September 8, 2025 ☼ The Intersection ☼ social capital ☼ hyperdiversity ☼ public policy ☼ economics
A response to Pratap Bhanu Mehta's indictment of Indian capital
This is from The Intersection column that appears every other Monday in Mint.
Pratap Bhanu Mehta offered a searing indictment of Indian capitalism in the Indian Express a few days ago. At a time when tectonic shifts in world politics requires Indian capital to step up, he finds that it “shows little appetite for risk, no courage, little ambition for leadership, and little confidence in its own ability to build.”
He echoes what Naushad Forbes has argued for a long time: that India’s top companies underinvest in R&D. At a mere 0.3% of GDP, private spending on R&D is a fifth of the world average. India’s ten most profitable firms invest a mere 2% of their profit in research, compared to the 29-55% that their counterparts in the United States, China, Japan and Germany do. Alphabet, BMW and Huawei individually invest more in R&D than India’s entire private sector does.
Two questions follow: why is this the case and what can be done about it? Of the many causes, I want to focus on two that I think are most important.
The easier one first: Indian firms are sheltered from competition and have few incentives to innovate. Why invest in R&D when you can sell the same stuff to millions of new customers emerging across the vast country every year? Why venture into something risky — whether it is R&D or foreign market — when there are returns to be had by serving the growing domestic market? Substantial parts of the domestic economy are walled off, with FDI restrictions and import tariffs.
By 2010 we already had empirical evidence that trade liberalisation following the 1991 reforms had boosted firm productivity and R&D expenditure in India. The effect was not merely limited to competition. Cheaper imports allowed Indian firms to access inputs, technologies and processes that enabled innovation. Pinelopi Goldberg, Amit Khandelwal and colleagues found that “lower input tariffs account on average for 31 percent of the new products introduced by domestic firms” and that input tariff liberalization “relax(ed) technological constraints through firms’ access to new imported inputs.” In another study, Khandelwal and Petia Topaleva found that when trade and FDI rules were liberalised together, firm productivity went up four times compared to just lowering import tariffs.
If Chinese firms have become R&D powerhouses in the past two decades it is because they face cutthroat competition in both their domestic and foreign markets. Indian firms are relatively more protected. We have always given ourselves good reasons for this: from central planning, socialism, economic nationalism, geopolitics and economic statecraft. Well, if we believe that these are higher priorities, we should stop accusing Indian capital for under-investing in R&D. If necessity is the mother of invention, protectionism is its most common contraceptive.
It follows then that relaxation of trade and investment barriers are leverage points to galvanise Indian capital into greater competitiveness and innovation. That is why the Modi government should advantage of Trump’s tariff rampage to stir competition and shake up the fat cats.
Promoting competition will certainly move the needle, but I suspect that even so, India will underinvest in R&D due to a deeper, more difficult problem: inadequate social capital. India is a hyperdiverse, a large population of small caste-communities that have strong in-group bonds but weak inter-group ones. One of the economic consequences of this is that capital stays within communities, but opportunities, talent and risk appetite do not. A dispassionate analysis of why India did not industrialise in the 19th century leads us to conclude that, unlike in Meiji-era Japan, there were few financial institutions that could aggregate surpluses across the community and channel it to entrepreneurs in sufficient quantities.
Evidence from around the world shows that for entrepreneurs and R&D labs to be adequately funded you need generalised social trust. Yijun Meng and her co-authors studied over 14,000 firms in 72 countries in a period spanning 1992 to 2016 and found that “higher level of societal trust creates a higher R&D expenditure”. Indeed, R&D might be the sharpest test of social trust, for it requires large sums of money to be invested in ventures with long gestation periods, high failure rates and uncertain monetizability. More importantly, it requires trusting people who are different from you.
I have written about how democratic politics in India sharpens social differences, damages civic community and reduces social trust. Whatever the usefulness of a caste census it will strengthen bonds within caste groups and competitiveness between them. Votaries of this path to social justice have perhaps not contended with its economic and strategic costs. Indian firms can be blamed for being unwilling to train their workforce (and partly covering for the failure of education system to do so). That said, we should ask ourselves how much of this can happen if public policy and attitude continue to accentuate caste and linguistic identities.
Economic policy can change behavior to some extent. Competition under a fair, neutral umpire will create greater incentives for innovation. Nonetheless, Indian capital is cut of the same cloth as the rest of Indian society. It is unreasonable to expect it to vibe to a different tune. Mehta concludes that Indian capital is perhaps getting the government it deserves. We might as well say that Indian society is getting the capital it deserves.
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