labor that could stay in education, and get better educated for longer? And second question is, really, is this a problem which I think the U.S. has, which is the elite universities, to stay elite, restrict supply? And now, have ways of scaling themselves, principally digitally, that they don’t really embrace?

Raghuram Rajan: On the first question, agriculture is not a barrier. If you look at people in agriculture, they desperately want to leave. Because it’s low productivity, low paying. If you look at agricultural wages, they haven’t increased for the last decade or so by more than one percent. So, people want to leave agriculture. And the way out is good education.

We have an example in the book of this young boy, Mustafa, who was stuck on the farm. The problem is he doesn’t have support at home, and he fails in sixth grade. And that’s the problem with many Indian kids. They drop out of school because they don’t have either good education at school, or the support at home to continue learning. And they fall further and further behind in class, and they drop out. He drops out. He’s pulled back into class by his teacher, who says, “Come. This is the only way out.”

And it’s a formidable story of this guy working really hard, topping the class in mathematics after failing, starting to get his classmates to come around and respect him, topping the school. And then eventually, starting a firm which makes fresh idli batter. It distributes it in a bunch of urban cities, and now employs 2,500 people. That’s the sort of beautiful story of New India that we would like to see more of. But the barrier is a good education. Primary schools need improvement in quality. Secondary schools need improvement in quality. And there are ways, to the point about, how do they mass produce quality education?

One of the examples we offer in the book is of this entrepreneur who started something called Orchids International. Which is an attempt to give high quality high school education in mass numbers. And the way he does it is through what is called scripted learning. Every class has been mapped out. “Here is what you will teach in the beginning of the class. Here’s the video you’ll put up. Here’s the exercise you will give the students. And we automatize grading.”

And what happens is, every class, the 30,000 lesson plans prepared, you don’t need a great teacher to deliver them. You need a reasonable teacher. And so, what you’ve got at the end of it is a very scripted curriculum. But you managed to scale up from those small private schools, which are much sought after, to teaching 300,000 students in a year. That’s the number he has.

And so, my point, or our point, is that we need to find innovative solutions like this. Scripted learning has been found by colleagues in the Harris School, including Nobel laureate Michael Kremer, to be really effective ways of improving the learning for kids in school. And India has to embrace much more of this to improve quality.

Your second point. So, in other words, poor parents desperately want their kids to get out of agriculture. And they’re willing to pay to take the kids out of government schools into—these are called private schools. But they’re really schools where you pay a fee, and the teacher actually shows up. And that’s the advantage over the government school. And they’re willing to do that just to give their kids a better chance. So, nobody wants to stay in agriculture if they can help it.

To the second point, are the elite universities sort of holding back? No, I think the problem really is that we have a ton of lower quality universities which are trying to see education as for profit. And haven’t invested in getting better quality teachers, better quality facilities, ensuring that the labs actually have equipment, and the faculty know what they’re teaching.

You are seeing some of those bad universities, bad colleges, which often are set up by politicians who get the licenses to set these up, that those are being weeded out. And so, quality is emerging very slowly. But we really need far more universities of high quality. And even our elite universities are good, but not great. We don’t have a Tsinghua. The closest India has to that is the Indian Institute of Science, which needs substantial upgradation to be of a similar quality.

So, much work to be done. I think it’s to some extent, the lower quality universities, which are sort of holding India back and need an improvement in quality, rather than the elite universities.

Hugo Scott-Gall: So, if India is going to be—I mean, it already is in some ways. Think about IT services. If it’s going to become a services powerhouse, who is it going to take market share from?

Raghuram Rajan: So, it’s an interesting question. I mean, that’s a question which sort of asks—you have a fixed pie, and let’s see how we divide it. The pie will also grow. And of course, that’s the easy answer. The pie will grow, and we need to—but let me give you some examples of how it can grow if we do the right thing.

I mean, medicine is a place where many industrial countries actually have a problem because they don’t have enough supply of doctors, nurses, and so on. In the U.S., for me to get an appointment to see a general practitioner, it takes three months just to get an appointment. And I have private insurance. So, it’s not as if this is the national debt scheme. But you also have NHS, which is backlogged hugely.

If we could reach a deal, whereby some elements are taken up by telemedicine and some elements are taken up by health tourism. Send your patients to our hospitals which have spare capacity, and we can serve both our poor patients, but also rich patients in the industrial world, at a fraction of the cost that it would take there. It would be win-win. You see the patient backlog come down in the U.K. and the U.S., and you get low-cost services being provided at a distance.

Now, this requires a lot of work. I mean, for example, you need to trust the doctor in India. How do you trust the doctor in India? Well, you need organizations spanning countries. For example, the Cleveland Clinic. If it went to India and set up a branch there, providing telemedicine, it could provide the front which would sell those services in the U.S., and similarly an organization in the U.K. But also, what you need is a change a national health insurance. That we’re willing to pay for certain services. If you get them elsewhere, that will help bring down our queue.

Now, what is the advantage for the industrial country? It’s one, of course, as the populations age, they still manage to provide some of these services. The second, equally I think important, is you don’t have to import the doctor, lock, stock, and barrel, into the country, and then have the issue of assimilation. And so, one, they can work at a distance, and it can be beneficial. So, those are really, that’s in one example. Of course, there will be areas where there will be competition. But again, a rich Indian, sort of upper middle class, what do they spend their money on? They spend their money on a lot of goods and services from the West. So, I think it can be win-win. It doesn’t have to be lose-lose.

Hugo Scott-Gall: So, I want to talk a bit about the role of institutions. And there’s a lot of literature here. I guess there’s Robinson and Acemoglu. There’s a little bit Joe Studwell, How Asia Works. Does India have the institutions it needs to allow for—to be very good at services, I think you could argue that you need an education system that rewards some aspect of creativity, some elements of creative thought. So, a system that allows for entrepreneurialism and risk taking.

To do that, you probably need to have quite strong institutions. Strong in the sense that they are underpinned by rules that are adhered to, so you have property rights, you have strong laws. And probably, you have a strong democracy underneath. Do you agree with what I’ve said? And then secondarily, do you think India has sufficiently strong institutions? Or if it doesn’t, do you see it on the road to having sufficiently strong institutions to allow for risk-taking entrepreneurialism, creativity, that allows you to compete in international markets and services?

Raghuram Rajan: This is important, and it’s sort of the substory in the book. The book is sometimes read as, we’re advocating a fresh look at services. We’re certainly doing that. But we’re also saying that what used to be core of India’s weakness, it’s democracy. If you look at democracy and development time, India became a democracy well before the U.K. or the United States. It became a democracy when it was really, really, poor. And some people have argued that democracy held India back. That you couldn’t build the roads, and airports, and railway lines. You couldn’t force development like many of the East Asian countries did. Maybe there’s some truth to that.

It also turns out India didn’t do as well on education as Communist China or Communist Vietnam did. That is surprising, but it’s a fact. What we’re saying is, okay, that may have been a problem earlier, but today, democracy stands as a strength for India. Because of what you just said, it creates some of those institutions. Which are really important, both to enhance the capabilities of your population, to give them the room to be creative, to innovate, and as important, to inspire trust in other countries. So, you’re seeing today, for example, in the United States, proposals to ban TikTok. Because there is a concern that TikTok will harvest people’s data and then be available to the Chinese Communist Party.

What you need is a democracy which puts checks and balances on the government, so that you can inspire trust in other countries. Services are hugely data intensive. And no country would want another country’s government to have access to data on their citizens. So, one way India can expand services growth is by actually putting strong privacy protections, including protections against the government. And this is something India can do. The book is written in a way to say, if you are eliminating these protections, if you are eliminating checks and balances, if your democracy is becoming less sound, this is also hurting your economic future, and it needs to be reversed.

So, does India have a reasonable democracy? Yes. Is it strengthening? No, it’s weakening. And that needs to be reversed. India needs to focus on making many of its democratic institutions more independent. And that will allow it to actually expand in these areas much more so than if it goes the China way. That’s sort of another reason for saying the China Way doesn’t utilize your greatest strengths, your democratic institutions.

Hugo Scott-Gall: Do you think the argument you just made is well understood, and then dismissed? Or do you think it’s not well made, and therefore, isn’t well understood?

Raghuram Rajan: I think that it certainly is well understood by people who read the book. I think there is China envy in India. We see where China is, and then we want to be like China. And of course, that fits well with an authoritarian streak in the current ruling establishment, the BJP. And as a result, we have been held back by democratic niceties. We need a strongman who will lead us into the 21st century. In a sense, the point of the book is no, a strongman led us into the 20th century. We need a more democratic structure to lead us into the 21st century. And that’s as critical to our economics as all the other things we’ve talked about. Including health and education.

And in fact, the quality of health and education requires empowerment of people, so that they can demand better quality to what they’re getting. And simply thinking that a strong leader will get us to where we need to go is misreading history in many ways.

Hugo Scott-Gall: It’s very interesting what you say about China. How it looms very large, for any country, particularly one as populous as India, in trying to move up that developmental curve and trying to increase its GDP per capita. So, obviously, what China did, you look at what China GDP per capita changed, China’s GDP changed in the 1990s, the early 2000s. It was incredible. But China is there. China is, I think a comment you said, that China is a gorilla on the ladder. So, it’s difficult to go past.

But do you agree with this statement assertion that, right now, India has pretty high soft power in the world. Everyone wants to be India’s friend. It’s not China. So, on the China Plus One argument. So, it is courted by the West, courted by these—and it tries to stay neutral, but it’s certainly desirable. It’s strategically desirable. So, should India make sure it uses that soft power dividend wisely? And do you think it is, given its the world geopolitically is clearly a different one versus 20 years ago, versus 30 years ago—some countries, that’s bad news—for India, maybe that’s good news?

Raghuram Rajan: I do think that the world is looking for an alternative to China. Whether it’s the China Plus One idea or finding a way to diversify from China. Whether it is people looking for new markets which they can access without the fear of conflict between countries. People looking for workforce which can provide cheap labor. I think that search is certainly on. And India fits the bill in many respects.

The concern that some of us have is that India has strength. Why it is seen as a reasonable alternative is precisely its democratic values. If it moves towards new authoritarian structure, it becomes, eventually, less desirable as a friend by the democracies of the world. And so, that’s another reason to ensure that we do stay democratic. And there is a battle before democracy in India today. That’s one of the big themes in the elections.

Regardless of what happens in the elections, I think India needs a strong opposition to ensure that there are checks and balances on the government in power. It also needs to revisit some of the powers that the government has, which were set up by our founding fathers, in the post independence era, to keep the country together, but have ended up giving the central government tremendous power. Which a big country like India requires far more decentralization, far more checks and balances. And that’s what we need to work on also, even as we work on our economy.

And I think if all this goes well—and there will be ups and downs. There will be a period, potentially, of authoritarianism. My hope is that India finds within itself the ability to reverse some of these things. And that in the longer run, it becomes a country that stands by its values, its democratic values, and is trusted by the democracies of the world.

Hugo Scott-Gall: I guess one of the lessons from China is that decentralization was actually very powerful. That local government, local authorities. Now you can maybe say, now there’s been a property collapse that actually, maybe there’s—some of those revenues were assessed. But local governments were in power to do things, and they did do things, they got things done. Does India need more of that?

Raghuram Rajan: You’re exactly right. I mean, if you look at the China model, I mean, Chinese rules and regulations are as bureaucratic as India’s. But what happened is that many local authorities could redefine the rules, sometimes break them, for the local firms. And those competition between the local authorities, because they were rewarded on issue—on the growth they produced locally, and the promotion that the Communist Party happened much faster, they did well.

We call that competitive cronyism. The competition keeps the cronyism down. But the cronyism is very effective in creating a path through the thicket of rules that hamper business. And while we’d prefer not to have cronyism, we’d prefer the rules to be much more sensible, the notion that local authorities can help business is certainly something that India should be inspired by. That’s one of the benefits of decentralization.

The other benefit, which India already experiences from the few states that are decentralized, is that the local authorities have much more of an incentive to improve the quality of healthcare, to improve the quality of education, of the local schools. First, because the parents can hold them responsible, and can protest if things aren’t good. But second, if you do the right thing, you can get reelected, reappointed fairly easily. While if you’re in the central government, and you’re changing the nature of education, it’s much more and more, takes much longer, and you don’t really get rewarded for it.

So, where one of the strongest messages in the book is India has to be centralized far more, the state of Uttar Pradesh has 240 million people. By the strength of the people counted, it would be the fifth or sixth largest country in the world, but it’s all governed from the state capital of Lucknow. That’s really over centralization.

Hugo Scott-Gall: I guess one final question. In your book and your prescription, it’s clearly optimistic that if India can do half the things that you hope it does, there’s an optimistic future for India. Do you feel there’s enough optimism within India? And do you think that optimism has a role to play in making change? In understanding some that uplands how to get there?

I think you made the case, certainly from my point of view, very well, that if India is going to set out to be like China, the big problem is there’s already China. But if India sets out to really maximize its competitive advantages, which it’s already demonstrating in some of the service industries, that is likely a more optimistic case for India. But there needs to be—the argument needs to be well made. Obviously, you’re making your contribution. But you do need optimism. You need tools and resources to solve problems. And you probably need some optimism, some risk taking. Do you think there’s enough of that in India? Is it well understood? As a country that’s got a very socialist history, has the case for capitalism and all the good sides of capitalism been made well enough?

Raghuram Rajan: It has. The worry we have is two-fold. One is excessive confidence. Breeding and complacency. Our time has come. We’re there. And we’ve done everything we need. And we have the ruling party which will take us there. And that’s where I see, perhaps, the lack of a vision. What is there? It can’t be China. Because as you said, China is already there, sitting on the ladder. And if you’re trying to replicate China, be a poor China as we say, that vision is going to lead nowhere very quickly, and lead to disillusion. So, one is to guard against excessive complacency.

The second is really to say that it’s building on the first. If things go business as usual, you will fail. Because you will not have invested in what is the critical asset you need to build up, which is your human character. And if you don’t recognize the fact, that is where you need to put your resources. We will continue trying to get up the manufacturing ladder. A few people will come to India. You will celebrate when Apple builds—says it’s going to build its iPhones in India. But you will stay very low end. You will not move up the value chain. And for India to become rich before it gets old, and it is getting old by around 2050, it has a window about 25 years in which it needs to accelerate through.

And so, in this book, what we offer is a large number of examples of how India can do things right. But that is not to say those examples reflect the norm. They reflect the outliers. What is possible. And what India has to do is make it more that the norm reflects those outliers. There are states in India which have healthcare, which approximates a high second world, almost first world level. And there are states in India which have healthcare, which approximate the worst outcomes in sub-Saharan Africa.

And so, what we need to do is win business jobs and ensure best practices across the board. How do we do that? How do we shake ourselves up and say, “We need a new path”? And that will not happen unless we recognize where we need to go, and how we need to get there. This book is, in some sense, a wake-up call. India is capable of a lot but needs to recognize that it needs to do its homework. And the greatest danger for India is chest thumping nationalists who say, “We’ve arrived, and all we need to do is collect the rewards.”

Hugo Scott-Gall: That’s a great place to finish. So, I want to say thank you for coming on the show. Thank you very much. It’s been great, and a pleasure, and a treat to have you.

Raghuram Rajan: Thank you for having me.