Table of Contents

India’s future growth depends critically on the nation’s ability to populate its missing middle—the medium-sized producers and middle class of consumers. The greatest number of Indian businesses are small or microenterprises, many operating in the informal economy and not contributing to India’s tax base. Agricultural production is hampered by tiny and decreasing farm sizes and by the impracticality of applying technology to increase crop yields.

The causes of the missing middle relate to government policies, such as a growth-stifling regulatory environment; India’s large population of individuals living below the poverty line; and, perhaps of most concern for its pervasiveness, poor performance on human development measures. A deficit in education despite a generally adequate number of school buildings and the low participation of women in the paid workforce are two factors contributing to an inadequate supply of skilled workers and low production output. Without a middle class of producers (income earners), there is no middle class of consumers. A 2015 Pew Research Center survey found that less than 3 percent of the total population of India had incomes sufficient to be classified as middle class.5 In turn, the poor performance of India on labor market metrics suggests an extended period of drag on the national economy. As India stumbles toward crafting its missing middle, a generation or more is likely to pass before positive effects are felt in the market.

Labor Market Constraints: The Human Resource Development Challenges

Most discussions of labor market constraints in the context of the Indian economy revolve around growth-stifling labor market regulations. The regulatory regime undoubtedly needs reform, but three larger if less discussed labor market constraints are: the abysmal quality of primary education, resulting in a growing mismatch between the demand for and the supply of skilled workers; a dysfunctional healthcare system; and the very low level of female workforce participation. Ameliorating any one of these would help the economy grow, but these problems permeate the economy and social expectations, and their adamantine nature means no easy solution is in sight.

The Need for Education and a Skilled Workforce

The poor state of India’s primary education system, which has now been captured in several learning outcomes assessments, must count as one of the country’s biggest development failures. If this problem is not addressed soon, the country’s much-vaunted demographic dividend—an increase in economic productivity resulting from a shift in the population structure to more working-age adults with fewer dependents—could well turn into a demographic disaster.

If education were only about schools, about physical infrastructure, materials, and ensuring universal enrollment, then India has succeeded spectacularly. Every large population center has a school; most schools have buildings and teachers assigned; and students have study materials. It was hoped or assumed that once the schooling inputs were in place, education and learning outcomes would somehow follow automatically. But this has proved not to be the case. Lant Pritchett, an education researcher with Harvard’s Kennedy School of Government, has evocatively described the situation as “schooling ain’t learning.”6 And schooling without learning leads to very poor educational outcomes, a finding supported by the 2014 Annual Status of Education Report, the largest nongovernmental household survey undertaken in rural India:

51.9% of Class 5 children in rural India cannot read a Class 2 text; only 25% of children in Class 5 and 46.8% in Class 8 could read simple English sentences; just 25.3% of Class 3 children could do a two-digit subtraction, 26.1% of Class 5 children and 44.1% of Class 8 students could do division.7

As the 2009 Program for International Student Assessment (PISA) results indicated, much the same outcomes were found for private and urban schools, and those results were obtained in the two best-performing states in India, Tamil Nadu and Himachal Pradesh. Apart from India placing 72 among 73 countries evaluated by the 2009 PISA, the shares of fifteen-year-old students attaining the highest levels of achievement in math, reading, and science were so low as to be negligible.

The poor quality of the educational system has direct effects on the quality of the labor pool and on employability. Every year, a semi-employable or unemployable army of 12 million seek entry into the workforce, threatening to turn India’s demographic dividend into a demographic curse. Early proponents of the benefits to be reaped from India’s anticipated redirection, in the 1990s and 2000s, spoke of a 2 percent boost in India’s productivity per annum as a result. That proved to be a fallacy. A 2010 study by the Tata Institute of Social Sciences in Mumbai found that only 10 percent of new graduates and 25 percent of graduates of engineering and MBA programs had adequate skills to be employable.8 Numerous other surveys have confirmed the results. Insofar as a generation of the workforce is stuck in this rut, with more of India’s youth joining the labor force and seeking jobs in the years ahead, the gap between the demand for and the supply of skilled workers is likely to become more acute.

Ensuring an adequate supply of skilled labor is, for India, a monumental task, but achieving a high economic growth rate is critically dependent on developing a skilled workforce. To achieve and then sustain high growth rates, the country would have to increase the number of its higher education institutions and dramatically improve the quality of existing ones. This would entail finding trained and motivated instructors to work in schools and students of good quality to fill the seats. Beyond these immediate hurdles lies the problem of a dysfunctional education regulatory system. Weak state capability and abysmal school learning outcomes compound these challenges enormously.

The Need for a Well-Functioning Healthcare System

An important dimension of human resource development is healthcare, especially affordable preventive and primary care. Unfortunately, as has been documented by numerous studies, India’s existing healthcare system is in serious disrepair. It is characterized by dysfunctional primary care, grossly deficient secondary care, overburdened tertiary care, a corrupt medical education system, and a rapacious and largely unregulated private system.

A prolonged period of deterioration in the quality of care provided by public healthcare facilities encouraged the emergence of a large and thriving private care network. As a result, people fled the public system en masse. Today, only the poorest and disenfranchised, those without any other recourse, are likely to visit public primary and secondary care facilities. The picture is compounded by the flight of the better-off to private care facilities, which has enfeebled the public institutions and left them with no demand-side pressures to force accountability.

Inattention to healthcare has contributed to a seemingly intransigent situation; healthcare has never been a politically salient issue in India.9 This is reflected in the very low public spending on healthcare, which has remained at about 1 percent of GDP for decades despite commitments from successive governments in New Delhi to devote more funds to public facilities and care. One result of this abdication is that India has one of the highest shares of out-of-pocket healthcare expenditures among major developing countries. Nearly 60 percent of healthcare spending in India is paid out of pocket, and catastrophic health expenses are the largest contributor to poverty. The government-affiliated Planning Commission estimates that health problems push 39 million people into poverty each year: 47 percent of hospital admissions in rural areas and 31 percent in urban areas are financed by loans and asset sales, while 30 percent of those needing care in rural India and 20 percent of those in urban areas go untreated because of inability to pay for healthcare.10

The low level of public spending on healthcare both contributes to and amplifies a quality-of-care problem. As with school education, a rich body of research shows that the primary healthcare system delivers abysmal outcomes. A cross-national observational study of the quality of primary care delivered in three low-income countries, India, Indonesia, and Tanzania, found a shocking level of apathy, lack of knowledge, and low effort. Doctors in India performed the worst with respect to adhering to protocols during the examination of outpatients.11

In recent years, this deterioration in quality has been accompanied by a proliferation of insurance schemes initiated by state governments. These schemes have been extremely popular since the prospect of the poor being able to access hitherto out-of-reach expensive tertiary care at a hospital of their choice, perhaps even at the same facilities as are used by the rich, is laced with deep social symbolism and exerts a strong populist political appeal. The intelligentsia view it as the arrival of a progressive welfare state. Governments view it as a much simpler and easier way to address healthcare issues while avoiding making the messier and politically difficult choices. It has led to a dramatic growth of private multispecialty hospitals that cater to the needs of those enrolled in these insurance schemes. Thus the provision of free choice has had the effect of further drawing patients away from public facilities.

The situation seems to call for better public facilities and at least a stab at more universal coverage, and in 2014 Prime Minister Modi’s government did propose a national health plan that would have provided Indian citizens with free drugs, diagnostic procedures, and insurance for treating serious problems. However, the proposal was never implemented owing to budgetary concerns. Moreover, evidence from various states across the world indicates that doubly universal coverage—coverage for all citizens and for all medical conditions—is simply fiscally unsustainable for a country like India.

Finally, the institutional and human resources edifice of the country’s healthcare system is crumbling. The Medical Council of India and similar regulatory institutions remain mired in politics and rife with corruption. Apart from the acute deficiency of personnel, especially in dentistry and nurse midwifery, the quality of medical training has been declining alarmingly.12

There are no easy solutions to these problems. The political economy behind many of them presents a formidable barrier to meaningful change. In the absence of far-reaching reforms, including an understanding of healthcare as a public good, a significant attempt to bring down India’s outsized contribution to the global burden of infectious disease, and eliminating impoverishment from high out-of-pocket expenses, the expectations of any sustained economic growth predicated on improving national health may remain just that.

The Need for Greater Female Workforce Participation

A third major labor market deficiency is the country’s shockingly low female workforce participation rate. At 24 percent in 2014, it was comparable to levels in the Middle East and North Africa, and just half that in Indonesia. A 2015 report from the McKinsey Global Institute showed that the female contribution to India’s GDP, at 17 percent, is the lowest in the world among a sample constituted of countries and regions, and less than half the global female share of GDP at 37 percent.13

The report estimates that if India did as well as the best-performing country in South Asia on this metric, by 2025 its incremental output would be higher by 16 percent, or $700 billion. But this would require, even more than enabling public policies, a social transformation on a scale equivalent to that which led to the weakening of caste barriers in Indian society in the latter part of nineteenth century and the early twentieth century.

An Unproductive Agricultural Sector

The missing middle is a problem that afflicts India’s farming sector as well as its industrial sector. Around 85 percent of India’s farms are small to marginal, and less than 1 percent are large (above 10 hectares). The average size of all farms in India is only 1.16 hectares, a figure that has declined steadily from around 2.82 hectares in 1970–1971 as family farms have been subdivided (see figure 2).

This fragmentation of farmland has contributed to India’s low level of agricultural production. Moreover, growth in yield per hectare has slowed considerably since the start of the new millennium: small farm size does not lend itself to the application of yield-increasing technology, improved production methods, or even monetization. According to the Finance Ministry’s Economic Survey 2014–15, even India’s best yield is well below the best in the world.14

Industrial Base: Small Is Not Beautiful

India’s industrial base, even the entire nonfinancial business landscape, is dominated by micro- and small enterprises. In 2012, microenterprises (with investment below 2.5 million Indian rupees, or INR, equivalent to around $40,000) made up 94.9 percent of the registered micro-, small, and medium-sized enterprises (MSMEs) in manufacturing and 70 percent of the employment.15 Proprietary enterprises accounted for 94.5 percent of all MSMEs and public limited companies for just 0.28 percent. Of the 261 lakh (26.1 million) enterprises (both in manufacturing and in services), 52 percent are rural, and about 71 percent of those do not use any electricity.16

In 2013, 793,446 enterprises were registered with the Ministry of Corporate Affairs, of which 92.7 percent were private limited companies. Private limited companies have fewer disclosure requirements and governance standards than public limited companies. This number included 705,733 nonfinancial companies, of which just 2,776 (or 0.4 percent) had paid-up capital above INR 25 crore (INR 250 million, equivalent to $4 million), and only 51,484 (or 7.3 percent) had paid-up capital above INR 1 crore (INR 10 million).

A comparison with the number of nonfinancial enterprises in the other BRIC countries—Brazil, Russia, and China—and their turnover ranges exposes India’s rather narrow industrial base (see table 2), with the majority of industries compressed into the lower growth stages.17

This trend is mirrored in the wider pool of economic activities. As a measure of all nonsubsistence economic activity, the Sixth Economic Census (2012–13) identified 58.47 million establishments.18 They employed 127.7 million people, reflecting a decline in the number of people per establishment from 2.35 to 2.18 since 2005. Of the 58.47 million establishments, 11.98 million (20.47 percent) did not have any physical premises, and 22.44 million (38.4 percent) were operated out of homes. Only 1.2 million enterprises contributed to employer-based pension plans and 1.1 million to employer-based health insurance plans and were formally registered as companies.

The government’s Annual Survey of Industries 2013–14 found that of the 185,690 factories in operation, just 1.9 percent employed more than 1,000 people, and 73.2 percent employed fewer than 50 people (see figure 3).19 Factories employing more than 1,000 people made up 46.63 percent of the total fixed capital employed and 41.24 percent of the total output, whereas the smallest factories, which employed nearly three-fourths of the labor pool, accounted for just 7.06 percent of total fixed capital and 11.18 percent of total output. As a measure of total cumulative capital invested in plant and machinery,20 though 91.31 percent belonged to the MSME category, collectively they accounted for only 13.1 percent of the total fixed capital employed, and they contributed just 27.03 percent of the total output.

The picture revealed by these figures is concerning. The number and proportion of small and microenterprises are staggeringly high. Their contribution to output and employment is infinitesimally small. Yet romanticism in policy circles with micro and small has endured far longer than is justified by their economic value added. Small has not been beautiful, as the capital and labor locked up in these unproductive enterprises represent lost economic opportunity.

Furthermore, most such enterprises are informal and operate beneath the radar of tax authorities and other regulators. Of the 261 lakh MSMEs in the Fourth All India Census of Micro, Small, and Medium Enterprises (2006­–2007),21 more than 52 percent were unregistered. No matter how forceful the argument is, the facts speak louder and more clearly. India’s industrial base has a gaping hole in the middle. Specifically, India has a preponderance of microenterprises and a tiny set of large enterprises. It has neither small nor medium-sized enterprises.

All this assumes great significance in light of the overwhelming evidence that usually jobs are created and output is generated by firms that start small, in the formal sector, and grow large over time. In India, this dynamic is turned on its head. Most Indian firms start in the informal sector and never grow or, worse, diminish in size over time: according to a 2013 International Finance Corporation study comparing the size of thirty-five-year-old firms in India, Mexico, and United States with their size at start-up, in India the size had declined by a fourth, in Mexico the size had doubled, and in the United States the firms were ten times as large.22 That is deeply troubling. As firms age, they are expected to get larger and to employ more people. Since India’s experience is orthogonal to this expectation, something in the Indian business ecosystem is badly broken.

A growing body of research underscores that the misallocation of resources—whether capital, labor, or public support—across firms is an important contributor to the persistence of low firm productivity. Chang Tai-Hsieh and Peter Klenow suggest that 40–60 percent of the total factor productivity differential between firms in India and the United States is the result of misallocation of resources and capital among the millions of micro- and small enterprises in India.23

In any case, neither microcredit nor micro-entrepreneurship propels societies into higher incomes. Financial inclusion and other forms of state support for microenterprises should be aimed at helping them grow from their small beginnings, not at keeping them there. Without getting into the causality debate, it is pertinent that higher incomes always correlate with wage employment intensity. It is no surprise that while just one in nine working Americans is self-employed, nineteen out of twenty Indians are self-employed. For a comparison with a developing economy, while two-thirds of workers in Mexico’s Nuevo Leon state are employed by private incorporated businesses, just one in seven is in Chiapas state, and this difference in employment structure is associated with a nine times per capita income differential in favor of Nuevo Leon.24

A statistical update on employment in the informal economy published by the International Labor Organization in 2012 showed that India has one of the world’s largest informal sectors.25 At 83.6 percent, the share of informal employment in the country’s overall nonagricultural employment total is the highest in the world. Furthermore, India’s labor force participation rate is one of the lowest in the world. Only Egypt and Honduras fare worse.

A report published jointly by the International Labor Organization and the World Trade Organization in 2009 had a stark message for India: “Countries with large informal economies tend to experience more frequent growth crises and extreme growth events. . . . Even though growth acceleration may occur more frequently in countries with larger informal economies, the risk of sudden stops and economic crises is also significantly larger in these countries, preventing sustainable long-run economic expansion. It should be noted that this. . . does not causally link the two phenomena but suggests an empirical regularity.”26

India must address its missing agricultural and industrial middle if it is to avoid sudden stops and economic crises and to make headway in manufacturing and farming. Without these sectors, there will not be jobs for the millions of young people seeking entry into the workplace each year. If the demographic bulge becomes a bulge of the under- and unemployed, it will have dire implications for social stability and national security. It used to be thought that the solution was to liberalize the labor laws that discouraged hiring because they made shedding labor difficult. But that is only a partial answer; more aggressive solutions are needed.

A quick tour of the historical reasons for India’s highly fragmented, inefficient, and anti-employment production structure in farms, factories, and enterprises may provide some clues to tackling the root causes of the missing middle. Before independence, India’s colonial rulers snuffed out enterprise by exporting India’s raw materials to nurture businesses in their own countries. The capacity to create and nurture big businesses in the private sector in sufficient numbers has never been achieved since the state occupied the commanding heights of the Indian economy in the first three decades after independence. Moreover, the postindependence legal and regulatory framework favored small businesses: the production of certain items was reserved for small-scale industries, and labor protection was emphasized rather than efficiency and scale. Because of India’s experience of being ruled by a foreign trading company, a suspicion of big businesses still lingers. Many other reasons for the missing middle could be adduced in connection with India’s economic context at the time of independence.

A few steps have been taken toward increasing efficiency and scale. The reservation of production for small-scale industries has now been fully removed. Firms have figured out how to overcome the constraints imposed by labor market regulations through hiring temporary and contract workers, though that is not the same as having a committed and productive workforce of employees. The accumulation of learning and knowledge in the labor force is not possible with temporary and contract labor. Hence, labor market regulations may still act as a tether constraining firms’ growth.

Scale may prove more difficult to achieve than efficiency. The dearth of qualified and skilled labor has emerged as a serious impediment to the growth of several micro- and small manufacturing enterprises. If only 2 percent of the labor force is formally skilled, as noted in the Indian government’s Economic Survey 2014–15,27 that is not just a problem but a national emergency, one that poses an enormous challenge for India’s economic future.

Rather than incrementalism, a characteristic of some of the changes just discussed, more radical steps and an overhaul of India’s regulatory environment may be warranted. The Economic Survey 2015–16 raises the Chakravyuha challenge, a metaphor for India’s twenty-first-century economy, derived from the Chakravyuha legend of the Mahabharata. The challenge refers to the ability to enter the marketplace but not exit, with serious adverse consequences. The survey introduces the legend to describe the Indian economy’s gradual transition over the past six decades as it moved from “socialism with limited entry to marketism with limited exit.”28 Its point: firms need much greater exposure to the dynamism of the market, both at entry and exit, through a far less overbearing and costly regulatory environment. This would help create the market conditions that encourage firms to start in the formal sector, allow unimpeded growth, and force exit when necessary.

The Missing Middle Class of Consumers

If India’s agricultural and industrial output is hobbled by a fragmented production structure and a missing middle, the same is true of India’s consumption market. India’s middle class is often touted as its biggest strength. Sadly, the “middle” is missing here, too. The conventional narrative concerning India’s growth prospects is spun around a hypothetically existing or soon arriving middle class some 200 million to 300 million strong. But a considerable and growing body of evidence, including official government statistics, indicates it may be a long time before those numbers are realized.

A 2014 report by the McKinsey Global Institute defined an empowerment line as the minimum per capita income required to meet eight basic needs at a level sufficient to achieve a decent standard of living, and it estimated that 56 percent of the Indian population lacked the means to meet their essential needs.29 It found that 90 percent of the population could afford a per capita monthly consumption expenditure of just INR 2,800 per month, or about $560 per annum (at a conversion rate of INR 60 to $1).

A Pew Research Center income survey found that in 2011, less than 3 percent of the total population, or 37 million people, had incomes above $10 per day, or enough to be classified as middle class. The government of India’s Socio-Economic and Caste Census 2011 found that in three-fourths of the country’s 179.1 million rural families, the highest-earning member brought home less than INR 5,000 every month, or $1,000 annually.30 These numbers are corroborated by the country’s tax assessor numbers.

A country’s consumer base is defined by its middle class. In India’s case, the contrast with China is staggering. Data from BMI Research show that in 2014, per capita spending by those in the middle 60 percent of the income distribution was estimated at $4,036 in China, 5.5 times India’s $735, a level that China reached at least eleven years earlier. In 2012 an estimated 192 million Chinese households had an annual income above $10,000, a rough measure of the middle-class threshold, compared to just 24.5 million Indian households, and again, China had reached that figure well before the turn of the millennium. At the top end of the income ladder, per capita spending by the richest 10 percent of Chinese in 2014 was $14,555 to India’s $2,626.31

Finally, Credit Suisse’s Global Wealth Databook for 2015 found similar patterns. It found that India’s middle class numbered just 24 million households, less than one-fourth of China’s 109 million, one-seventh of the Asia-Pacific region’s 171 million, and only slightly more than Africa’s 19 million. In addition, it found that 95.4 percent of Indians had wealth below $10,000, a far higher share than the global average of about 70 percent. The share of the population with higher incomes was essentially negligible.32

It was recently reported by the Wall Street Journal that the leading global fast food chains, which entered the Indian market with expectations of decades-long high growth rates, have hit a wall, with declining sales growth.33 Their expectations, possibly based on models of a China-type massive middle class, were unlikely to have been realized.


5 Rakesh Kochhar, “Despite Poverty’s Plunge, Middle-Class Status Remains Out of Reach for Many,” Pew Research Center, July 8, 2015,

6 Lant Pritchett, The Rebirth of Education: Schooling Ain’t Learning (Washington, DC: Center for Global Development, 2013).

7 “ASER 2014: Annual Status of Education Report,” ASER Center, January 2015,

8 Puja Pednekar, “Only 10% Fresh Graduates and 25% MBA Passouts Are Employable, Says TISS Study,” DNA India, October 20, 2010,

9 Healthcare’s political salience has increased in recent years with the emergence of the various state-sponsored health insurance schemes.

10 Planning Commission of India, High Level Expert Group Report on Universal Health Coverage for India (New Delhi: Government of India, 2011),

11 Jishnu Das, Jeff Hammer, and Kenneth Leonard, “The Quality of Medical Advice in Low-Income Countries,” Journal of Economic Perspectives 22, no. 2 (Spring 2008): 93–114,

12 Vikram Patel et al., “Assuring Health Coverage for All in India,” Lancet 386, no. 10011 (December 12, 2015): 2422–35,

13 Jonathan Woetzel et al., “How Advancing Women’s Equality Can Add $12 Trillion to Global Growth,” McKinsey Global Institute, September 2015,

14 Ministry of Finance, Economic Survey 2014–15, vol. 1, chap. 1 (New Delhi: Government of India, 2014).

15 Microenterprises have less than Rs 2.5 million (about $37,350) invested in plant and machinery, small enterprises have Rs 2.5–50 million invested, and medium-sized enterprises have Rs 50–100 million invested.

16 G. Sajeevan, “Present Status of MSME Statistics,” Journal of Industrial Statistics 1, no. 2 (2012): 269–82,

17 Vivek Pandit, Toshan Tamhane, and Rohit Kapur, Indian Private Equity: Route to Resurgence (New York: McKinsey & Company, June 2015), exhibit 2.1.

18 Ministry of Statistics and Programme Implementation, Sixth Economic Census 2012–13 (New Delhi: Government of India, 2012),

19 Ministry of Statistics and Programme Implementation, Annual Survey of Industries 2012–13 (New Delhi: Government of India, 2012), There are 179,102 factories registered with the chief inspector of factories in each state.

20 The total cumulative capital invested in plant and machinery forms the basis of the Ministry of Micro, Small and Medium Enterprises (MSME) classification.

21 G Sajeevan, “Present Status of MSME Statistics,” Journal of Industrial Statistics 1, no. 2 (2012): 269–82, accessed on September 11, 2015.

22 International Finance Corporation, IFC Jobs Study: Assessing Private Sector Contributions to Job Creation and Poverty Reduction (Washington, DC: International Finance Corporation, January 2013),

23 Chang Tai-Hsieh and Peter Klenow, “Misallocation and Manufacturing TFP in China and India,” Quarterly Journal of Economics 124, no. 4 (November 2009): 1403–48,

24 Ricardo Hausmann, “Does Capitalism Cause Poverty?” Project Syndicate, August 21, 2015,

25 International Labor Organization Department of Statistics, “Statistical Update on Employment in the Informal Economy,” International Labor Organization, June 2012,

26 Marc Bacchetta, Juana P. Bustamante, and Ekkehard Ernst, Globalization and Informal Jobs in Developing Countries (Geneva, Switzerland: World Trade Organization Secretariat and International Labor Organization, 2009),

27 Ministry of Finance, Economic Survey 2014–15, vol. 2, para. 9.12 (New Delhi: Government of India, 2014).

28 Ministry of Finance, Economic Survey 2015–16, vol. 1, chap. 2 (New Delhi: Government of India, 2015).

29 Rajat Gupta et al., India’s Path from Poverty to Empowerment (New York: McKinsey Global Institute, February 2014),

30Rajesh Pandathil, “Socio Economic Survey: Three-Fourth of Rural India’s Highest Income below Rs 5,000,” Firstpost, July 4, 2015,

31 “Data Tool,” BMI Research,

32 “Global Wealth Report 2015,” Credit Suisse,

33 Preetika Rana, “McDonald’s, Pizza Hut Cook Up New Plans for India,” Wall Street Journal, March 22, 2016,