Why India might never become an economic superpower

India's moment of creation was defined by Nehru's vision of its "tryst with destiny". It probably explains why our policy makers have acted as if India's emergence as a global economic power is indeed its destiny and not the outcome of purposeful policy actions that they need to take. Fed on a staple diet of India's historic grandeur, evidence of a glorious past has in itself and by itself become the raison detre for a grand future. Further, driven by growth starvation, the global economic community, too, has contributed in creating a delusional sense of the inevitability of India's long-term economic glory.

Recent events have led to some introspection, but none of it seriously questions the long-term prospects of the Indian economy - only the short-term decision making of its policy makers. But it still makes sense to ask how and if India may yet falter at the precipice of economic glory.

It still makes sense to ask why India's rise as an economic power has never been its birthright but something that will require immense discipline, sensible statecraft and some measure of good luck - if for no other reason than to shine a light on what needs to be accomplished, beyond everlasting and occasionally blind faith in our tryst with destiny.

Service sector led growth is unsustainable
India's model of growth and development is unprecedented in the annals of global economics. It started with a large and rapidly growing services sector, and is now attempting to reinvigorate its manufacturing base. This is precisely the reverse of the usual transition process where economies use a large manufacturing base to propel themselves into the services sector. In fact there isn't a single comparable example of a nation that has even attempted India's reverse transition, much less done it successfully.

The criticality of transitioning to a strong manufacturing base for the successful emergence of global powers is well established in history. It suggests that a rise in sustainable global economic power is almost always preceded by a rise in manufacturing capabilities. Further, this relationship has held true over 400 years of economic, technological and geopolitical upheavals.

In the 18th century, Spain's status as the world's first global superpower was mostly driven by its manufacturing prowess - the backbone of its famous armada. In the 19th century, Britain's rise as a global economic power was preceded by the 'Industrial Revolution' and a rise in its share of global manufacturing output. Its share rose from two per cent of global output in 1750 to 20 per cent by 1900, the peak of its global economic power. Even more illustratively, its decline was mirrored by its share of global manufacturing, which had fallen back to two per cent by the late 1990s, when it gave up its last colony, Hong Kong.

Similarly, the United States's rise as a 20th century global power came on the back of its legendary railroad and automobile manufacturing industries. And its recent underperformance, when the dust settles on history, will also likely be linked to its loss of manufacturing competitiveness to China.

China's own share of global output has risen from four per cent in 1990 to 20 per cent in 2010 - almost concurrent with its rise in global economic stature in the 21st century. History's message is clear. Global powers rise and fall with the ebb and flow of their manufacturing sector, irrespective of time and geography. This doesn't bode well for India, whose share of global manufacturing has been virtually stagnant - increasing from 1.2 per cent to 2 per cent - over the last four decades. Its productivity is also abysmal by global standards. For example, US manufacturing produces a value of output per hour worked of $51.2, compared with $10.9 in China and just $0.8 in India. So the Indian manufacturing sector still accounts for only 12 per cent of GDP and 15 per cent of employment. As a result, a country aspiring to global status, with 17 per cent of the world's population, produces only two per cent of its goods and earns only one per cent of its income. Unfortunately for India, there isn't a single global power of note that has been able to overcome that sort of manufacturing handicap. In short, unless India's manufacturing capabilities dramatically improve, it will remain on the wrong side of history.

Demographic dividend no more
According to demographic projections, India alone will contribute two-thirds of the entire global increase in labour over the next 15 years. The total available labour in India will in fact be more than that in China and the US put together. A large labour surplus is usually perceived as good news - often referred to as India's "demographic dividend". However, to effectively utilise this "dividend", we need to find a way to provide education, followed by vocational training and finally jobs on an unprecedented scale (more than 100 million additional jobs in the next decade, compared to the less than 20 million created in the previous one). Otherwise, the "demographic dividend" will quickly become the "demographic tax" - a large surplus of a skill-less and jobless population.

Usually economies can leverage their fastest growing sectors to contribute to such job creation efforts. Unfortunately, India's largest and fastest growing sector, services, can't provide these jobs. Service sectors by definition are based on high value but low employment structures. They are not designed to generate mass employment since they don't offer significant backward linkages to other sectors. Even at its peak, the outsourcing sector employed only about 0.2 per cent of India's population. Put another way, even at its current breakneck growth rate, it would take another 50 years before outsourcing can offer the same number of jobs as agriculture does today.

Further, assuming that the current service sector growth rate will continue is not realistic, since any competitive advantage based on cost alone tends to be transitionary. We have already begun to see a gradual shift away from India to lower cost countries such as Philippines and Vietnam. Hence, although IT services and outsourcing are shining examples of India's contribution to global economics, they are unlikely to be able to feed, clothe or employ India's teeming masses. They are the basis for much of the global fanfare about India, but they are not the workhorses that can take India into economic 'superpowerdom'.

India might still be able to achieve the truly unprecedented - a ride to global superpower status without creating jobs and without any significant contribution from manufacturing. But the point is that we shouldn't bet on it - or worse, behave as if it's an assured outcome. This fallacy seems to have affected our governance over the last few years - a lackadaisical approach to rectifying structural issues rather than the energetic, almost frenetic, response that it is the need of hour.

Why, after 60 years of independence, are there 300 million Indians who still can't afford two square meals a day? Why do 700 million Indians still lack access to basic sanitation facilities? Why do we still spend only two per cent of GDP on education when we need to spend more than five times that amount just to keep pace with current levels of education? Paradoxically, it is in the answers to these difficult questions, and not the unbridled swagger of our presumed birthright, that we are likely to find India's tryst with destiny.

(Rakshit Pandey works with a large global Wall Street investment firm in New York, where he analyses emerging markets)