The Past The Indian economy lacked competition, which meant it was less innovative. This situation kept out foreign investors and knowledge, resulting in limited access to advanced machinery and equipment from the developed world. Additionally, the basic products needed to create new factories, machines, and equipment were managed inefficiently. Consequently, India adopted some of the worst aspects of both systems.

As a wise man once said, “You should never half-ass two things; whole-ass one thing!” Thus, India’s economy in the 1940s and 50s grew slowly—so slowly, in fact, that India decided to ask for foreign aid. By utilizing elements of both a Soviet and a Western economy, India maintained a good relationship with both sides of the Cold War, taking advantage of this by securing funds from both.

By the 1950s, foreign aid had become the largest source of investment in India, yet the economy continued to grow slowly. The leaders realized they were doing a poor job and concluded that the reason for the sluggish growth was the government’s lack of control over the economy. As a result, existing businesses were nationalized, and private enterprises were allowed in fewer industries. Throughout the late 50s and early 60s, the Indian government became increasingly involved in economic management.

However, relying more on a failing system did not resolve its inherent issues. The more control the government exerted, the less efficient the economy became, leading to an increased demand for foreign aid.

India was caught in a cycle: the more it took control over the economy, the less efficient it became. As it lost customers abroad, government tax revenues declined, increasing reliance on foreign aid. This, in turn, compelled India to exert even more control over the economy to manage the aid, further diminishing efficiency and leading to more lost customers.

From the outset, India faced significant challenges: a culture that did not emphasize innovation, the potential for regional divisions following the British military’s departure, a government that controlled essential aspects of economic growth, and a form of capitalism that stifled healthy competition. It became clear that the economic system in place was fundamentally broken and incapable of fostering growth.

Independence from the British ultimately resulted in dependence on the Soviet Union and the United States to sustain the economy. Meanwhile, other countries were achieving far greater success. Western Europe and Japan rapidly recovered after World War II, while South Korea, Taiwan, and Singapore experienced significant economic growth. The people in these regions were becoming wealthy at a much faster pace than India, all while thriving as capitalist nations. Clearly, government control of the economy was not an effective strategy for achieving prosperity.

The present India faces significant challenges in various sectors. Its education system is inadequate, with only 55% of 10-year-olds able to read and understand a simple story. Many people lack access to healthy meals daily, contributing to nearly half of all childhood deaths being caused by droughts. The financial system is also in poor shape; unhealthy banks, which are crucial investors in an economy, lead to fewer investments.

Foreign companies often find it difficult to do business in India, preferring to operate in countries like Bangladesh or Vietnam. Additionally, the Indian healthcare system struggles to care for its entire population.

As more developing countries implement effective economic policies in the 21st century, competition will increase. Whether India can compete with better-managed nations remains uncertain. While it is unlikely that India will become a superpower within the next decade, many believe we will eventually witness its rise as a dominant global power. By 2050, India is expected to surpass the USA in economic strength, becoming the second-largest economy in the world, right behind China.

Provided the Indian government avoids major mistakes like those of the past, this optimistic outlook appears plausible. A world with India as one of the three superpowers seems increasingly likely.

India’s government employee count is basically the opposite of that of China and the United States. Whereas in the US and China, by far most government employees work at the local level, and only some at the state or federal level. In India, it is the other way around. Most of India’s government employees work at the state and, to a lesser extent, federal level, whereas only a few work at the local level. This can explain why India’s local governments were not able to invest or help foreign investors around the rules on the same scale as their Chinese counterparts did.

But if just local capacity was the only problem, then it could simply be solved by giving the local governments more money to hire more people, right? Well, sadly, that will likely not completely fix the problem. You see, there is something really strange going on with India’s local governments despite high unemployment. Many local governments have thousands of unfilled open positions. Even worse, some of India’s poorest local governments do not even spend all the money that they get from the central government. So what else is going on?

Well, this brings us to Kapur’s second explanation of why, in this case, local governments are not living up to their potential: India’s infamous caste system, which divides people into a hierarchy of social categories based on their birth. But before getting into that, we should note that the caste system has effectively been outlawed. However, despite that, in many parts of the country, it is still very much a political reality.

The caste system can explain India’s dysfunctional local governments in three different ways. Firstly, realizing that the caste system was still strong at the local government level, India’s founders on purpose made sure that local governments were not too powerful, which can explain why this graph looks the way that it does. Secondly, even if a local government has adequate capacity, they might not have the right incentives, meaning that they may frustrate the implementation of well-meant central government policies because it is not in line with the caste system.

As an example, Professor Kapoor mentions that quite a few federal education programs where schools were built to improve the education of girls failed at the local level because, and I’m quoting, “what happens within the classroom is affected by caste and gender norms.”

The issue of governance Thirdly, in some extreme cases, the caste system even leads to government vacancies potentially being left open because they only have candidates from higher castes. For example, in their book The Narrow Order, Professor Acemoglu and Robinson describe how, in one of India’s poorer states, Bihar, the state had thousands of vacancies for engineers that were not filled despite high unemployment. Why not? Well, because those qualified to be engineers are typically from higher castes. But because the province’s reigning governor, Lalu Prasad Yadav, was from a lower caste, he refused to fill these positions.

Of course, as a consequence, everyone suffered because the government here was so severely understaffed that it could not even spend all the money it got allocated from the central government to upgrade the local infrastructure. But okay, that is an extreme case which may not be applicable to all states. However, it is applicable to the third reason why its local governments are not enabling businesses like their Chinese counterparts, and that is that India is a democracy.

Now, I want to stress that in itself, this is not a problem at all. Sure, in China, the incentives of a promotion in the party meant that local governments could override local concerns to build infrastructure and go out of their way to attract foreign firms. However, in well-functioning democracies, this does not need to be a problem, since the democratic process itself could give local governors the incentive to invest in their cities and to attract foreign firms. After all, if you as a local governor grow your economy, then you’re more likely to be reelected as local governor again.

Indeed, democracy has produced the vast majority of growth miracles, ranging from West Germany to Italy to Japan and to the United States. However, unlike these countries, Professor Kapur claims that India is a so-called precocious democracy, meaning that the country became democratic before it was perhaps ready to become democratic. Professor Kapur discusses three reasons why this is holding India’s local governments back.

The first is that a precocious democracy can get into a vicious cycle in which it delivers poor public services like schools and health care. As a consequence, wealthier people will exit the public system and start using private schools and hospitals instead. Therefore, they are now less willing to pay taxes, making local government services even more dysfunctional. Indeed, as Professor Kapur notes, local governments in India, in particular, seem to be very hesitant to raise their taxes, the taxes that they need to improve their cities.

But sadly, there’s more. The second reason why being a precocious democracy is holding India back is that, because India is so divided, local government officials that were elected by their specific caste, religious group, or any other interest group tend to prefer rewarding their voters by giving them subsidies or other specific benefits rather than investing in public services that can be enjoyed by all. Finally, in precocious democracies, politicians will tend to emphasize public goods that are highly visible and relatively easy to provide.