Steven Pearlstein
Steven Pearlstein
Columnist

What’s holding India back from real growth?

Kuni Takahashi/BLOOMBERG - Bajaj Auto, faced with stiff competition from importers, created a new culture and moved beyond the old Indian standard of ‘’good enough.’’ It is now producing 4 million vehicles a year.

Pune, India

Tucked away in three converted storefronts at the back of an old shopping mall in this thriving city is a little company that explains why so many Americans are anxious about globalization.

Steven Pearlstein is a Pulitzer Prize-winning business and economics columnist at The Washington Post.

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April 12 (Bloomberg) — Jerry Webman, chief economist at OppenheimerFunds in New York, talks about India's economy and investment opportunities. He speaks with Lisa Murphy on Bloomberg Television's \

April 12 (Bloomberg) — Jerry Webman, chief economist at OppenheimerFunds in New York, talks about India's economy and investment opportunities. He speaks with Lisa Murphy on Bloomberg Television's "Fast Forward." (Source: Bloomberg)

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Here, dozens of ambitious 20-somethings are crammed in like commuters in a subway car, sitting at long banquet tables in front of well-worn computer screens creating Web sites and graphic interfaces and software applications for companies in the United States and around the world that they know little about, taking their assignments from people they will never meet or talk to.

Most of the workers make about $270 a month — enough to pay for a small apartment, a scooter and weekend outings to the food courts at local shopping malls. And they are sufficiently in demand that 40 percent of them move on every year to bigger firms such as Wipro and Infosys, which offer Saturdays off, subsidized lunchrooms with ping-pong tables, and the glamour of working in one of the gleaming new high-tech parks that have sprung up on the outskirts of this college town and industrial center.

The company is Panacea, and it gets half of its work by bidding for jobs through freelancer.com, an Australian outfit. With annual revenue of $150,000 a year, Panacea is one of the site’s most successful suppliers in India. And later this year, when Panacea expects to win its first ISO certification, owner Vivek Ghai hopes to land subcontracting work from local offices of Accenture and IBM, which he says typically charge $30,000 for jobs that he and his crew do for $3,000.

In many ways, Panacea is emblematic of the Indian economic boom, one built on low wages, entrepreneurial energy and Internet technology that has created the kind of perfectly competitive markets that once existed only in the imagination of neo-classical economists. What toys, shoes and electronics are to China, call centers, back-office processing and software development are to India, a fast-growing source of export-oriented jobs and wealth that is lifting millions out of poverty.

Like China, India’s success has come at the expense of some Americans whose livelihoods are being hurt by the low-cost competition. Unlike China, however, India’s exports to the United States are roughly balanced with its imports, allowing the benefits of trade to flow more evenly in both directions.

The problem for India is that it may not be able to rely on service-sector exports to sustain its growth. There is no likely scenario in which the demand for reservation agents and programmers — or India’s ability to supply them — can create the million jobs a month needed in a country of 1.2 billion where half the population is under 25. They can’t all work for Infosys.

India’s education system is already having trouble keeping up with the demand. Public elementary and secondary schools are underfunded and staffed by poorly trained teachers who too often don’t show up for work and who rely on rote learning when they do. And although India’s elite universities are world class, the quality falls off pretty quickly after that.

As a result, only 75 percent of graduates of technical colleges, and 85 percent of all university graduates, are considered employable by globally competitive firms. And even those who are hired have to be put through three-month training programs just to get them onto the first rung of the ladder.

The shortage of talent is driving up wages for highly skilled tech workers by 30 to 40 percent a year, which is great for them but quickly eroding the cost advantage of India’s high-tech sector. It was big news here when the chief executive of General Electric recently declared that it costs only 10 percent more to do some functions in the United States than in India. In Pune, “Mannie” Vangala, an executive at SAI, a research firm that has outsourcing contracts with many of the world’s top pharmaceutical companies, predicts his 50 percent labor cost advantage over the United States could disappear within five years.

Next door in the booming Hinjawadi Infotech Park, Emcure Pharmaceuticals is churning pills and vaccine doses from a modern 26-acre complex of production plants and laboratories. Mukund Ranade, who oversees Emcure’s business development, notes that his company has the same equipment and regulatory compliance costs as U.S. firms, even as the annual salaries of top Indian scientists have reached $90,000. Ranade says U.S. pharmaceutical clients now have “unrealistic” expectations of the cost savings in India.

Shift to manufacturing

That’s why India’s economic policymakers have shifted their focus to manufacturing products for the fast-growing Indian market, which offers the prospect of providing many more jobs for those with much lower skills and education.

Cummins, the big U.S.-based engine company, has had a plant in Pune since 1962, and demand for its products are so brisk that it will open a second, bigger production campus 90 miles away. Regular electrical failures mean that half of all customers — from shopping malls and apartment buildings to upper-class homes — have backup generators, and Cummins owns half of that fast-growing market.

Raj Menon, who leads the Cummins operation in India, says the key advantage to producing in India — low labor costs — still outweighs the disadvantages of poor infrastructure. The facilities, he says, have the same or better quality and efficiency than Cummins plants in any other country. But he and his colleagues say it has taken time, patience and persistence to overcome cultural tendencies that make it difficult for workers to acknowledge problems, take responsibility for team performance and question those above them in the hierarchy.

Bajaj Auto, which produces many of the black-and-yellow three-wheelers that shuttle people around Indian cities, went through a similar transformation. In the days when the License Raj set prices and production quotas, Bajaj had a virtual monopoly in the Indian scooter market, with a 14-year waiting list for its products. But once the economy was liberalized in the 1990s, Bajaj found itself facing stiff competition from Honda and other Japanese importers, particularly in the fast-growing and profitable market for bigger and more powerful motorcycles. To meet the challenge, the company created a new R&D shop, radically consolidated its supply chain and opened a factory in Chakan, an hour’s drive from Pune, where it hired workers, created a new culture and moved beyond the old Indian standard of “good enough.”

Bajaj is now producing 4 million vehicles a year — four times what it did in 1995 — with the styling, reliability and price that have allowed it not only to hold its own at home, but export to developing countries in Africa and east Asia. More significantly, Chakan is a thriving auto production cluster with dozens of parts makers supplying not only Bajaj but new Volkswagen and Mercedes plants as well.

The China of India

The biggest obstacle to India’s industrialization remains the lack of infrastructure, and no state is tackling that more aggressively than Gujarat. The entire state has been turned into one large public works project, with billions of dollars in investment being poured into dams, canals, power plants, highways, gas pipelines, electric grids and ports. The state is even assembling the land to create industrial cities along the path of a high-speed rail freight line that the central government is planning between Delhi and Mumbai.

Gujarat’s notoriously efficient, autocratic and incorruptible chief minister, Narendra Modi, is a strong adherent to the Asian-style industrial policy who believes that if you build it, they will come. And they have, bringing oil refineries, shipbuilding facilities, steel and auto plants and LNG terminals. With 5 percent of India’s population, 15 percent of its industrial production, 17 percent of its capital investment and 22 percent of its exports, the joke is that Gujarat has become the China of India.

Rajan Shah started Harsha Engineers in Ahmedabad in 1972, back when textile mills were what passed for Gujarat’s manufacturing base. Harsha got its big break in 1997 when Timkin, the giant ball-bearing maker in Canton, Ohio, decided to stop making the metal cages that are used to hold its bearings and rely on Harsha instead, and the company has grown steadily ever since. Shah figures he still has a 10 to 15 percent cost advantage over global competitors, thanks in part to Gujarat’s low wages and the ready availability of good design and production engineers. But just in case, he’s opening a second plant — in China.

Despite such successes, India has a long way to go to modernize an economy where 80 percent of economic activity takes place in the “informal” sector. Beyond the more obvious problems of corruption, poor infrastructure and a low-productivity workforce, too much of the formal economy is controlled by a handful of family-run conglomerates who are quick to use their political and financial muscle to move into any sector that shows promise. In a nation of naturally entrepreneurial people, this creates headwinds for independent companies trying to attract talent and capital. It contributes to the growing concentration of wealth in the hands of a business elite that by all accounts has grown increasingly disconnected from the rest of the country. And it has encouraged many of the best and the brightest either to leave the country or follow the golden path into real estate and finance rather than manufacturing or government.

It also has an effect on foreign investors, who are keenly aware of the dangers of trying to compete against the local oligarchs. Enron tried it and wound up losing $1 billion on an ill-fated energy project. And I found it telling that Wal-Mart, which for years has been pushing hard for the government to relax rules that prevent foreign firms from opening stores in India, may chose to continue its joint venture with the Bharti family rather than go it alone.

A somewhat closed financial system is also restraining growth. India’s central bank is most proud that its tight restrictions on the flow of borrowed money into the country minimized the impact of the recent global financial crisis on India. But business executives complain that those same restrictions also prevent the development of a corporate bond market that is badly needed as a source of infrastructure funding. They require banks to keep so much of their deposits on reserve, or directed to low-return loans to farmers, that the cost of borrowing for businesses and consumers is two percentage points higher than it needs to be. It also doesn’t help that Indians continue to put much of their savings into gold rather than into a financial system that would recycle it into the economy.

In recent years, all the major investment banks and private-equity firms have opened offices in Mumbai and Bangalore in the hopes of cashing in on the bonanza. So far the results have been modest. The central bank tightly restricts how much borrowed money can be used to buy companies, which dramatically limits the returns they can make. And with so many firms competing for a relatively small number of widely shopped deals, the transaction fees are so low and the price of firms so high that the best investors can often hope for is returns that match the growth in the economy. Early-stage venture capital is almost nonexistent.

Study in contrasts

Like most foreigners, I came away from a two-week passage through India jarred and intrigued by the contrasts between modern and backward, rich and poor, and how they coexist. While the economy’s recent growth rate of 8 to 9 percent has been impressive, just about everyone acknowledges that it could just as well be half again as much with the right policies and better governance.

In development terms, there’s enough low-hanging fruit that India can easily grow at the current pace for another decade. But without more structural reforms and the difficult political and social trade-offs those involve, India could easily find itself in the middle-income trap from which only a small number of companies have emerged. While most Indians, like many Americans, view India’s economic ascendancy as inevitable, I’m not totally convinced.

I mentioned my doubts to Ajit Gulabchand, the construction magnate developing the new city of Lavasa. “We’ll make it,” he assured. “Just don’t ask me how.”

 
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