India is never going to grow just the manufacturing way

Lord Meghnad Desai is a renowned economist and professor emeritus at the London School of Economics. He is also a life peer of the Labour Party in Britain and a noted writer of non-fiction and fiction. He spoke to Fortune India on how India can sustain growth and become an outlier nation. Edited excerpts:

BRICS is dead, they say. India must walk alone.
BRICS was a lazy idea. By saying ‘buy BRICS’, Jim O'Neill [the British economist who created the term] was giving a simple handle to young stockbrokers who didn't want to spend their time studying these economies. An assortment of entities was put together, where Brazil and Russia are land-rich, labour-scarce economies, and India and China are land scarce, labour-rich economies. Then, you know, South Africa was added and all that. It didn't really make sense as a group.

What was the problem? Why didn't it make sense?
Except for the fact that in the early years of the 21st century, when the stock markets of China, Brazil, Russia, and India became accessible globally, and were rising fast, and it seemed like ‘Oh, here's another market people can go to’, [there was nothing really common among them]. No one bothered to stop can ask that [If by combining these countries together made sense.]. Russia was a seriously underdeveloped economy. Brazil was a middle-income economy. India and China were on the lower side, and South Africa later proved to be dud. So I think there was no logic to it.

India's path from the beginning was quite peculiar, especially because of the way it started. It gave up its old socialism much later than China did, and it had never been an exporter in a big way. It has always been a domestic (market-driven) economy. And because of the peculiarity of legislation on labour, it made manufacturing growth difficult. That's why it grew the services way. That's the uniqueness of the Indian path. India is never going to grow the manufacturing way. That's its comparative advantage. Let the East Asian countries do manufacturing; they have made it cheap. If India ever does big manufacturing, it will be hi-tech. It will never be low tech.

And yes, there is a point in saying that India doesn't have to get classed into any group of countries at this stage. It can have its own character and policies.

If growth is not going to be led by manufacturing, what do you think will be the main triggers for India? How will it create millions of jobs?
India will have a vibrant and vast services economy consisting of sectors such as e-commerce. The growth of e-commerce in India is quite spectacular. Mobile telephony has transformed India in a far greater way than labour laws and manufacturing would have ever done. And what you see is e-commerce going into rural areas to outsource, and becoming a far more effective way of mobilising different parts of the economy.

So, maybe if Narendra Modi is successful, the Make in India sort of platforms will [focus on] high-tech manufacturing, not labour-intensive manufacturing.

Where will the millions of jobs, which we need, come from?
The growth of the retail sector, the services sector, a lot of self-employment—such trends that will bring the jobs. It seems difficult now, but it is going to happen because the time for India to reform its labour laws and go into, say, Malaysia-style manufacturing is gone.

What is interesting is that Modi actually does not want to reform labour laws. He actually is not a radical. He has the same economic philosophy as the Congress. He likes the public sector as much as the Congress did; he wants to make it more efficient. He is quite happy to reform labour laws at the state level but he doesn't want to get into that at the national level because he knows that it is politically far more expensive. He is an implementer but he is not a risk taker.

People should stop talking about Modi as someone who will radically reform the economy. He will get in foreign direct investment (FDI) to build high-tech platforms in India to export from India. There will be a vast services economy, including a major push towards startups. And that is the way the economy is going to grow. The problem: What do you do with agriculture? How can you keep people on the land and still ensure that they make a good living through agriculture? So there will be a lot of crop insurance, and even subsidies, to postpone the need to move people off the land and into manufacturing.

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Can India show the world that an economy of its size can be driven by services? And if it can, will it then be an outlier?
What happened from 1991 was that India liberalised itself but it didn't really transform itself. There was no deep reform of labour laws. It began to take advantage of international trade dismantling its tariffs, importing manufactured goods by and large, and exporting services. So, it is the first large economy for which the path to growth lies in exploiting comparative advantage and going the services way.

India had to do it that way because the existing labour laws made labour expensive. Large-scale factories require cheap labour. India could not have cheap labour. No government was going to go up that road because politically, defeat was certain; every trade union is against labour law reform. And alongside all this, a services revolution happened, which no one could have expected in 1991.

India has come up by exploiting the services sector and there is no reason why it should not keep doing that. What China is doing now—transitioning into domestic demand-led growth—India has done long ago. India never relied on exports, it always relied on consumer demand at home. It will grow faster because costs are continuously falling. The thing about the coming of the Internet is that costs are continually falling.

One of the problems with the informal sector model is quality. For instance, Germany for instance and its famed mittelstand [small and medium] companies are world-class manufacturers in small niches, like, screws. People worry that India is not able to do that.
India will make things for itself. And what it cannot make of quality, it will buy. It will sell software and buy screws! India has quadrupled GNP [gross national product] without doing anything serious about manufacturing. People have to now understand that Modi is not going to change labour laws—he is a fairly middle-of-the road, conservative leader.

You are saying Narendra Modi might be, in economics at least, more socialist than anything else.
In India there is absolutely no difference between political parties on the basic model. The RSS (Rashtriya Swayamsevak Sangh) is as much statist as the Congress—and anti-foreign. This comes from the legacy of the colonial struggle. One of the things that the Narasimha Rao-Manmohan Singh revolution did was change this to some extent. They made India more relaxed about foreigners. Modi is in that tradition. He is not worried about foreign capital even though some in the RSS and BJP might be. So Modi is welcoming of foreign direct investments and foreign corporations, but he is not a Margaret Thatcher.

What about the goods and services tax (GST)?
It will go through later this year. But everyone is overestimating the impact of GST. No one really knows how big or small its impact will be. These things are guesswork. It has an iconic status because it has been in the works for 15 years. It will be good to have a national market. But India has many fast-growing states. India needs to take the federalism business more seriously. India is Europe—there is no reason why the whole of India should be growing at the same time. India is going to be unique: It will be an economy of economies. It has come this far with all of this and there is no reason why it should not go on.

So, if it goes on like this, will Modi win in 2019?
There is, I think, a 70% chance that he will win in 2019. Don't go by state results. Like America, we are a split-ticket nation now. People vote differently for state and national elections.