09 Feb 2023 4 min read

Manufacturing wealth: is India the new China?

By Erik Lueth

In the first of a series of blogs considering the economic prospects for the South Asian giant, we examine the role manufacturing plays in India’s development


230209 Manufacturing wealth - is India the new China.jpg

Given the slowdown in China’s growth in recent years, and ongoing geopolitical tensions, a lot of investors – notwithstanding the Adani story – are wondering whether India might become the next global growth story. With dynamic IT and service sectors, favourable demographics, and a political system more in line with the West, it has a lot going in its favour.

In this series of blogs, we will take a closer look at each of these factors and shed some light on India’s long-term growth prospects.

Made in India?

When we assess a country’s long-term growth prospects, our first point of reference is always manufacturing. This sector is struggling in India, as shown below. Not only is it smaller as a share of GDP than that of peers at similar levels of development, it is also shrinking.

230209 Manufacturing share of economies.png

Why is manufacturing so important for countries’ development?

First, productivity gains in manufacturing are greater than in services or agriculture. Second, manufacturing goods are tradable. By selling into global markets, countries compete with the best, incentivising them to move towards the technological frontier. Third, the sector can absorb large quantities of unskilled agricultural workers, thereby boosting overall productivity almost overnight. These features have gained manufacturing the label of ‘escalator sector’.

India’s government is aware of these game-changing properties. In September 2014, Narendra Modi’s government launched its ‘Make in India’ campaign, with the goal of raising the country’s manufacturing share to 25% of GDP by 2022 (later revised to 2025). In April 2020, it followed up with the ‘Production Linked Incentive (PLI)’ scheme, an effort to attract foreign companies and foster homegrown manufacturing in 14 key sectors.

Technical advances have made some services more like manufacturing over the past decades. These services are increasingly tradable and highly productive. India excels in these kind of services — IT services or business process outsourcing (BPO), for example — and so some have argued that India can leapfrog the manufacturing phase of development. Most of the sell-side reports that tout India as ‘the next China’ focus on these high-end service sectors.

Services vs jobs

The problem is that these sectors do not employ a lot of people. For example, IT and BPO services account for just over 1% of India’s labour force:

230209 India employment in high-skill service sectors.png

Also, high-productivity services are not likely to employ a lot of people anytime soon. This is because they are very skill-intensive and these skills are not available among the wider Indian labour force. Put differently, you can move swathes of farmers into factories, thereby boosting productivity in a very short time. You can’t, however, move masses of farmers into law offices, banks and medical practices. Without the potential to employ lots of people, high-end services are unlikely to be as transformative as manufacturing was in South Korea, Taiwan, or China.

The mismatch between the demands of India’s most dynamic sectors and its abundance of unskilled labour is apparent in the youth unemployment rate. As we can see below, youth unemployment is higher in India than in Asian peers with similar GDP per capita – and rising.

230209 Youth unemployment.png

Historically, all growth miracles have been driven by manufacturing — the few exceptions are commodity-driven growth spurts. While we like to believe in the transformative power of India’s service sector, the burden of proof is stacked against us. India’s best hopes probably still lie with manufacturing.

This is the first of a series of blog posts covering the Indian economy; future instalments include discussions of India’s role in friend-shoring at a time of global uncertainty, and a quantitative analysis of India’s future prospects.


Erik Lueth

Global Emerging Market Economist

Erik identifies investment opportunities across emerging markets. He uses quantitative models, past experience and lots of common sense. Prior to joining LGIM, Erik worked for a hedge fund, a bank, and the IMF.

Erik Lueth