Despite starting the 20th century at broadly comparable levels of development, India’s economic trajectory has diverged sharply from countries such as China and South Korea. While these economies underwent deep industrialisation, India’s manufacturing sector has remained stagnant as a share of GDP and has increasingly ceded space to services. This persistent underperformance has revived debates on whether India’s policy choices inadvertently constrained its path to structural transformation.
India’s manufacturing puzzle in comparative perspective
China and South Korea used manufacturing as the engine of growth, absorbing labour, boosting exports, and driving productivity gains. India, by contrast, experienced early deindustrialisation: manufacturing never expanded enough to employ surplus labour at scale. Instead, growth became services-led, bypassing large sections of the workforce. Understanding why this divergence occurred is central to debates on India’s long-term development model.
The Dutch disease argument and India’s State-led wages
In a discussion around his book A Sixth of Humanity, economist argued that high public sector wages played a key role in holding back manufacturing. He invoked the concept of the ‘Dutch disease’ — originally developed to explain how the discovery of the Groningen gas fields in the Netherlands in 1959 weakened Dutch manufacturing.
What exactly is the Dutch disease?
The Dutch disease describes how a boom in one sector can harm others through price and wage effects. A windfall — such as oil or gas — raises wages as the booming sector attracts labour. Resource exports also strengthen the currency, making other exports less competitive and imports cheaper. Manufacturing, which is highly price-sensitive, suffers as a result, shrinking relative to the booming sector.
Applying Dutch disease to government services
Unlike natural resource booms, India’s case involves policy-driven expansion of a non-tradeable sector: government services. High public sector salaries raised economy-wide wage expectations beyond what manufacturing — given its productivity levels — could sustain. Higher incomes also increased demand for domestic goods, pushing up prices. Under free trade, consumers shifted towards cheaper imports, causing an appreciation of the real exchange rate even without a change in the nominal exchange rate. Manufacturing thus lost competitiveness at home and abroad.
The limits of the analogy
A key critique of this argument is that Dutch disease was designed to explain natural windfalls, not democratic policy choices. Public sector wages are political decisions, not exogenous shocks. While the price mechanisms may be similar, equating a salary policy with an oil discovery risks oversimplifying India’s development constraints.
Why didn’t higher wages trigger innovation?
Turning the question around reveals a deeper issue. If high wages were initially a constraint, why did Indian manufacturing not respond with technological upgrading? The theory of induced innovation suggests that labour scarcity and high wages push firms to adopt labour-saving technologies. Economist Sir John Habakkuk argued that Britain’s labour scarcity drove faster technological change than in the U.S. Economic historian Robert C. Allen linked Britain’s high wages to the Industrial Revolution itself. More recently, Nobel laureate has shown how ageing, labour-scarce economies such as Germany, Japan and South Korea used automation to raise productivity and wages.
India’s cheap labour trap
India’s experience appears different. Abundant labour kept wages low, reducing incentives for firms to invest in productivity-enhancing technologies. This is evident even in fast-growing services and IT sectors, where entry-level salaries at major firms have stagnated since the 2000s. The rise of platform companies such as Swiggy, Zomato, Blinkit and Ola reflects scale-driven growth using cheap labour rather than deep technological upgrading.
Growth without wage expansion
India’s private sector has been dynamic, but the gains have been uneven. Productivity increases have not translated into broad-based wage growth, contributing to rising inequality. This raises uncomfortable questions: did government intervention crowd out innovation, or did manufacturing become dependent on cheap labour and fail to modernise? The answer likely lies in a combination of policy choices, labour abundance, and weak incentives for technological change.
What to note for Prelims?
- Dutch disease and its economic mechanism
- Difference between nominal and real exchange rate
- Role of manufacturing in structural transformation
- Induced innovation hypothesis
What to note for Mains?
- Reasons for India’s weak manufacturing growth compared to East Asia
- Applicability and limits of the Dutch disease framework in India
- Relationship between wages, technology, and productivity growth
- Policy lessons for industrialisation and employment generation
