Table of Contents

The preceding chapters focused on homegrown challenges to economic growth. Chapter 2 discussed the missing middle in production and consumption, while chapter 3 examined the financial constraints that India faces and chapter 4 examined the capability (or lack thereof) of the state to facilitate the country’s growth agenda. This chapter continues the discussion with an analysis of growth challenges from a global perspective. Developments in the global sphere, though not necessarily unique to India, nonetheless impinge on India’s economic objectives. Together with the domestic factors analyzed earlier in the report, these global trends—premature deindustrialization, the peaking of IT- and services-led growth, a fall in export-led growth, global economic growth stagnation, and the impacts of climate change, and others—compound India’s problems immensely.

Premature Deindustrialization

Historically the manufacturing sector has provided the platform for countries in their structural transformation from predominantly agriculture economies. The development trajectories of the East Asian economies and of the now developed Western economies have involved manufacturing-based industrialization.

Such countries have focused on manufacturing and moved up the production escalator, from less sophisticated to more technologically advanced products. The work of such development economists as Dani Rodrik has shown that labor productivity in formal manufacturing has tended to converge to the frontier: the smaller the initial productivity (and therefore incomes), the higher the growth in labor productivity (and therefore incomes).87

This relationship of industry to income helps economies absorb a large number of less skilled workers, with prospects of their moving up the skill chain on the escalator of industries. Accordingly, the development trajectories of all advanced economies show that manufacturing’s share of output and employment has tended to rise, peaking as the country attains middle income, and then decline.

But a weakening of this trend has become evident in recent years, with countries becoming service economies before going through the full cycle of industrialization.88 Rodrik has characterized the aborted industrialization trajectory as “premature deindustrialization.”89 Certain structural changes that have been active in manufacturing for many years, driven by the tide of trade liberalization and by the globalization of production chains, now raise questions about the efficacy of the traditional manufacturing-led rapid economic growth path.90

The process of deindustrialization appears to be occurring much earlier now among the emerging economies, including China; nor has India been spared the impact of these secular global trends. That situation compounds the historically low share of manufacturing from which India has been suffering, the result of domestic policy choices such as the reservation of certain production lines for small industries, the requirement for extensive industrial licensing, and labor regulations, in addition to an infrastructure deficit and a shortage of skilled workers.

In India, manufacturing’s share of output has been stagnant at about 16 percent of GDP for a long time. After the 2008–2009 global recession it declined to less than 13 percent in 2014 (see figure 11).91 The decline was swift. India’s manufacturing share of GDP is now where it was in the 1960s.

However, manufacturing’s share of employment peaked at 13 percent of the labor force in 2002. Worse, India started deindustrializing at a GDP per capita of $2,000, in contrast to the $9,000–$11,000 income levels at which manufacturing in Western economies started to decline.

A 2014 working paper published by the Asian Development Bank and written by Jesus Felipe, Aashish Mehta, and Changyong Rhee reported that GDP per capita at the time employment peaks has been declining much faster than that at which manufacturing’s share of total output peaks.92 Research by Amrit Amirapu and Arvind Subramanian using national cross-panel data shows that at any stage in their development, not only is the point in time at which the industrial share of employment peaks occurring earlier but also that countries are devoting less of their workforce to industry.93 This potentially dampens the prospects for manufacturing-led rapid growth and job creation for such countries as India and Africa.94

Amirapu and Subramanian also found that much the same trends held among Indian states, with manufacturing’s share of output declining in all Indian states (see table 3). They highlight this point with the example of Uttar Pradesh:

It reached its peak share of manufacturing, of 10 per cent of GDP, in 1996 at a per capita state domestic product of about USD1200 (measured in 2011 purchasing power parity dollars). Indonesia attained a manufacturing peak share of 29 per cent at a per capita GDP of USD5800. Brazil attained its peak share of 31 per cent at a per capita GDP of USD7100. So, Uttar Pradesh’s maximum level of industrialization was about one-third that in Brazil and Indonesia; and the decline began at 15 to 20 per cent of the income levels of these countries.95

Underscoring these trends, since 1996, coinciding with the high noon of Chinese manufacturing-driven economic growth, China’s manufacturing employment growth is estimated to have fallen by nearly one-quarter.96 One of the primary drivers of this trend is rapid factory floor automation of repetitive and routine tasks through mechanization, including the use of robots. The declining price of robots and the difficulty of recruiting and retaining adequately skilled labor, already acute in India’s factories, are most likely to bring these trends to India. According to one estimate, the major Indian automobile manufacturers have already automated nearly 30 percent of their plant activities.97

The automation trend highlights the need to shift the focus away from India’s traditional industrial policy, which has largely revolved around fiscal and other incentives for capital, often at the cost of labor. The announcement in the Union Budget 2016–17 of a budget line to subsidize the 8.33 percent employer contribution toward the Employees’ Pension Scheme is a welcome step in this regard.98 But much more can be done to move incentives away from capital and toward labor.

In this context, the role of construction, by now perhaps India’s second-largest employer after agriculture, assumes significance. Its share of the labor force rose from 5.6 percent in 2004–2005 to 11.3 percent in 2009–2010, while that of manufacturing declined from 12.2 percent to 11.4 percent over the same period. Furthermore, its elasticity, or change in employment for one unit change in economic output, has grown from 0.78 to 1.54 during the same period, even as the elasticity of employment across the economy declined from 0.44 to 0.01.99 This growth came on the back of the massive investments made in the construction-intensive infrastructure sector. It also helped that unlike in manufacturing, construction, especially its labor market, operates largely in the informal sector, through vast networks of largely informal subcontractors. This helps employers evade many statutory labor-related obligations, apart from minimizing tax liability, and increases construction businesses’ competitiveness. Because of India’s antecedent infrastructure deficiencies, the construction sector is likely to continue growing well into the future, thereby presenting a critical source of employment generation. Its growth needs to be nurtured.

Can IT and Services Drive Employment?

India’s relative success in the IT sector, despite the sector’s current small size and limited relevance to overall growth, has led some commentators to point to the potential for a new model of services-led economic growth for the country.100 Here, too, the work of Dani Rodrik is instructive. In 2014 he argued that the inherent dynamics of the services sector militated against generating similar growth and job creation trends, just as with manufacturing.101

The high-productivity sectors, which are typically tradable, being skill-intensive, cannot absorb many of the unskilled or underskilled workers who dominate the 12 million people entering India’s workforce every year (see table 4). In fact, the more productive and therefore rapidly expanding (and mostly tradable) services are also highly skill-intensive, far more so than manufacturing.102 Rodrik’s work also shows that there are very few examples of simultaneous growth of productivity and employment in the services sector.103

Furthermore, unlike in manufacturing, there is limited prospect for a natural progression up the skill chain in the services sector. While a textile- or toymaker can with minimal training move into assembling electronic goods, the prospect of a barber or a housekeeper moving into business services or banking, even at the lower end of the service, is remote or nonexistent.

India’s stark and persistent deficiencies in education and skill development are a major obstacle to reaping the benefits from tradable services in any significant manner. At a minimum, more than a decade of intensive focus on education and skill development would be required before the country could realize substantial benefits from tradable services. Addressing the deficiencies in those areas would take time, and, as with manufacturing, there are serious uncertainties over the possible disruption to parts of the services sector, especially at its labor-intensive end, from technological advances.

The less productive nontradable services face self-limiting constraints: labor-absorbing services are less productive and therefore slow-growing, whereas the fast-growing and more productive services experience higher relative wage growth, with resultant limits on job creation. As Rodrik writes, “Services sectors that have the best productivity performance typically shed labor; labor absorbing sectors typically have [the] worst productivity performance.”104 It is therefore difficult to envision nontradable services as the predominant channel for significant employment creation and rapid economic growth.

That is one reason that the government’s Economic Survey 2014–15 concluded that India had to address two challenges simultaneously: ensure that its existing unlimited supply of unskilled labor was utilized, and ensure that the inelastic supply of skilled labor was made more elastic. The Economic Survey conceded that both were major challenges but that India had no option other than to attempt to proceed on both fronts simultaneously. There is no precedent in the history of economic development for the simultaneous occurrence of both a utilization of unlimited supply of skilled labor and an improved elasticity of supply of skilled labor.105

The End of Export-Led Growth?

One of the defining features of successful economic growth over long periods in the recent past has been the central role of exports. The most prominent example is that of East Asia, where long periods of economic growth were sustained by strong export growth, in particular driven by the manufacturing sector. India clearly exports a far smaller share of its output than did any of the East Asian economies during their high-growth periods (see figure 12).

The prospects for the manufacturing sector becoming the engine of India’s growth do not appear promising, owing to the structural shifts taking place in the global economy and the concomitant trend of premature deindustrialization. More worryingly, the prospect of exports becoming a main driver of economic growth also looks bleak. A spring 2015 study by the Bank of Canada explored the trend of stagnation of global trade since 2008, after more than a quarter century of sustained increases.106 It also posits that at least some of the contributors to strong global trade in the past, such as trade reforms and technology innovations, may have been secular and may have played themselves out. Consequently, even when trade rebounds, its pace of growth may not match the rates prior to the crisis.

Superficially, megaregional trade pacts may appear to contradict this pessimism over exports. However, they reinforce the recent slowdown in global trade. First, regional trade pacts are no substitute for a nondiscriminatory global free trade regime. Second, most of the regional trade pacts are political in nature as they seek to include some nations and leave out others from their ambit, through their elastic definition of the geographies covered by the pacts. Third, the problem with these so-called second-best government solutions is that they give rise to third-best private sector behavior. To take advantage of low tariffs under these regional trade pacts, companies may shift production or divert trade to countries covered by the pacts. In doing so, they hasten the onset of premature deindustrialization in their parent countries, with a consequent adverse impact on employment. Therefore, the megaregional trade pacts are unlikely to herald a renaissance in global trade flows.

The global recession of 2008–2009 and the accompanying global economic weakness, amplified by troubles in the eurozone and by the recent alarms from China, have taken their toll on the Indian economy. But for a small bump in 2010, the annual growth rates of exports of goods and services have declined continuously for more than a decade, and there is nothing to indicate that any reversal of this trend should be expected. It is no coincidence that in the 2003–2008 high-growth period, Indian exports grew at an annual average rate of 26 percent.

Quite apart from global factors, India has its own share of reasons for export pessimism. When trade is not expanding, other countries try to increase their market share. India has not been able to do so. The Monetary Policy Report of the Reserve Bank of India, presented with the first bimonthly monetary policy statement for the year 2016–2017, noted that India’s share of global exports declined from 1.7 percent to 1.6 percent between 2014 and 2015.107 Other than India, only oil and resource producers have seen a decline in market share. India’s inability to maintain, let alone increase, its market share reflects the myriad problems that hold back its growth. Among other things, the fragmentation of production makes the realization of sustained productivity gains and the achievement of export competitiveness especially difficult.

In his comments on the growth rate of the Indian economy in the quarter ending June 2015, the then minister of state for finance Jayant Sinha noted that it was impossible for the economy to grow at higher rates when export growth was not stagnant but contracting.108

All these adverse factors make the likelihood of trade becoming a driver of economic growth, at least for the near future, very remote. The foreign trade policy for 2015–2020 announced on April 1, 2015, seeks to double exports to $900 billion by 2019, for an annual growth rate of more than 14 percent.109 In other words, India not only will have to reverse declining export growth rates of recent years (2014–2016) but will also have to reach its fastest export growth in five years, against the backdrop of a sharp slowdown in China and gathering gloom about medium-term global economic prospects. Frederic Neumann, chief Asia economist at HSBC, summed it up pessimistically: “Over the next five years, it’s very hard to see exports as the engine of Asian growth.”110 He is right.

Global Economic Growth Stagnation

Neither India nor its East Asian neighbors can rely on export growth to drive overall economic growth. That is because most advanced economies have not addressed the core issue that led to the global recession of 2008–2009: the rapid accumulation of debt since 1970. That represents the largest and longest period of accumulation of debt in peacetime since 1870. Government debt in advanced nations rose rapidly during the two world wars, then declined equally quickly (see figure 13). The relentless rise in debt since the 1970s, however, is something new and will likely have much longer-lasting consequences. It has risen without a break for more than four decades, and without the excuse of war.

Between 1980 and 2014, the GDP of advanced economies rose by 5.6 times, while their public debt rose by 14.4 times. Nearly 55 percent of all GDP (in 1990 U.S. dollars) created since year 1 of the Common Era was created in the twentieth century alone. Even more staggeringly, 23 percent of all economic output since year 1 was generated in the first decade of the twenty-first century. This figure exceeds the cumulative output created in the world economy in the first nineteen centuries of the Common Era.111

Thus the inexorable rise in public debt, coupled with a rise in private debt, had been the engine of growth. That debt has to be paid back. Growth will inevitably slow in the developed world and will also become more volatile as efforts to sustain growth through asset bubbles will generate frequent boom-bust cycles. Indeed, the Great Moderation witnessed since 1980 in the economies of advanced nations appears to be over. A lower average economic growth rate coupled with more volatility is in store for economies the world over. This has implications for India.

Export-led growth serves many objectives. It enables a higher domestic savings rate and creates a constant pressure for quality and productivity improvements in domestic manufacturing. A difficult or even hostile export environment means that this automatic driver of greater domestic savings and productivity improvements will be missing in action. There will be a greater burden on other policy drivers to bring about improvements in domestic savings and productivity rates. Hence the difficulty of achieving a permanently enhanced economic growth rate is compounded by an unfavorable external environment in many ways.

In an op-ed piece published on the Project Syndicate website in February 2015, RBI governor Raghuram Rajan pointed to several external challenges for growth in India.112 One is that India will need an open system of international trade and finance to access essential commodities freely. Second, India will need multilateral institutions to develop frameworks that cater to the interests and capital needs of emerging economies. Third, advanced economies might both turn inward with respect to global monetary and financial systems and turn protectionist in matters related to trade. Right now, they continue to be dominated by frameworks that serve the interests of the developed economies.

There is a tiny ray of hope. In December 2015, Shinzo Abe, the prime minister of Japan, visited India and signed several landmark agreements with India, including one for the large funding of a high-speedtrain between Mumbai and Ahmedabad on extraordinarily soft terms; a technology collaboration; and a nuclear energy deal. If this is just the beginning of Japan paying more attention to its relations with India for strategic reasons, then India will be an undoubted beneficiary. As Dhruva Jaishankar pointed out at the time,

In the early 1990s, just a few years after the Tiananmen Square crackdown drew international opprobrium, China began raking in foreign investment. Between 1990 and 1996, some $435 billion was committed to China, helping to fuel that country’s transformative economic modernisation. Japanese pledges during that period accounted for a significant proportion, including almost 11 percent of total investment into Shanghai. At the same time, Tokyo was committing similar amounts to the Asian Tigers (Singapore, Hong Kong, South Korea and Taiwan) and to the emerging economies of Southeast Asia (Thailand, Indonesia and Malaysia). If there is one takeaway from Prime Minister Shinzo Abe’s just concluded visit to India, it is that Japan is willing to make the same big bet on India that it once did on China and Southeast Asia.113

India needs to understand the importance of investing in and nurturing these bilateral arrangements owing to the global risks that the RBI governor highlighted. That said, India will be able to reap the full rewards of Japan’s financial and technological support only if state and private sector capability is improved. These issues are addressed in the policy and program recommendations in chapters 7 and 8.

The Costs of Climate Change

It is difficult to do full justice to the topic of climate change and its impact on India. For an unambiguously India-centric angle on the issue of climate change in terms of both the costs imposed by climate change and the costs of mitigation efforts, the comprehensive work of Arvind Panagariya, published in 2009, before the Copenhagen Summit, serves well.114 In the Paris negotiations on climate change that concluded in fall 2015, India appeared to make some notional gains while suffering clear setbacks on some of its important negotiating points. India will have to deal with the consequences of climate change that were set in motion a long time ago while at the same time working to keep its own growth and development agenda from being derailed by the climate change imperatives of the developed world.

For instance, there is a very real risk that the global capital available to finance India’s thermal power projects might be restricted, with the lenders citing climate change concerns. Furthermore, as Nitin Sethi wrote in a piece about the Paris climate change talks for the Business Standard,

India relented, as did other developing countries, to set in motion a process through which by 2020, when [the] Paris agreement comes into force, the world will be looking at common rules for measurement, reporting and verification of the actions of all countries. . . .

India was not . . . able to keep alive the explicit reference that no country should be able to take unilateral measures like border taxes on imports based on climate-change considerations. It was also not able to keep alive a more explicit indirect reference to the need of resolving the issue of intellectual property rights that make clean technologies costly.

Some fear that the reporting requirement will bring equivalence between developing and developed countries in through the back door.

Fundamentally, the Indian economy faces the challenge of internalizing the full cost of environmental and social externalities (such as labor standards) without compromising its own economic growth prospects. Historically, these externalities were factored into economic decisions gradually in the course of a country’s development trajectory. The gradual absorption of costs kept overall costs lower and markets more inclusive. Now, producers face higher production costs and consumers face higher prices.

Then there are the direct costs of climate change and other related environmental problems. The increasing frequency of climate change–induced natural disasters brings with it greater human suffering and increasing rehabilitation costs. A growing body of evidence shows that the poor, both among and within countries, are the most affected.116 Disasters from climate change have the potential to push those most vulnerable even deeper into poverty and interrupt the diligent economic mobility of millions. Recovery from such episodes can take years.

In sum, climate change might be emerging as a big obstacle to India’s growth in many ways. That needs to be factored into any assessment of India’s economic growth prospects and risks.

This chapter and the immediately preceding ones may have sounded like a relentless onslaught of bleakness and pessimism. However, the intention of this report is not to prognosticate gloom and doom for India’s economic prospects—quite the opposite. But to find solutions to problems, it is important to begin by acknowledging the problems and trying to understand them. The various domestic and international barriers to growth can be addressed one by one, though it may take a generation or more to implement solutions and see outcomes.


87 Dani Rodrik, “The Past, Present, and Future of Economic Growth,” Working Paper 1, Global Citizen Foundation, June 2013,

88 Dani Rodrik, “The Perils of Premature Deindustrialization,” Project Syndicate, October 11, 2013,

89 Dani Rodrik, “Premature Deindustrialization,” NBER Working Paper 20935, National Bureau of Economic Research, February 2015,

90 Dani Rodrik, “Premature Deindustrialization in the Developing World,” Dani Rodrik’s Weblog (blog), February 12, 2015,

91 This figure is symptomatic of India’s data deficiency. The base year for the data in the chart is 2004–2005. In 2015 India changed the base year for national income aggregates to 2011–2012. But the history (time series) has not been updated to reflect the new base year. So the spreadsheet shows the sectoral GDP (at factor cost) share up to 2013–2014 with 2004–2005 as the base year. Then it provides the sectoral share of gross value added (GVA) at basic prices from 2011–2012 on. It is impossible for researchers to undertake long-term trend analysis. Policymaking is poorer for it.

92 Jesus Felipe, Aashish Mehta, and Changyong Rhee, “Manufacturing Matters . . . But It’s the Jobs That Count,” ADB Economics Working Paper no. 420, Asian Development Bank, November 2014,

93 Arvind Subramanian, “Premature De-industrialization,” Views From the Center (blog), Center for Global Development, April 22, 2014,

94 Dani Rodrik, “An African Growth Miracle?” Ninth Annual Richard H. Sabot Lecture, Center for Global Development, April 2014,

95Amrit Amirapu and Arvind Subramanian, “Manufacturing Futures,” Business Standard, May 9, 2014,

96 J. Banister and G. Cook, “China’s Employment and Compensation Costs in Manufacturing through 2008,” Monthly Labour Review 134, no. 3 (2011): 39–52.

97 T. E. Narasimhan, Hrishikesh Joshi, and Sohini Das, “Robots Rising in Auto Factories but No Labour Replacement Yet,” Business Standard, June 6, 2015,

98 “Budget 2016–2017” (speech of Finance Minister Arun Jaitley, February 29, 2016),

99 “Employment Across Various Sectors (in millions), Employment Elasticity, CAGR & Share of Employment and GVA: 1999–2000, 2004–05, 2009–10,” table, in Planning Commission of India, Databook (New Delhi: Government of India, December 2014),

100 Ejaz Ghani, ed., The Service Revolution in South Asia (Oxford: Oxford University Press, 2010).

101 Dani Rodrik, “Are Services the New Manufactures?” Project Syndicate, October 13, 2014,

102 Arvind Subramanian, “Economic Growth: Glimpsing the End of Economic History?” presented at the World Bank Conference on New Growth Strategies, Washington, DC, October 13, 2014, Competitive Industries and Innovation Program,

103 Dani Rodrik, “New Growth Strategies,” presented at the World Bank Conference on New Growth Strategies, Washington, DC, October 14, 2014, Institute for Advanced Study,

104 Ibid., slide 26.

105 “What to Make in India? Manufacturing or Services?” in Economic Survey 2014–15 (New Delhi: Government of India, 2014).

106 Michael Francis and Louis Morel, “The Slowdown in Global Trade,” Bank of Canada Review (Spring 2015),

107 RBI Monetary Policy Report, April 2016,

108 Arup Roychoudhury, Dilasha Seth, and Indivjal Dhasmana, “Open to Get More Private Sector Talent to PSBs, Jayant Sinha: Interview with Minister of State for Finance,” Business Standard, December 2, 2015,

109 New Foreign Trade Policy: $900 bn Exports by FY20, Indian Express, April 2, 2015,

110 Josh Noble, “China Export Woes Mirrored Across Asia,” Financial Times, August 20, 2015,

111 “Daily Chart—Death,” Graphic Detail (blog), Economist, June 1, 2012,

112 Raghuram Rajan, “Maintaining Growth in India,” Project Syndicate, February 2, 2015,

113 Dhruva Jaishankar, “Japan Bets Big on India: Abe Lends New Delhi the Same Helping Hand That China and Southeast Asia Leveraged to Take Off,” TOI Edit Page (blog), Times of India, December 15, 2015,

114 Arvind Panagariya, “Climate Change and India: Implications and Policy Options,” presented at the Sixth India Policy Forum, New Delhi, July 14–15, 2009.

115 Nitin Sethi, “India Defends Most Red Lines in Paris Pact,” Business Standard, December 14, 2015,

116 Center for Research on the Epidemiology of Disasters (CRED) and United Nations Office for Disaster Risk Reduction (UNISDR), “The Human Costs of Weather Related Disasters, 1995–2015,” UNISDR, 2015,