With a per capita income of around $2,300, India is now on the verge of entering the ranks of middle-income countries. But even at a very respectable growth rate of 4 percent, per capita income will only reach $10,000 by 2060, which is lower than China’s level today.

India must do better. Over the next decade, the nation will see a possible “population dividend” – that is, a rise in the share of its population of working age. If India can generate good employment for all its youth, it will accelerate growth and have a shot at becoming comfortably upper-middle class before its population starts aging.

Can India become rich before it becomes old? To do this, India needs a sense of urgency. The unfortunate reality is that very few of the fast-growing developers have escaped the “middle-income trap,” South Korea and Taiwan being the rare exceptions. Brazil, Malaysia, Mexico and Thailand have yet to break through. What will it take India to get to $10,000 per capita more quickly, and go on from there to the more rarefied $30,000 club within our lifetimes? If Indians want the journey to be short, they need to know where they are going.

Why Is The Manufacturing Ladder Harder To Climb Now?

Can India catch up with globally competitive manufacturers around the world? Foreign manufacturers are siting some production in India, if only to access the growing domestic market. For instance, Vestas, the Danish wind turbine manufacturer, now assembles parts in Sriperumbudur in south India. It was attracted to that place in part by the heady projection that India will soon be the second-largest market for turbines made by Vestas. Some heavy manufacturing – such as the composite 260-foot-long wind turbine blades made by American contract manufacturer TPI Composites – is also coming to India because the costs of transportation to the Indian market warrants it.

Today, most goods are produced by global supply chains, crisscrossing many countries. The supply chains exploit labor arbitrage so that little is produced by expensive workers in industrialized countries unless they are aided by significant automation. Instead, Indian labor will be competing with labor from Vietnam – or from China, which has still not fully exhausted its supply of cheap labor, especially in its less-developed Western provinces. Unlike the situation for early-developing economies decades ago, Indian workers, adjusted for quality, will not be much cheaper than their competitors. Therefore, any labor-cost advantage will be small and will not pay for other deficiencies.

And India has important deficiencies. For a product such as a fan motor to even be assembled competitively in India, border tariffs have to be lowered to rock bottom. Importantly, they have to be lowered not just on the imports of intermediate inputs, such as motor parts, but also on Indian fan motor exports to other nearby countries through which the supply chain snakes. Moreover, nontariff impediments, such as differential safety standards and border inspections, also have to be addressed to make exports seamless. But that requires India to be a part of regional trade agreements. Unfortunately, India has been resistant to signing those.

Indeed, without accounting for tariffs, a report by the Swiss bank UBS finds little difference in costs between India, China and Vietnam in the low-skill task of assembling and shipping a fan. However, Vietnam is a signatory to many more regional trade agreements and can import or export its products virtually duty-free. No wonder global supply chains go through Vietnam, and much less so through India. In fact, the share of global value-chain-related manufacturing output for India rose only slightly from 14 percent to 16 percent between 2007 and 2021, whereas for Vietnam this same share grew from 35 percent to over 56 percent in the same period.

Cipla and Intellectual Property

Consider the very successful Indian generic pharmaceuticals industry, which exported around $25 billion in 2022-23. One of the most prominent figures in this industry is Yusuf Hamied of Cipla.

Hamied’s family owned a small pharmaceutical company, which got underway producing medicines for India during World War II when imports were difficult. But after the war, multinational firms again resumed their dominance in India because their drug patents prevented anyone else from making drugs without expensive licenses – India followed the strict British Patent Act of 1911.

Cipla researcher at the R&D facility in Mumbai.

Hamied worked on a PhD in chemistry at the University of Cambridge in the late 1950s, studying under Prof. Alexander Todd, who would later receive the Nobel Prize in chemistry. After his return to India to join the family company, Hamied started campaigning against the patent act, arguing that India needed more freedom to produce drugs.

The campaign succeeded in 1972 under interesting circumstances. Cipla introduced a generic version of a blood-pressure drug, Propranolol, in India. The multinational ICI, which owned the patent, sued. Hamied sent a message to the prime minister, Indira Gandhi, making the case that the generic drug would save millions of lives and should not be denied to Indians. In response, the Indian government changed the patent law so that the end-product, the drug, could not be patented – but the process by which it was made still could. So if an Indian company found another way to make the final drug, it could do it legally. Cipla had freed itself from the patent law.

Many multinational firms left India at this time, seeing little profit in competing with generic manufacturers like Cipla and Ranbaxy. This opened the door for the Indian generic pharmaceutical industry, which started manufacturing the active pharmaceutical ingredients that go into drugs as well as the drugs themselves.

The new patent law played to the strengths of Indian pharmaceutical companies. Finding new processes to make drugs is a form of incremental innovation, which Indian scientists did very well – much as Indian engineers incrementally improve productivity. Indeed, Hamied argues that even large multinationals government-funded research more widely available in a country that did not have such a well-endowed government.

There is a broader point here. Domestic firms in developing countries primarily consume intellectual property as they try to catch up. And their ability to do so, as well as to innovate incrementally, would benefit from fewer protections for intellectual property. Josh Lerner from Harvard University has found, after examining the patent policy of 60 countries ranging over 150 years, that an enhancement in patent protection in a country is associated with more patent filing by foreign firms while reducing filings by domestic firms. This phenomenon is particularly pronounced in developing countries.

Cipla’s international claim to fame, however, came with the treatment of AIDS. In early 2001, a cocktail of three anti-retroviral drugs came to be accepted as the most effective treatment against AIDS. The prevailing price of the cocktail from multinational drug firms at that time was $12,000 a year, which put it beyond the reach of poor countries in Africa where the disease was rampant. Hamied offered it to the NGO Médecins Sans Frontières for $350 a year – that is, less than $1 a day. The offer made the front page of the New York Times. And Cipla started leading the fight against AIDS, which is no longer the death sentence it used to be.

In the meantime, multinational pharmaceutical companies started recognizing the threat that generic producers posed to their profits and worked with the U.S. government and the World Trade Organization to change patent laws across the world. By signing the Trade Related Intellectual Property Rights Agreement (TRIPS), negotiated under the auspices of the WTO in 1994, India agreed to long periods of patent protection even though this could hurt Indian firms.

Hamied argues that not only did the Indian government sign a bad deal, thus foregoing India’s natural advantage in generic drugs. But it also betrayed the Indian pharmaceutical industry by agreeing to accelerate enforcement to 1995 and to not delay enforcement to 2005 as he claims was promised. With Indian pharmaceuticals now having to pay hefty royalties on drug production, their pathways to growth became more limited.

Most countries start by expropriating intellectual property, either by outright theft or, as in India’s case, by weakening the enforcement of patents. However, once the country has built a base in R&D, it eventually starts enforcing patents strictly so that its own firms have the incentive to do research and produce original patents. Was 1995 the right time for India to start enforcing product patents? It is too early to tell, but we have not seen an outpouring of Indian pharmaceuticals research since then.

Hamied argues that with his profit margins, he really has no ability to invest in cutting-edge research. Perhaps in the longer run Indian pharmaceutical firms will participate in concept research – certainly with Indian universities, but also with U.S. universities – and start selling the drugs they have patented. Rather than going back to weak patent enforcement, this seems the better way to go. Toward this goal, research in Indian universities will have to be strengthened. For now, it seems the generics pathway to growth will have much diminished returns.

Globalization Backlash

The current inward turn in the West, a retreat from globalization, is driven partly by the Chinese dominance in manufacturing and the associated loss of manufacturing jobs in the West. But it is accentuated by the geopolitical concerns raised by China’s possible dominance in sunrise industries – 5G, artificial intelligence, battery technology and electric vehicles (EVs), drones and so on – which are capable of both commercial and military uses. In fact, despite agreeing on little else, both President Donald Trump and Joe Biden seem to agree on rolling back free trade.

Is Nearshoring an Opportunity for India to Get on the Manufacturing Bus?

The expanding conflict between the United States and China for geoeconomic supremacy suggests a possible opportunity for India. In case the two superpowers apply wide-ranging sanctions on each other or enter overt conflict, Western corporations fear supply chains running through China will get disrupted and production choked off.

They already experienced such disruptions during the pandemic. So they are looking to diversify. Many multinational Western firms are developing their “China+1” strategy – that is, for every segment of the supply chain that is in China, they are looking for an alternative producer in a country that is likely to remain friendly to the Western bloc. Some global supply chains are looking to India as their China+1 producer, especially given the growing attraction of India’s domestic market.

Yet, as they choose, they also see reasons why India is not the obvious choice. These include, of course, all the reasons we have listed earlier for why manufacturing in India is difficult, including still-high tariffs on inputs.

Even if these are addressed, though, there is the issue of physical distance. Regional trade has always accounted for far more of a country’s trade than flows to and from distant lands. Roughly speaking, there are three big regional trading blocs. About 70 percent of European trade is within Europe, 50 percent of East Asian trade is within East Asia and 40 percent of North American trade is within North America. This preponderance of trade with nearby countries is a regularity that economists refer to as the gravity model of trade.

The TravelKhana call center in Noida, India.

With the exception of China, India is surrounded by relatively poor countries. If a U.S. company wants a cheap production locale that is not subject to as much disruption risk as China, it might prefer Mexico, while a European company might prefer Romania. These “nearshoring” alternatives are connected by a variety of land routes and are nearby, so trade is harder for war, climate or pestilence to disrupt. They are also part of low-tariff regional trade agreements.

For industrial countries, the most fail-safe way of eliminating any supply-chain disruption, as well as to deal with the political pressure to create manufacturing jobs, is to bring back the entire supply chain to the country – what is called “reshoring.” Rich countries know that by reshoring, they will lose access to cheap labor elsewhere. So reshoring is being accompanied by frenzied efforts at automating the production chain to minimize the use of labor. And, of course, machines offer another advantage: They can never down tools or protest.

In sum, projecting from current patterns, India is not necessarily going to be a huge beneficiary of the global trend toward near-shoring production other than from firms seeking access to the Indian market, or in cases where transportation costs are a small part of value.

Could India succeed through renewed protectionism?

India could avoid global supply chains and produce everything in-house, so long as the final goods it exports do not attract tariffs at their destination. But this requires it to match the most efficient producers in the world in every segment of the supply chain. That is, India would have to be better at research than the United States, at design than the Italians, at manufacturing than the Germans, Chinese and Vietnamese, and so on.

Put differently, global supply chains have been optimized, as a result of which the prices of final manufactured goods have fallen steadily over the years. Each country that dominates some segment of the supply chain not only has a natural advantage in that segment, it has also honed that advantage by years of learning and skills training. Consequently, it is difficult for a country to compete in global markets against global supply chains by relying on an entirely homegrown supply chain.

India’s domestic market has grown substantially in recent years. A manufacturer that caters simply to the Indian domestic market can achieve some scale, “learn by doing” in a relatively familiar and proximate market, and reach a reasonable level of productivity even without embarking on exports. India could thus close off its market by erecting protectionist tariffs so as to give uncompetitive domestic producers a chance. Indeed, it seems to be on this path: Since 2014, India’s average import tariffs have been raised steadily from 13.5 percent to nearly 18.1 percent in 2022.

One sector that has benefited is steel. But while this makes the domestic market much more attractive for producers, they typically become uncompetitive globally operating behind high tariffs. Clever policy design, such as promising that tariffs will be removed once the industry has had breathing space to recover, rarely works. Once used to tariffs, industry will lobby to maintain them. Furthermore, knowing the government is amenable, every manufacturer will start clamoring for tariff protection so as to enjoy an easier life.

Furthermore, the argument that the Indian domestic market is large is true only for mass-market goods that everyone consumes – for instance, bicycles. However, India’s upper middle class – equivalent in per capita purchasing power to the middle class in industrialized countries – is still small, so to achieve scale in areas like electric passenger vehicles or high-end electronics, there is still no alternative to exports.

If India’s producers are reliant only on the domestic market, they will also suffer higher costs from production at inadequate scale. Consequently, growing protectionism will slow India’s rate of growth and force its households to pay high prices for shoddy products, thus favoring inefficient but well-connected businesses and keeping Indians poor.

All this is not idle theorizing. It is exactly what happened during India’s last spell of protectionism, which ended only with the liberalization in the early 1990s. The world was not nearly as competitive then, so India got a chance to remedy its errors when the economy was liberalized. This time would be harder.

Would Subsidies to Manufacturing in Addition to Protection Offset Our Weaknesses?

What if India abandons the notion that its firms are mature, taking the position that they are still infants and adding subsidies to the protection? It is not that the Indian government is unaware of the difficulties of manufacturing in India. The government says, for example, that the domestic electronics sector suffers a competitive disadvantage of 8.5-11 percent on account of factors such as the lack of adequate infrastructure, high cost of finance, inadequate availability of quality power, limited design capabilities in industry, neglect of R&D and inadequate skills of Indian workers.

Since addressing these weaknesses will take time, the government wants to offset these disadvantages through production subsidies. The Production Linked Incentive (PLI) scheme, first introduced in mobile phone production, works as follows.

In 2016, the Indian government started raising tariffs on imported mobile phone parts, and in April 2018 it imposed a 20 percent tariff on imports of finished mobile phones. Over and above the tariff protection, the government essentially pays manufacturers in India – whether Indian or foreign-owned – a sum of 6 percent of a phone’s invoice price, coming down to 4 percent in the fifth year for every incremental unit produced in India. In addition, state governments offer tax incentives, and power and land subsidies, for setting up production in their state.

At first look, the scheme seems to have worked. In the period from April 2017 to March 2018, imports of mobile phones amounted to nearly $3.6 billion, while phone exports were a measly $334 million. Net exports were thus –$3.3 billion. By the end of the 2022-23 financial year, phone imports were down to $1.6 billion, while phone exports were up to nearly $11 billion. Net exports were thus $9.4 billion, a turnaround of $13.1 billion from 2017-18.

Yet the details are far less impressive. Exports of final goods is not a useful metric if we are subsidizing manufacturers to finish in India and then export. What matters for manufacturing prowess is how much value is being added in India. Apparently, very little!

India has become a mass assembler of mobile phones, the least value-added part of the supply chain accounting for only a few percentage points of the total value of the mobile phone. Most of the parts, including the most sophisticated elements, such as logic chips, are imported. Indeed, it is not even clear if the value added in India exceeds the subsidies that are offered.

Government ministers admit India has started off only assembling but reason that this is a steppingstone to manufacturing higher value-added parts. Clearly, countries have followed such a path in the past. But is it a likely path today? If the cost of transport is small – and it is for tiny mobile phone parts – why would Xiaomi increase parts manufacturing in India if it is cheaper to manufacture elsewhere? So is India going to offer PLI schemes for each part also?

Put differently, there is an assumption that assembly at scale will lead to production at scale. While this may have been true in the past when logistics were more difficult, it is not obvious that it will be true going forward.

Korea is often cited as an example of a country that aggressively promoted an “infant” domestic industry through protectionism and subsidies to help it achieve scale in global markets. But we have to be clear about what worked. Korea’s early industrial policy in the 1960s and 1970s was almost entirely exports-driven and not sector-specific – whoever exported would get a subsidy. With the government not picking winners, there was pressure on Korean industry to pick areas where it could become globally competitive. Korean policy did become more directed or sector-specific, but only for a brief period in the 1970s, when credit was disbursed to six important sectors at cheap rates.

Korean President Park Chung Hee was a big believer in industrial policy. After his assassination in 1979, these sector-specific benefits were withdrawn and the economy was largely liberalized. Korean companies were forced to contend with market forces. Thus industrial policy in Korea was introduced in a focused way: first with explicit export incentives and then subsidies for a limited time in certain priority sectors, and then liberalized to encourage competitive performance. Even when Samsung, which started off as a vegetable trading company, wanted to go big in electronics, Korean banks helped only to the extent of cheaper credit. Samsung was still expected to compete in the global market from the outset.

To succeed, industrial policy of the Korean type needs to be ruthless and dispassionate; it cannot harbor favorites or stay protective. By contrast, the Indian PLI policy starts with an opaque selection of sectors to favor, with little public debate or transparency on which sectors are favored or why. Only a subset of firms is given subsidies, which puts all other firms at a disadvantage. We don’t know if subsidies were needed to get firms to invest or if subsidies are simply a gift from the nation. We don’t know what the metrics of success are, or even when the subsidies will be withdrawn – in some sectors, the duration of the subsidies has already been increased in response to lobbying by beneficiaries.

The real problem is that the PLI scheme is a policy shortcut, a substitute for the harder task of fixing the impediments to manufacturing in India. It is not even clear if it is a useful short-term policy tool to “crowd in” initial investment. Net foreign direct investment into India has fallen from $44 billion in fiscal year 2021 to $28 billion in 2023. PLI also cannot substitute for real reforms – after all, if India has not remedied its weaknesses, won’t those who came in to produce in India leave as quickly when subsidies end?

There is some sign that with the building of infrastructure – better roads and ports, and more efficient railway freight haulage – logistics costs are coming down in India and getting nearer to globally competitive levels. But despite this, India still believes it has to offer subsidies to attract low-skilled manufacturing, the most competitive segment of the global supply chain. If every segment of the global supply chain is optimized, does that not mean there is not much point paying to “own” low-skilled assembly, since it gives India little advantage in conquering higher-value-added segments?

Are We Chasing A Chimera?

What is the alternative? How does India go about breaking the mold? Why not work on reducing the impediments to job growth, whether in manufacturing or services, or some combination of both, so that India can get investment and job creation without offering huge subsidies?

Today, despite India’s large and young population, the constant refrain one hears from employers is that their existing employees are fine, but they cannot find adequately trained new workers. India must improve the capabilities of its workforce significantly so that global manufacturers come looking for them and its workers can move up the jobs ladder. This requires, among other things, improved nutrition, education and health care at all levels of the population.

Services and Services for Manufacturing

History has gifted India an advantage that neither China nor Vietnam has: the ability to speak in the global tongue. Indians have adopted English, the language of their former colonial power, and made it their own. This is now playing out in interesting ways. For example, almost 60 percent of global websites are in English, which gives artificial intelligence algorithms based on English a much bigger database to train on. Most of the world’s textbooks and scientific papers are published in English, and ad hoc translations are rarely as easy to read. More prosaically, while real-time translation by bots will come, perhaps soon, the ability to converse in a common language with the world will be an advantage in providing real-time services, and in business transactions, for years to come.

India also needs to increase the numbers of its best-educated and trained professional workers – doctors, engineers, consultants, lawyers and professors – who could provide services directly to the world even as they serve the domestic market. Because they provide services at a distance, they can bypass the tariff and other barriers that are impeding the flow of goods. As services have not been central to regional trade agreements, India’s lack of membership in those agreements will matter less.

The opportunity is enormous and growing. Digitally delivered service exports nearly quadrupled between 2005 and 2022, accounting for 12 percent of global trade today, while goods exports have increased only about 2.5 times – even though this period accounts for China’s great expansion in goods exports.

A class at Ramjas College at the University of Delhi.

But all this requires that Indians raise their aspiration levels. Instead of bringing mobile phone assembly to India, India needs to design the phones and chips of the future, and the associated software and app platforms, thereby profiting from the truly value-added parts of the global supply chain. Phone assembly coming to India would also be nice, the cherry on its value-added cake, but not if it has to pay enormous subsidies for it.

Entrepreneurship

India must also create the conditions for better-educated workers to become entrepreneurs, to be able to start ventures of all kinds. There is a sense that entrepreneurship only means high-tech innovation. Yet the bulk of new businesses, even fast-growing ones, don’t require significant innovation. What is important is to recognize a need out there, have the risk appetite to try to address it – including giving up an existing job and the associated income – and have the organizational capability to set up a functioning enterprise. Even the idea of selling fresh idli [rice cake] batter to households across India can employ many and add tremendous value. Prosperous India will need thousands, if not tens or even hundreds of thousands, of such companies.

India has not succeeded in commoditized manufacturing, where low cost is all that matters – if you want cheap umbrellas or, for that matter, a clay Ganesha, the revered Hindu God with an elephant head, India is not your natural supplier. Nor has it excelled (thus far) in businesses that require a great leap in product innovation. No global bestselling drug or social media phenomenon, such as Twitter or Facebook, has emerged from India.

Instead, India has found its niche in businesses where incremental innovation or engineering to ensure product reliability, product customization and affordability are necessary. Indian businesses have drawn on India’s pool of engineering and scientific talent, developed in good undergraduate universities, to address such applied challenges. Thus far, such incrementalism has played out more in India’s export of services like software. As more manufacturing employs services as an intermediate input, India stands to gain a leg up in the new-age industrial revolution if it prepares itself well.

Thinking Bigger

But India cannot be satisfied with the status quo. It must embrace a truly ambitious path to development, where India comes up with world-beating ideas and products along with companies or organizations to deliver them globally. No developing country has taken this path before, but India could. Remember, no large developing country had skipped the standard route, jumping from agriculture straight to high-skilled services, but India did. Now it has to reinvent itself once again.

Instead of making generic pharmaceuticals, India should turn to finding new cures for the diseases that plague its people and sell those new medicines to the world. Instead of buying expensive 5G technology from a vendor in an industrialized country, India should create a cheaper version in India and sell it to the emerging world, assuring buyers that India will create no backdoors through which it can snoop on them. It is important to recognize that India has the foundations on which it can build to fulfil these aspirations. But it is not there yet.

For instance, India has only a few top-quality research institutions, like some of the Indian Institutes of Technology, the Tata Institute of Fundamental Research and the Indian Institute of Science. To move from incremental innovation to path-breaking innovation, India needs to raise many more of its universities to global standards and to encourage and fund innovative research as well as business-academia collaborations.

In sum, while India should create the conditions for more manufacturing at home, export-led, low-skilled manufacturing no longer offers the most effective path to becoming a middle-income nation. Instead of trying to capture the bottom of the value-added chain and climbing up from there as the East Asian countries did, India could aspire to own the high end of the value chain directly. In some cases, the low-skilled segments would migrate naturally to India. While services can also expand to provide the foreign exchange and jobs India needs, the emphasis should be on new firms, ideas and products, whether in manufacturing or services, that can allow India to leapfrog.

India’s Democratic Advantage

Citizens benefit intrinsically from democracy – the dignity that comes from being able to vote and to express your opinion through it, having freedom of thought and expression more generally, being treated fairly, enjoying the rule of law and so on. But there is also a more tangible reason why we should strengthen our democracy.

In the early stages of development, the focus is on catch-up growth. The ideas and know-how needed for development are already out there, discovered by some other country and its businesses; they simply have to be imitated or licensed.

The development path we suggest will depend far more on Indians having innovative ideas and being creative, expanding the intellectual frontier. Growth at the frontier requires debate and argumentation, which an authoritarian government rarely tolerates. It is not that authoritarian countries cannot innovate to some degree – the Soviet Union had a flourishing military-industrial complex. But authoritarian governments want to direct research and innovation, which ensures they are limited by the imagination of those directing it. If these are apparatchiks from the government, innovation will be very limited indeed, especially if the apparatchiks interfere constantly because they worry these directions may not be consistent with the views of the supreme leader.

By contrast, innovation in a democracy does not have to respect the existing power structure, and its beliefs and can be really path-breaking. Chip technology in the Soviet Union was behind that of the United States because the Russians simply could not innovate in that area. So they were forced to steal the intellectual property when it became widely available, which always put them behind.

China’s political system may have been ideal for catch-up, infrastructure-led growth. Arguably, it is much less so as China approaches the technology frontier. For instance, China has imposed requirements that artificial intelligence essentially respect the primacy of the Communist Party. This could limit the extent to which firms can explore what AI can do for fear they might inadvertently cross regulatory boundaries.

Economic historians have studied the relationship between creativity and economic and political freedom over the long run. One such study looks at the consequences of the French occupation of German cities after the French Revolution in 1789. Among the key reforms the occupying French implemented was abolition of local guilds (an early form of business cronyism or License/Permit Raj). The French also brought in their civil law, under which the judiciary was made independent from the local administration and all citizens were treated equally before the law. The study finds that cities that were occupied for the longest period, and thus where these French reforms took greatest hold, had 2.5 times the patents per capita almost a century later (in 1900) than cities that were not occupied.

A related study looked at which cities in Europe saw a rise in births as well as the immigration of notably creative people between the 11th and 19th centuries. The researchers found that independent cities that assured their citizens political freedoms were most likely to see a rise in the presence of such people. This suggests the argument made by some Indians that all will go well in India if only it has an iron-fisted leader is just silly.

Indian poverty meets Greek chic.

Today, such an authoritarian leader can only build more roads and monuments but cannot allow the environment of free thinking and speech that India needs for innovative ideas and products. For such a liberal environment would open the door to criticism of all authority. By trying to control debate, the authoritarian leader will make it hard for India’s researchers to be innovative, attract free thinkers from the diaspora or retain its youth, who are unhappy with the status quo. An authoritarian leadership is certainly not what India needs today.

Is Manufacturing Needed for Security?

Before ending this chapter, we must ask an important question: If India does not have a strong manufacturing base, will its national security be impaired?

Take, for example, the global race to get into the manufacture of advanced logic chips. Both the United States and Europe are trying to bring more high-end chip fabrication to their shores, while China is trying to upgrade its existing facilities as the United States bans the sale of high-end chips to China. Should India also fabricate chips?

Start first with the obvious point: If short-term disruptions in chip availability are the concern, as during the pandemic, the solutions are simpler. India could have larger inventories of critical chips, possibly even a national reserve. It could source chips from multiple countries and companies. Indian firms could build flexibility around production processes so that products can be redesigned to replace the chips in short supply with the chips that are available. All this is much cheaper than manufacturing chips domestically, given that even a plant making chips that are a few generations behind the current technological frontier would cost tens of billions of dollars in subsidies.

If the longer-term concern is that India might face sanctions from potential enemies, the solution is to have a wider and more diversified set of friends. It is hard to imagine that democratic India will take a course of action that will make the Euro area, the United States, South Korea, Japan and Taiwan all want to sanction it. But what if the unimaginable happens and the democratic world turns against India?

If so, simply having factories making older chips will not be enough. India will need to make state-of-the-art chips (that is, the kind that go into mobile phones and AI machine-learning processors). It will need to make the machines that make the chips (firms that make those machines, such as the Dutch company ASML, will also apply sanctions). And it will have to make every part of the chip supply chain starting from the silicon wafer, all of which requires specialty processes and chemicals that India does not have. Put differently, unless India brings the entire manufacturing process for chips to India, there will always be choke points that run through other countries. Total self-sufficiency is nearly impossible, even if India is prepared to invest hundreds of billions of dollars. And logic chips are just a small part of what India would need if sanctioned.

In short, India cannot obtain security with a toehold in chip manufacturing. Chip manufacturing, unless more carefully thought out, could be like the prestige-project white elephants that India has had plenty of in the past. Should India spend tens of billions in subsidizing chip manufacturing when the world has periodic gluts of chips, or should it devote those tens of billions to opening tens of thousands of high-quality primary schools, thousands of high-quality high schools and hundreds of top-notch universities? Is India better off dominating chip design with the tens of thousands of additional engineers and scientists it will produce, and starting firms like Nvidia, Qualcomm or Broadcom (none of which fabricate their chips)? Or does India want to imitate China, especially when it has much better relations with the chip manufacturing world? Once again, rather than imitating others blindly, India needs to look at its own advantages.

Some argue that India needs chip fabrication so that it can build strength in chip design or other parts of the supply chain. But there is no evidence that this is the case – witness Nvidia in the United States or ASML in the Netherlands. Note, too, the fact that other countries are jumping to subsidize chip fabrication is good for India. It will increase India’s choices as an importer, especially when the periodic glut emerges.

That is not to say India should never enter chip fabrication. As the current frenzy of subsidies dies down, investment in the industry will eventually be worthwhile. Once India’s engineers and designers have the human capital to participate in the innovation that is so crucial in this industry. India should not hesitate. Nor should it hesitate if anyone wants to invest in India without massive subsidies. But it does not seem wise at this moment to enter this ruinous subsidies game. India is better off investing in its human capital to produce ideas and creativity.

Fitting With The Emerging Political Economy of Trade

While ideas and creativity should be India’s main vehicle for growth, there is a reason services and manufacturing-related services may be easier for India to expand in than manufacturing.

China’s dominance of manufacturing, and the consequent loss of middle-income factory jobs in industrial countries, has made the West wary of opening the way for any entrant that may turn out to be another China. Protectionism in manufacturing is rife. Services, however, are still relatively virgin territory. For instance, an Indian consultant with pretty much the same capabilities still costs a fraction of what a U.S. consultant costs. This is why many global service firms are looking to India even without the incentive of subsidies.

As the world grows richer and older it will disproportionately expand its demand for services, but climate change suggests additional urgency. The world has to slow the growth in its consumption of goods if it is to mitigate climate change. This offers one more reason for India to be mildly biased toward services and manufacturing-related services, even while emphasizing that our focus should be on ideas and creativity, wherever these apply.