India's Growth Puzzle Is Really About Capability

Strong headline growth has not settled the debate about the Indian economy. Concerns about private investment, employment generation and the quality of growth continue to surface with surprising regularity. Concerns about weak private investment, declining net foreign direct investment, shallow manufacturing depth, rupee vulnerability and India's position in emerging technologies such as artificial intelligence are often treated as separate economic problems. Each has generated its own explanations and policy prescriptions.

Yet the persistence of these concerns despite the government's claim of a decade of visible achievements raises a broader question.

Much of the conventional narrative surrounding the Indian economy remains positive. Financial inclusion has expanded. Digital public infrastructure has transformed payments and welfare delivery. Public capital expenditure has risen from around 1.7% of GDP in 2019-20 to more than 3% in recent years. The banking system is considerably stronger than it was a decade ago. India is also widely regarded as a potential beneficiary of the ongoing reconfiguration of global supply chains.

Despite these gains, private investment remains well below the levels seen during the 2007-08 investment cycle, when gross fixed capital formation approached 38% of GDP. Net FDI has weakened sharply even as gross inflows remain substantial. External shocks continue to generate concerns about inflation, the current account and the rapidly depreciating rupee.

These developments are not unrelated. They reflect a deeper tension within India's growth model.

Cost Structure of Growth
Since the 2008 global economic crisis, the state has assumed a larger role in shaping economic outcomes. Transfers, subsidies, public investment, welfare programmes and incentive schemes have increasingly been used to support incomes, encourage investment and cushion households against economic shocks.

These interventions have produced measurable gains. They have also required sustained fiscal resources.

Those resources are mobilised through taxation, pricing policies, regulatory instruments, and administrative mechanisms that influence the economy's cost structure. Fuel taxation contributes significantly to public revenues but also feeds directly into logistics and transportation costs. Cross-subsidisation in electricity pricing supports the agricultural sector and vulnerable sections, but often results in industrial users paying substantially higher tariffs than those in competing manufacturing locations in East and Southeast Asia. Compliance requirements designed to serve stated public objectives impose cumulative costs on firms operating across multiple jurisdictions.

The consequence is a tension that receives less attention than it deserves. The same policy architecture that has expanded participation and improved the delivery of public services may also be increasing the costs faced by firms expected to generate investment, jobs, exports, technological upgrading and future growth.

This becomes particularly relevant when examining private investment. Gross fixed capital formation remains at around 30% of GDP, significantly below the level achieved during India's most rapid phase of expansion.

The issue increasingly appears to lie not in the availability of capital but in the economics of expected returns. Investors compare locations, not trajectories. A multinational evaluating a manufacturing facility, research centre, or AI-related investment is not asking whether India is better than it was ten or twenty years ago. It is comparing India with Vietnam, Indonesia, Malaysia or Mexico. Market size and infrastructure matter. So do energy costs, logistics costs, compliance burdens and regulatory predictability.

Manufacturing Beyond Assembly
The manufacturing sector illustrates this challenge particularly well.

India has achieved notable successes in sectors such as electronics. Mobile phone exports have grown from negligible levels a decade ago to become one of the country's largest export categories. Production-linked incentives have attracted investment into a range of industries.

Yet manufacturing continues to account for only around 15-17% of GDP. The issue is not the volume of production but its composition.

Industrial transformation occurs when firms move beyond assembly and processing into design, engineering, specialised component manufacturing, research and product development. These activities generate stronger domestic linkages and higher value addition.

Their location depends on more than incentives. Reliable and competitively priced energy, efficient logistics, skilled technical manpower, research capability, supplier ecosystems and regulatory predictability all influence where firms place higher-value functions.

India has made progress in some of these areas, but in most others, the gap with competing manufacturing destinations remains significant. Logistics costs are estimated at around 13-14% of GDP compared with roughly 8-10% in several export-oriented economies. The innovation ecosystem remains underdeveloped relative to competing manufacturing locations.

These constraints do not prevent manufacturing growth. They do influence which segments of the value chain are located within the country. Assembly operations may expand while design, advanced engineering and technology development remain elsewhere.

 Next Frontier
Artificial intelligence brings the same issues into sharper focus.

India possesses significant advantages: a large digital population, abundant technical talent and a sophisticated digital public infrastructure. These strengths ensure that India can be an important participant in the AI economy.

The larger economic gains, however, are likely to accrue to countries that possess the institutions supporting technological leadership. Universities, research laboratories, advanced computing infrastructure, venture capital ecosystems and sustained investment in scientific research form the foundation of frontier innovation. Investments in research infrastructure are most effective when accompanied by academic and institutional environments that encourage scientific inquiry and experimentation.

India's expenditure on research and development remains below 1% of GDP, far below the levels seen in countries that dominate advanced technologies. The more important question is whether the institutional and financial foundations required for technological leadership are being built with comparable urgency.

The same question applies to robotics, semiconductors and other technology-intensive sectors.

Looking Beyond the Symptoms
Weak private investment, declining net FDI, limited manufacturing depth, technological dependence and recurring vulnerability to external shocks are usually analysed as separate challenges. Taken together, they point to a deeper concern about the sources of India's future growth.

Over the past two decades, India has expanded financial inclusion, improved welfare delivery, strengthened infrastructure and enhanced state capacity. These achievements are significant. Yet many of the structural constraints affecting investment, industrial competitiveness and technological capability remain stubbornly persistent. High logistics costs, expensive industrial power, regulatory complexity and weak research ecosystems continue to influence where firms invest, where technologies are developed and where higher-value economic activity is located.

This outcome is not simply the consequence of unfinished reforms. It reflects policy choices. The fiscal, regulatory and pricing mechanisms used to finance and sustain inclusion have often transferred costs to the productive sectors of the economy, reinforcing some of the very constraints that limit investment, innovation and industrial deepening.

The challenge is not to choose between inclusion and growth, but to recognise that sustainable inclusion ultimately depends on growth generated by investment, innovation and rising productive capacity. India's experience between 2005 and 2015 demonstrated that social protection and poverty reduction are most effective when supported by a rapidly expanding economy. The task before policymakers is therefore not to scale back inclusion, but to reconnect it with a growth strategy driven by investment, innovation and rising productive capacity.