India’s Growth Path: Steady but not Straight

By almost any reckoning, the Indian economy is booming. This year, Indian officials revised their estimated economic growth for 2006 from 8% to 9.3%. This growth has been sustained over the past several years, effectively doubling India’s income every eight to nine years.

Since 1991, the year India removed some of the most crippling controls ever imposed on business activities in a non-communist country, it has not only been attracting large amounts of foreign investment, it has also begun luring back many skilled Indians who had chosen to live overseas. It has also lifted millions of Indians out of poverty.

Such a scenario seemed impossible to conceive in 1991, when the Indian economy was on the ropes, as its foreign reserves plummeted to a level that would cover only three weeks of imports and the main market of its exports (the Soviet Union, and by extension, the eastern bloc) unravelled. Forced to make structural adjustments to its economy, India lifted many restrictions on economic activity, as a result of which macroeconomic indicators have improved vastly (Table 1). Foreign investors, once shy, have returned.

The gross domestic product grew at a compounded rate of 9.63% annually during this period, and capital inflows increased dramatically. This change is remarkable because since India’s independence in 1947, it had pursued semi-autarkic policies of self-sufficiency and self-reliance, placing hurdles and barriers in the path of foreign and domestic businesses. Foreign investors shunned India because they were not welcome there. Restrictions kept multinational firms out of many areas of economic activity, and once in, companies were prevented from increasing their investments in existing operations. In 1978, the government asked certain multinationals to dilute their equity to 40% of the floating stock or to divest. IBM and Coca Cola chose to leave India rather than comply. Six years later, a massive explosion at a Union Carbide chemical plant in Bhopal, which killed more than 2,000 people within hours of the gas leak, brought India’s relations with foreign investors to its nadir.

The biggest change in 1991 was that India stopped micromanaging its economy by instituting policies:

• Allowing foreign firms to own a majority stake in subsidiaries;
• Liberalizing its trading regime by reducing tariffs, particularly on capital goods;
• Making it easier for businesses to take money in and out of India;
• Lifting limits on Indian companies to raise capital, to close business units that were no longer profitable, and to expand operations without seeking approval from New Delhi; and,
• Complying with the World Trade Organization (WTO), after considerable internal debate and opposition, by strengthening its patent laws.

This last measure is a brave one, because there is a considerable body of Indian opinion, ranging from anti-globalization activists to open source enthusiasts, aligned against strengthening the patent regime. India has had an ambivalent relationship with the idea of property and private ownership: Squatting on somebody else’s property is not unusual; Indians copy processes and products, not always successfully; they resent multinationals exercising intellectual property rights; they protest when foreign firms establish such rights over products or processes Indians consider to be in public domain; and India has one of the world’s most enthusiastic communities of software developers who prefer the open-source model.

After passing legislation confirming India’s compliance with the WTO intellectual property rights regime, government officials now hope that many more companies will join the 150 multinational companies, including GE and Microsoft, that have set up research and development (R&D) labs in India to tap into the country’s talent pool of engineers. But its legislative will is already under challenge. The Swiss pharmaceutical company Novartis, which makes an anti-leukemia drug called Gleevac specifically targeting a particular form of cancer, has tested the new law, by seeking to overturn a local ruling that would have prevented Novartis from extending its patent over Gleevac, at a time when Indian generic drug makers want to enter the market. The new Indian law allows patents to be granted on new versions of older medicines, provided the company can show that the new version is a significant improvement on the original version. Health activists say millions of lives are at stake; Novartis says only about 7,500 people in India are affected by this form of cancer, and 90% of them receive the medicine for free, as part of the firm’s philanthropic activities. The case, which is being heard in an Indian court, will be a measure of India’s determination to continue opening its economy.

Because of its well-founded concern with providing millions of poor people with affordable medicine, India has for years maintained a drug price-control order, which restricted the prices companies could charge for pharmaceuticals. In addition, its patent policies prevented multinationals from patenting products; they could only patent processes. Indian generic drug manufacturers could circumvent patenting processes, which meant an Indian company could manufacture a copycat drug, with virtually no development costs, simply by finding an alternative process for producing the drug. That is changing now, and with interesting consequences.

Today, most sectors of the Indian economy are open for foreign investment (Table 2). As a result, foreign investment has increased across the board, with electrical products, electronics products, and telecommunication sectors being the main beneficiaries of the new regime (Table 3). To be sure, these figures appear small compared to the amount of foreign investment India’s immediate rival China attracts yearly. But domestic capital formation is high in India, making India less reliant on foreign investment than is China, and Indian governments have had to do with a fractious opposition, which has vocally opposed liberalization.

Indeed, the past 15 years haven’t been politically easy. The kind of stories for which India routinely attracts headlines—terrorist attacks, religious strife, caste-based violence, natural disasters, the nuclear standoff with neighboring Pakistan, violence by movements seeking greater autonomy, if not outright independence—have continued to appear with unfailing regularity. On top of that, India has had five parliamentary elections in this period, yielding five different prime ministers leading outwardly unstable coalitions. And yet, the economy has continued to grow, as if on auto-pilot, ignoring these distractions.

Annual economic growth of 8% means that India adds the equivalent of the national income of a medium-sized European economy to itself every year. In theory, it means giving every Indian $200 a year in a country where one in four Indians continues to earn less than a dollar a day. This has raised millions out of poverty, spread stock ownership among the middle class, and made billionaires out of some Indians. There are now more than two dozen Indians on the list of the world’s wealthiest individuals published by Forbes magazine, and you find them increasingly at the World Economic Forum at Davos.

Indeed, for the past several years, India has been the talk of the town at Davos. Whether among delegates or among speakers on various panels, Indians are ubiquitous. India has used this visibility to distinguish itself from China by emphasizing its pluralist democracy as much as its high-growth potential. At the Zurich airport where most Davos delegates arrive, India has posters advertising itself as “the world’s fastest-growing free market democracy.” This growth momentum is remarkable because for a long time, the economy grew at what the economist Raj Krishna derisively called “the Hindu rate of growth” of some3% per year.

The un-China

In many ways India is emerging as a major counterpoint to China. To be sure, China is far ahead of India in having built much superior infrastructure. It attracts multiples more of dollars in foreign investment and dominates global trade. China is extending its railway lines to remote parts of its western region, and today there are more skyscrapers in Shanghai than in Manhattan. But while China is building from scratch, India is fixing and tinkering with its creaking infrastructure. China had few railway lines to start with when the Communists assumed power in 1949; India had the world’s largest rail network at Independence in 1947. In keeping with its revolutionary ethos, China eliminated its entrepreneurs, sending them into exile or labor camps; socialist India permitted them to operate, keeping them hidden from public view as though they were the family’s black sheep.

India can only tinker with its infrastructure and cannot steamroll reforms, because it cannot ignore people at home who oppose its policies. As we shall see, this opposition applies to how India deals with its technology as well as to how it handles its political and religious conflicts. China has the luxury of not dealing with public opinion. Mountains are high and emperors are far away when it comes to making money, but the unitary state asserts itself if anyone disrupts what Beijing considers harmony. In India, adversity in the countryside can attract media attention and broad public outrage, which can be powerful enough to topple a ruling party.

China is overwhelmingly dependent on foreign capital (although as its savings mountain rises higher, less so), whereas in India, the domestic private sector, which has always existed, reinvests much of its retained earnings, and its domestic stock markets are relatively efficient at intermediating between savings and investments. As a result, annual flow of foreign direct investment (FDI) is not a good indicator of the Indian economy’s attractiveness: FDI inflow into India in 2005 was $6.6 billion; in China, the figure was $72.6 billion. But nobody thinks that China is 12 times more attractive than India. In fact, the investment bank Goldman Sachs now says that in the long run India will grow faster than China. India, which ranks 50th in world competitiveness indices, (China is 49th), has moved up five notches in recent years; China has fallen three notches, indicating a narrowing gap. The FDI Confidence Index, prepared by the consulting firm A.T. Kearney, which tracks investor confidence among global investors, ranks India as the world’s second-most desired destination for FDI after China, replacing the United States.

Sectors that dominate foreign investment in India—software, electric products, electronic products, telecommunication, chemicals, pharmaceuticals and infrastructure— require highly skilled professional staff, and India’s sophistication in these sectors surprises many outside India. How could a country with more than 300 million illiterate people also have the kind of scientific human resources that bring some of the world’s largest corporations to base their R&D labs in India?

Today, GE and Microsoft are among many multinationals that have set up such units in India, tapping the skills of Indian engineers and scientists and patenting discoveries for commercial applications. According to the U.S. Patent and Trademark Office, Indian entities registered 341 U.S. patents in 2003 and had 1,164 pending applications, compared to a mere 54 applications ten years earlier. At home, there were 23,000 applications pending for Indian patents in 2005, up from 17,000 in 2004. Indian authorship of scientific papers also rose from 12,500 articles in the ISI Thomson database in 1999 to 15,600 in 2003.

Recapturing past glory

Saying that the 21st century will belong to India, Raghunatha Mashelkar, director-general of the Council for Scientific and Industrial Research (CSIR), India’s nodal science research institute, said: “India will become a unique intellectual and economic power to reckon with, recapturing all its glory, which it had in the millennia gone by.” The glory he is referring to is of the Indus Valley civilization (2500 BCE), which had developed a sewage system that was then unrivaled in the world. The mathematical concept of zero was invented in India in the first millennium, and many concepts in the decimal system and geometry were explored by Indian mathematicians. Its ancient medical science, ayurveda, is still practiced in India, and some accounts say that in 200 BCE Indians were perhaps the first in the world to smelt iron to make steel.

Capturing the rational impulse of science was a priority for India’s first prime minister, Jawaharlal Nehru, who governed India from 1947 to1964. He told his audiences he wanted India to cultivate “a scientific temper.” At independence, Nehru said: “Science alone … can solve the problems of hunger and poverty, of insanitation and illiteracy, of superstition and deadening customs.” For him, science would pave the way towards self-sufficiency, which was a cornerstone of his concept of national security. As a fan of the Soviet-style planned economy (India continues to produce five-year plans), Nehru saw great promise in a state-led industrial effort and invested significant resources to build a massive public sector. He called those steel plants and power plants “temples of modern India.”

Nehru’s thoughts continue to reverberate in speeches Indian leaders make. In the science policy the government issued in 2003, it broadened the aims of science, recognizing its “central role in raising the quality of life of the people … particularly the disadvantaged sections of the society.” Nehru’s grandson Rajiv Gandhi, who was prime minister between 1984 and 1989, instituted technology missions to identify and champion specific technologies and to bring the inventions in the labs to market, albeit guided by the state.

The current Indian president (a largely ceremonial post) is Abdul Kalam, a missile scientist who ran India’s elite Defense Research and Development Organization lab. In his speeches, he has regularly stressed scientific thinking, promoting innovation of technology to harness the power of science to achieve broader social and economic goals.

The major initiative in this regard is the Technology Information Forecasting Assessment Council (TIFAC), set up as an autonomous organization under the department of science and technology, chaired by R Chidambaram, a former chairman of India’s atomic energy commission. The council observes global technological trends and formulates preferred technology options for India. Its objectives include:

• Undertaking technology assessment and forecasting studies in select areas of the economy;
• Observing global trends and formulating options for India;
• Promoting key technologies; and,
• Providing information on technologies.

It has produced feasibility surveys, facilitated patent registration, and prepared two important documents: “Technology Vision 2020 for India” and “A Comprehensive Picture of Science and Technology in India.” The Vision 2020 project provided detailed studies on infrastructure, advanced technologies, and technologies with socioeconomic implications, and it identified key areas on which to focus (see box).

Planning or dreaming?

Listing goals is relatively easy. Does India have the skilled people to achieve them? Does it provide sufficient incentives for R&D? Which sectors are promising? How seriously should the world take the Indian challenge?

Although the quantity and quality of India’s scientific professionals are a matter of some dispute, there is no denying that the Indian Institutes of Technology (IITs) produce what a recent Duke University study calls “dynamic” (as against “transactional”) engineers. Indeed, the saga of the IITs encompasses much of what is forward looking and backward looking in India.

The first IIT was inaugurated by Nehru, who called the IIT “a fine monument of India, representing India’s urges, India’s future in the making.” There are now seven IITs in India, and many states are clamoring for more. But there are concerns about managing quality, and a shortage of faculty members is forcing some IITs to look overseas to recruit faculty. Retaining faculty is also hard when better-paying jobs are available in the private sector.

The IITs’ extremely harsh selection regime ensures that only the brightest make it. The seven IITs accept only about 4,000 students a year, about one of every 100 who apply. Microsoft chairman Bill Gates calls the IIT “an incredible institution that has really changed the world and has the potential to do even more in the years ahead.”

The IITs have undoubtedly been good for India. They have burnished India’s reputation and produced many talented graduates who have gone on to play a major role in a wide range of businesses. But at home they are criticized as elitist and an impediment to social goals. Some have pointed out that a large number of IIT graduates leave India and that many never return even though the state has subsidized their education significantly. Kirsten Bound, who recently wrote “India: The Uneven Innovator,” a study of India’s science and technology prowess for Demos, the British think tank, as part of a project mapping the new geography of science, described an IIT as “a departure lounge for the global knowledge economy.” Although it is true that some 70% of IIT graduates left India for much of the past 50 years, in recent years the figure has dropped to 30%, according to CSIR’s Mashelkar. Other education activists have complained that instead of lavishing its resources on the IITs, the state should invest more in primary education to tackle the problem of mass illiteracy. Some argue that the IITs should replace their strictly meritocratic admission system with a quota system that guarantees that all social groups are adequately represented.

Although IITs have produced CEOs of leading western multinationals, they are not known for original research. And unlike western universities, they are not known to be incubators of entrepreneurial ideas that spawn new businesses.

IIT faculty and alumni are aware of that and encourage greater innovation. A strong foundation of research is growing in India, but it is not coming from the universities.

The environment for R&D has been evolving slowly but steadily in India. After relaxing curbs on foreign investment in 1991, India agreed to comply with the TRIPS rules on intellectual property protection. As a developing country, India was allowed a five-year period of adjustment (1995-2000) and a further five-year extension for pharmaceuticals and agricultural chemicals. Meanwhile, it amended its copyright law to be consistent with the Bern convention on copyrights and became a member of the World Intellectual Property Organization.

Multinationals recognized these changes and began establishing R&D operations. Texas Instruments set up the first real western R&D center in 1985, and today about 150 companies have R&D centers in India, where they have invested more than $1 billion. A survey by PriceWaterhouseCoopers found that 35% of multinationals said they were likely to set up R&D centers in India, compared to 22% in China and only 12% in Russia.

The Demos study found that Texas Instruments, Oracle, and Adobe have developed complete products in India. Microsoft has 700 researchers on its rolls in Bangalore, making it the company’s third-largest lab outside of the United States. GE employs 2,300 employees in Bangalore, making it the company’s biggest R&D center in the world. Many of these employees are Indians returning from abroad. Jack Welch, then CEO of GE, who decided to set up the R&D unit in India, said at the time of the opening of the center: “India is a developing country, but it is a developed country as far as its intellectual infrastructure is concerned. We get the highest intellectual capital per dollar here.” The Microsoft experience, too, has been positive for the company. Its India lab works on digital geographics, hardware, communication systems, multilingual systems, rigorous software engineering, and cryptography. Its list of advisors comprises star faculty from the IITs.

The trouble for India is that this successful commercial R&D culture has taken root in India’s domestic industries. As India was setting its course for the future, it found itself in a peculiar position. On one hand, it had a political leadership committed to promoting science and technology, and it invested in elite institutions that produced thousands of graduates with cutting-edge skills. But those graduates and institutes simply could not make breakthroughs or develop technologies in which the markets had an interest. One formidable barrier was that the governing class’s deep distrust of the capitalist model, which resulted in punitive tax laws and other policy measures designed to prevent individuals from earning excessive financial gains from their innovations. Many of those with the talent and drive to innovate decided that India was not the place for them.

The result was that government came to dominate Indian R&D. The state spends $4.5 billion a year directly, and when one adds the amount spent by state-owned companies, the state’s share amounts to an overwhelming 85% of total R&D expenditures in the country. Private firms have argued that they have not invested in R&D in pre-liberalization India because they were prevented from reaping the economic rewards of innovation. Indeed, a survey of annual reports of 8,334 listed companies on Indian stock exhanges in 2003 by the Administrative Staff College of India found that 86% of Indian companies spent nothing on R&D. Even InfoSys, arguably one of the leading Indian software firms, spends only 1% of its annual revenue on R&D, and R&D spending is low among all the IT outsourcing firms.

This may seem surprising, given that the Indian software industry has shown enormous growth in recent years and now accounts for nearly 5% of India’s GDP. The number of Indians working in the sector has grown phenomenally too, from 284,000 in 1999 to 1.3 million last year. By next year, IT exports may account for one-third of India’s total exports. Yet despite this growth, thoughtful observers have pointed out that India’s transition from maintaining source codes to innovative work has been slow. There are few Indian shrink-wrapped software products, and comparatively little intellectual property.

The major reason that India’s science infrastructure is not related to markets is because the policy environment removes some of the incentives for the private sector to invest in innovation. The critical link between the lab, the venture capitalist, and the marketplace has not been forged. Instead, India’s government-run research system focuses primarily on basic science with little near-term commercial value or develops products that do not meet market needs. According to T.S. Gopi Rethinaraj, a nuclear engineer who teaches science, technology, and public policy at the National University of Singapore: “One common feature is the general disconnect from commercially relevant and competent products and services.”

Indications that India is beginning to change are emerging in the pharmaceutical industry. India accounts for one-sixth of the global market for pharmaceuticals, and Indian companies are achieving significant success with production of generic drugs for export. The strengthening of intellectual property protection is creating an environment in which the companies believe that they will be able to reap the benefits of their research investments. Dr. Reddy’s Labs, a leading domestic drug company, spends 15% of its revenues on R&D, and other firms are approaching that level. Total R&D spending by Indian pharmaceutical companies rose 300% in the first five years of this decade, and Indian companies have begun making more complex formulations. Indian government labs and private companies have become the leading holders of Indian patents. Industry leaders believe that they could have a considerable cost advantage in the R&D stage of drug development if they can create a network of labs to work together.

Although there is considerable excitement in India with so many western firms setting up R&D units, nationalist-minded Indians worry that the country will not benefit. Some nationalists argue that talented Indians are lured from government labs by the higher salaries at multinationals and that once plugged into the global economy, they lose interest in Indian challenges and issues. But supporters say it is good that multinationals are coming to India, because it keeps Indian talent at home. Many Indians now see each new investment as a vote of confidence in India, and political opposition, while loud, has slowed. Businesses now know that India is a good place to do R&D, and many perceive that it will become even more so in the future.

Still, the public policy debate continues. The IITs have begun offering their students help in understanding the patent process, but counterfeiting remains rife. By one estimate, three-quarters of the software used in India is pirated. Criticism of the strengthening of the Indian patent regime has been most vociferous from social activists, who fear that India’s millions of poor may now find it impossible to access lifesaving medicines. They worry that Indian companies that now supply many inexpensive generic drugs to nonprofit groups for use in Africa will abandon these products. One critic, Sujatha Byravan, executive director at the Council for Responsible Genetics in Cambridge, Massachusetts, writes: “Pressure from international and domestic pharma companies has produced legislation that will create a situation where sick people will end up paying much more than they now do for desperately-needed medicines. Ignoring the ramifications of the patent bill is disingenuous.” More pointedly, she says that the Indian scientific community has been serving the needs of only the Indian middle class, not the hundreds of millions who live in abject poverty. CSIR’s Mashelkar counters that Indian laws permit compulsory licensing of drugs deemed essential, make it very difficult for companies to win extensions of their patents, and allow companies to manufacture drugs for poor countries not capable of producing their own.

The debate will continue, but over time it appears that India will become a more hospitable place to do R&D and that it will eventually spread from the labs of the multinationals to India’s domestic companies.

The long and winding road

In spite of all the hopeful signs, many major problems persist in India: The country abounds with avoidable diseases; its trains remain overcrowded; its buses fall over cliffs; its bridges collapse; its water taps run dry (and much of what comes from the tap is not safe); and the electrical system often breaks down, in part because of the widespread theft of power by the rich and poor alike. And there is the problem of the 300 million-plus people who cannot read or write. Economist Lester Thurow has pointed out that mass illiteracy is the yoke that will prevent India from rising higher.

There has been progress, but the work is never done. In 1980, two-thirds of Indians had no formal schooling, a figure that dropped to two-fifths by 2000. But that leaves a very large number of people who cannot read or write. Still, a youthful population engenders hope. President Kalam said recently: “India, with its billion people, 30% of whom are in the youthful age group, is a veritable ocean of talent, much of which may be latent. Imagine the situation when the entire sea of talent is allowed to manifest itself.”

India’s dreams remain elusive, but they are worthy dreams. The country’s emergence as a possible source of technological innovation highlights its ambiguous relationship with influences from abroad. In the Indian political culture major transformations can happen only incrementally, and a government in faraway Delhi cannot afford to ignore the demands from the hinterland.

There is genuine commitment to the Gandhian idea of self-reliance and a preference for home-grown technology and products. But there is also keen interest in modernity. In India, the land of synthesis, tradition and modernity need not be in opposition. It was modern India’s founding father, Mohandas Gandhi, who said: “I do not want my house to be walled in on sides and my windows to be stuffed. I want the cultures of all lands to be blown about my house as freely as possible. But I refuse to be blown off my feet by any.”