January 13, 2026
“India has become the back office of the world. But where is the factory floor?” — Anonymous economist, circa 2005
“We wanted to set up a factory for the Nano in West Bengal. The land was acquired. The protests began. We left.” — Ratan Tata, Chairman of Tata Group, 2008
“The labor laws are so rigid that firms stay small to avoid them. This is the tragedy of Indian manufacturing.” — Jagdish Bhagwati, Columbia University
[2024: Manufacturing is 17% of India’s GDP. In China, it’s 27%. In Vietnam, 25%.]
[Part 3 of 6]
New parts publish every Tuesday and Thursday at 9AM EST
In 1991, India and China were roughly comparable. Both were poor, populous, agricultural nations emerging from decades of socialist planning. Both were opening their economies. Both had ambitions to become global powers.
Thirty years later, China is the world’s factory. India is the world’s back office.
China manufactures your iPhone, your furniture, your clothes, your toys, and your electronics, with Chinese factories employing hundreds of millions of workers who migrated from farms to assembly lines in the largest movement out of poverty in human history. India, by contrast, writes your software, answers your customer service calls, processes your insurance claims, and manages your IT infrastructure through service companies that employ millions of educated workers in air-conditioned offices while generating billions in export revenue. Both are success stories, but they’re not equivalent.
Manufacturing absorbs masses of workers with limited education. You can train a farmer to work an assembly line in weeks. Service exports require English fluency, technical degrees, years of education. India’s IT boom created a prosperous urban middle class. It did nothing for the hundreds of millions still trapped on farms.
China moved 300 million people from agriculture to manufacturing, while India moved them from farms to... other farms. This is the story of the missing factory.
The IT Miracle (And Its Limits)
The 1991 reforms unleashed something unexpected: an IT revolution.
India had advantages no one anticipated. English fluency (a colonial inheritance Nehru had tried to replace with Hindi). A time zone perfectly positioned to work while America slept. Elite engineering colleges (the IITs) that produced world-class technical talent. And crucially, once import restrictions lifted, access to computers.
To understand how transformative this was, consider the telephone. In the 1980s, the waiting list for a landline connection stretched ten years or more. A working telephone was so valuable that families listed it as an asset in marriage negotiations, right alongside property and gold. People bribed officials or bought “out of turn” connections on the black market. The state telephone monopoly was a monument to dysfunction.
By the 2000s, India had more mobile phones than landlines had ever existed. Private telecom companies, freed by liberalization, built networks faster than the government had managed in four decades. The same pattern repeated across IT: once the government stepped aside, Indian entrepreneurs moved at astonishing speed.
The combination was explosive. Indian software companies, Infosys, Wipro, TCS, began as body shops, lending programmers to Western firms. They evolved into global IT services giants. Bangalore transformed from a sleepy pensioner’s paradise into India’s Silicon Valley.
But here’s the irony: India went into software because hardware was impossible.
Narayana Murthy, who would become one of India’s richest men as Infosys co-founder, tried to import a computer in the early 1980s through a process that took three years, fifty trips to Delhi, and endless forms, officials, and bribes. By the time the computer finally arrived, it was nearly obsolete.
“We chose software,” Murthy later explained, “because software was just ideas. You couldn’t regulate ideas. You couldn’t require a license for thinking.”
The hardware barriers weren’t just bureaucratic. They were geopolitical. In 1987, India’s scientists requested a Cray XMP supercomputer for weather forecasting and nuclear research. The United States refused, citing Cold War export controls. India might use the machine for weapons development.
The denial stung. But it also motivated. Indian scientists at the Centre for Development of Advanced Computing built PARAM, India’s first indigenous supercomputer, within four years. “Thank you for the sanctions,” one scientist reportedly said. “You forced us to become self-reliant.”
The lesson was clear: hardware meant dependency, either on bureaucrats in Delhi or politicians in Washington. Software meant freedom.
India’s IT revolution wasn’t a strategic choice. It was an escape route from a system that made manufacturing impossible. The entrepreneurs who built Infosys and Wipro weren’t software visionaries who saw the future. They were pragmatists who discovered the one sector the License Raj couldn’t strangle.
By the 2000s, “Bangalored” had entered the American lexicon as a verb meaning “outsourced,” with Indian call centers answering questions about American credit cards, Indian programmers maintaining American banking systems, and Indian engineers designing components for American tech companies. The numbers were staggering: IT services grew from essentially zero in 1991 to over $200 billion in annual revenue by the 2020s, creating millionaires, building gleaming corporate campuses, and proving India could compete globally in knowledge work.
But here’s what the IT miracle didn’t do: employ the masses.
The entire IT and IT-enabled services sector directly employs roughly 5 million people out of India’s workforce of over 500 million, meaning the IT boom, for all its visibility, touches perhaps 1% of Indian workers while the other 99% needed factories.
Why Factories Never Came
The 1991 reforms freed product markets. They did not free factor markets.
To build a factory, you need three things: land, labor, and capital. Post-1991 India had capital (foreign investment finally flowed in). It had land (in theory). What it didn’t have was a labor market that allowed factories to function.
The Industrial Disputes Act of 1947 remained untouched by reform. Under Chapter V-B, any firm with more than 100 employees needed government permission to lay off workers. In practice, permission was never granted. Politicians wouldn’t sign documents that could be used against them in elections.
This created a “regulatory cliff” where firms with 99 employees faced a stark choice: stay small, or grow and lose all flexibility forever. Most stayed small, and the math was brutal. A factory that might optimally employ 500 workers would instead employ 95, staying just under the threshold, or it would hire contract workers (exempt from the law) rather than permanent employees, creating a two-tier workforce with no job security for most.
The result was India’s “missing middle.”
Indian industry consists of a few massive conglomerates (Tata, Reliance, Birla) that are large enough to absorb regulatory costs, and millions of tiny micro-enterprises that stay small to avoid regulation. The mid-sized firms that drive manufacturing employment in every successful industrial economy barely exist.
In China, the average manufacturing firm employs far more workers than in India. Chinese factories achieve economies of scale. Indian factories, constrained by labor laws, fragment into inefficient sub-scale units.
Land acquisition was equally broken.
The Land Acquisition Act of 1894 (yes, colonial-era legislation) governed how the government could take land for industrial use. The process was slow, corrupt, and politically explosive. Farmers displaced by factories became protest movements. State governments that acquired land for industry faced electoral punishment.
Building a factory required navigating years of legal challenges, compensation disputes, and political opposition. Easier to write software in an existing office building.
Infrastructure remained inadequate.
Power costs in India exceeded those in competing countries. Electricity supply was unreliable; factories needed backup generators. Roads were poor. Ports were congested. Moving goods within India cost more than shipping them to China.
And then there was the Inspector Raj.
Even if you navigated labor laws, acquired land, and secured power, you still faced the inspectors. A typical Indian factory was subject to visits from over 50 different regulatory authorities: labor inspectors, fire inspectors, pollution control boards, weights and measures officials, factory inspectors, boiler inspectors, and dozens more.
Each inspector had the power to shut you down. Each expected to be “taken care of.”
Factory owners kept calendars tracking which inspector came which month. They budgeted for “chai-pani” (tea and water, the euphemism for bribes). A factory manager’s job was less about production efficiency than about managing the parade of officials who could destroy the business with a single adverse report.
One Bangalore manufacturer described his routine: “Monday is labor inspector day. Wednesday is pollution board. Friday is fire safety. I spend more time with inspectors than with customers.”
A manufacturer considering India faced rigid labor laws that prevented adjustment to demand, land acquisition that could take a decade, power that might not be there when needed, logistics costs that erased any labor cost advantage, and a gauntlet of inspectors who treated every factory as a revenue source. They went to China, Vietnam, Bangladesh. Anywhere but India.
The West Bengal Tragedy
No state illustrates India’s manufacturing failure more starkly than West Bengal.
In 1947, West Bengal was India’s industrial heartland. Calcutta was the financial capital. The Hooghly River corridor hosted jute mills, engineering works, steel plants. Bengal had what other states lacked: infrastructure, capital, an educated workforce, proximity to coal and iron ore.
By 2024, West Bengal is an industrial wasteland.
What happened? The Communist Party of India (Marxist) happened.
The CPI(M) won state elections in 1977 and held power continuously until 2011. Thirty-four years of uninterrupted communist rule. The longest-running democratically elected communist government in world history.
Their ideology was worker protection. Their method was labor militancy. Their result was industrial extinction.
Unions under CPI(M) patronage became extraordinarily powerful. Strikes were frequent, prolonged, and often violent. “Bandhs” (general strikes) shut down entire cities for political protests. Factory managers faced physical intimidation. Foreign investors learned quickly: West Bengal was not worth the risk.
The exodus began in the 1980s and accelerated through the 1990s. Manufacturers relocated to Gujarat, Maharashtra, Tamil Nadu, anywhere the government wouldn’t actively sabotage them. The jobs left. The workers stayed. West Bengal’s unemployment became chronic.
The Tata Nano debacle crystallized the tragedy.
The Nano was Ratan Tata’s dream: a car for the masses. He had watched Indian families of four, sometimes five, balanced precariously on scooters, weaving through traffic. These families deserved safety. They deserved dignity. They deserved a car they could afford.
His engineers delivered the impossible: a $2,500 automobile. To hit that price point, they stripped everything non-essential. One windshield wiper instead of two. No power steering. No air conditioning. The engine in the rear to maximize interior space. Every rupee counted.
In 2006, Tata Motors announced plans to build the Nano factory in Singur, West Bengal. The state government, still under CPI(M), had acquired land and offered incentives. For once, West Bengal would get a major manufacturer. The people’s car would be built in the workers’ state.
Then the protests began.
Mamata Banerjee, opposition leader, organized farmers who claimed the land acquisition was unjust. Demonstrations blockaded the factory site. Workers couldn’t enter. Suppliers couldn’t deliver. After two years of chaos, Ratan Tata made a decision that stunned India: Tata would abandon the nearly-complete factory and relocate to Gujarat.
“We cannot run a factory with threats and intimidation,” Tata said.
Gujarat’s chief minister, a politician named Narendra Modi, welcomed the factory with open arms. The Nano plant opened in Sanand, Gujarat, in 2010. West Bengal got nothing.
The symbolism was devastating. India’s most respected industrial house, building India’s most anticipated product, chased out of India’s former industrial capital by political dysfunction. If Tata couldn’t make West Bengal work, no one could.
The CPI(M) lost the next election. But the damage was done. Factories that left in the 1980s and 1990s never returned. West Bengal’s industrial base had been destroyed over three decades. You cannot rebuild an ecosystem overnight.
Today, West Bengal’s per-capita income ranks among India’s lowest. The state that should have been India’s manufacturing powerhouse became a cautionary tale about what happens when ideology defeats economics.
The Golden Era (2003-2008)
Despite the manufacturing failure, something remarkable happened in the 2000s: India boomed.
GDP growth averaged nearly 9% from 2003 to 2008. The “Hindu rate” was a distant memory. India was suddenly one of the world’s fastest-growing economies. Goldman Sachs coined “BRIC” (Brazil, Russia, India, China) to describe emerging market giants. Foreign investors poured money in. The stock market soared. A new confidence emerged: India’s moment had arrived.
What drove the boom? Several factors converged.
Global liquidity. The Federal Reserve kept interest rates low after the dot-com crash. Capital flooded into emerging markets seeking higher returns. India, with its newly liberalized economy, absorbed billions.
Infrastructure investment. The government, finally, began building roads. The “Golden Quadrilateral” highway project connected India’s four major cities. Telecom deregulation created a mobile phone revolution. The physical and digital infrastructure that had constrained growth began, slowly, to improve.
Demographic dividend. India’s working-age population was growing faster than its dependent population (children and elderly). More workers, fewer dependents, meant higher savings and investment. The demographic structure favored growth.
Corporate optimism. Indian companies, freed from License Raj constraints, invested aggressively. Banks, flush with deposits, lent freely. Corporate debt rose as firms built capacity for an India they expected to keep growing at 8-9% forever.
The optimism was intoxicating. Real estate prices exploded. Infrastructure projects launched on borrowed money. Steel plants expanded. Power companies built capacity. Everyone assumed the boom would continue indefinitely.
It didn’t.
The Twin Balance Sheet Crisis
The 2008 global financial crisis didn’t hit India directly. Indian banks had limited exposure to American subprime mortgages. But the aftermath revealed a deeper rot.
The infrastructure projects launched during the boom began to fail. Land acquisition stalled. Environmental clearances were denied or challenged. Coal supplies (controlled by the government) weren’t allocated. Power plants sat idle. Road projects ran into protests. Steel plants couldn’t get mining permits.
Projects that assumed 3-year completion took 7 years. Projects financed with 5-year loans needed 10 years to generate revenue. The math stopped working.
By 2011-2012, India faced what economists called the “Twin Balance Sheet Problem.”
Corporate balance sheets were broken. Infrastructure and industrial companies had borrowed heavily during the boom. With projects delayed and revenues missing, they couldn’t service their debts. Interest payments exceeded operating income. Companies that should have been profitable were technically insolvent.
Bank balance sheets were broken. Public sector banks (government-owned, 70% of the banking system) had lent aggressively to these projects. As borrowers defaulted, Non-Performing Assets (NPAs) exploded. By 2016, gross NPAs exceeded 11% of loans. Banks, constrained by bad debt, stopped lending to new projects.
The result: an investment collapse.
Gross Fixed Capital Formation (investment as a share of GDP) peaked at 36% in 2007-08. By 2020, it had fallen to 27%. Firms weren’t investing because they were over-indebted. Banks weren’t lending because they were drowning in bad loans. The virtuous cycle of the boom became a vicious cycle of stagnation.
Policy Paralysis
The crisis was compounded by political dysfunction.
The UPA government (Congress-led coalition) won re-election in 2009 but became paralyzed by scandal. The “2G spectrum” case alleged ministers had allocated telecom licenses at below-market prices, costing the treasury billions. “Coalgate” revealed that coal mining rights had been given to companies without transparent auction. The Supreme Court cancelled both allocations.
Bureaucrats, terrified of investigation, stopped making decisions. Environmental clearances that required months now took years. Infrastructure projects awaited approvals that never came. Foreign investors, watching the chaos, stayed away.
Growth collapsed. The economy that had averaged 8.5% from 2003-2010 slowed to 5% by 2012-2013. The rupee cratered during the “Taper Tantrum” of 2013 when the Federal Reserve signaled it would reduce stimulus. India was suddenly grouped with the “Fragile Five” emerging markets vulnerable to capital flight.
The promise of the golden era had curdled. India had grown fast for a few years, but the growth was built on debt and optimism rather than structural transformation. When the debt came due and the optimism faded, the underlying weakness was exposed.
Manufacturing remained at 15-17% of GDP. The same as before the boom. The same as before the reforms. Twenty years of liberalization, and India still hadn’t figured out how to build factories.
The Service-Led Trap
India’s growth model was historically unprecedented and deeply problematic.
Classical development follows a sequence: agriculture to manufacturing to services. Farmers move to factories. Factory workers’ children get educated and move to offices. Each transition raises productivity and absorbs labor.
India skipped the middle step. It went from agriculture directly to services, leapfrogging manufacturing entirely.
This created a dual economy. Gleaming IT parks in Bangalore, Hyderabad, Pune, filled with English-speaking engineers earning globally competitive salaries. And surrounding them: villages where farmers practiced agriculture largely unchanged from their grandparents’ time.
The IT sector couldn’t absorb rural labor. You can’t teach a farmer to code in three months. Manufacturing could have provided the bridge: semi-skilled jobs that farm workers could learn, factories that could locate in smaller cities, employment that didn’t require college degrees.
Instead, India’s labor force remained trapped in agriculture. In 1991, about 60% of Indians worked on farms. By 2020, it was still over 40%. The share had barely declined in thirty years, even as agriculture’s share of GDP fell from 30% to 15%.
This meant farm incomes stagnated. The same amount of agricultural output was being divided among almost the same number of workers. Productivity per farm worker grew slowly because there were too many farmers for too little land.
China’s manufacturing revolution moved 300 million people from farms to factories between 1990 and 2020. Their agricultural workforce shrank from 60% to under 25%. Farm sizes consolidated. Agricultural productivity soared as fewer workers produced more food with better technology.
India’s agricultural workforce barely moved. The farms fragmented further as families divided land among children. The average holding shrank below economic viability. Indian agriculture became a poverty trap rather than a development foundation.
The IT miracle was real. But it was an island of prosperity in an ocean of stagnation. India had found a way to generate GDP growth without transforming its economy.
What Comes Next
By 2014, India faced a reckoning. The golden era was over. The Twin Balance Sheet crisis was strangling investment. Policy paralysis had destroyed confidence. Manufacturing remained the missing piece that reforms had failed to deliver.
The service-led model had hit its limits. IT couldn’t employ 500 million workers. Agriculture couldn’t sustain them. Something had to change.
In Part 4, we’ll examine what happened when a new government took power promising transformation. Demonetization. GST. The Digital India revolution. And the persistent question: can India finally build factories, or is it destined to remain “the world’s back office” while others become “the world’s factory”?
The elephant had learned to run on one leg. The question was whether it could grow the other.
This is Part 3 of a 6-part investigative series on India’s economic transformation. Part 4 will examine the Modi era disruptions and the Digital India revolution.
Disclaimer: This article presents historical and economic analysis. The author has no financial interests in Indian markets or companies mentioned.
Footnotes
* India-China Comparison - In 1990, India and China had comparable per-capita incomes (approximately $370 and $340 respectively). By 2020, China’s per-capita income exceeded $10,000 while India’s remained below $2,000, documenting dramatically divergent development paths since economic reforms. World Bank Development Indicators. https://data.worldbank.org/indicator/NY.GDP.PCAP.CD?locations=IN-CN
* IT Sector Employment - India’s IT and IT-enabled services sector directly employs approximately 5 million workers out of a total workforce exceeding 500 million. The sector generates over $200 billion in annual revenue, demonstrating the concentration of growth in a relatively small workforce segment. NASSCOM Industry Reports. https://nasscom.in/knowledge-center/publications/technology-sector-india-2023
* Industrial Disputes Act - Chapter V-B of the Industrial Disputes Act (1947, amended 1976) requires firms with 100+ employees to obtain government permission for layoffs, retrenchments, or closures. Studies by Besley and Burgess (2004) found that Indian states with “pro-worker” amendments experienced lower industrial growth and employment. Besley, Timothy, and Robin Burgess. “Can Labor Regulation Hinder Economic Performance? Evidence from India.” Quarterly Journal of Economics 119, no. 1 (2004): 91-134. https://doi.org/10.1162/003355304772839533
* Missing Middle - Research documents that Indian manufacturing is characterized by a “missing middle” of mid-sized firms compared to other developing economies. Firms cluster below regulatory thresholds or grow into large conglomerates, with few mid-sized enterprises operating at efficient scale. Hsieh, Chang-Tai, and Peter J. Klenow. “Misallocation and Manufacturing TFP in China and India.” Quarterly Journal of Economics 124, no. 4 (2009): 1403-1448. https://doi.org/10.1162/qjec.2009.124.4.1403
* West Bengal Industrial Decline - West Bengal’s share of Indian industrial output fell from approximately 20% in 1960 to under 5% by 2010. The CPI(M) governed the state from 1977-2011. Multiple studies attribute the decline to labor militancy and anti-business policies that drove manufacturing investment to other states. Historical data from Central Statistics Office industrial surveys.
* Tata Nano Singur - Tata Motors announced the Singur factory in 2006, began construction in 2007, and announced relocation to Gujarat in October 2008 after prolonged protests led by Mamata Banerjee. The Gujarat plant (Sanand) opened in 2010. Ratan Tata’s statement: “We cannot run a factory with threats and intimidation.” Extensively documented in contemporary business press and case studies.
* Golden Quadrilateral - The highway project connecting Delhi, Mumbai, Chennai, and Kolkata was launched in 2001 and substantially completed by 2012, adding approximately 5,800 km of four/six-lane highways, representing India’s largest infrastructure project post-independence. National Highways Authority of India. https://nhai.gov.in/
* Twin Balance Sheet Problem - The term was popularized in India’s Economic Survey 2015-16. Gross NPAs in public sector banks exceeded 11% by March 2016. Corporate debt/equity ratios in infrastructure sectors exceeded sustainable levels, creating a cycle where overleveraged corporations couldn’t repay banks and undercapitalized banks couldn’t lend. Reserve Bank of India Financial Stability Reports. https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=17877
* 2G and Coal Allocation Scandals - The Supreme Court cancelled 122 telecom licenses in February 2012 (2G case) and 214 coal block allocations in September 2014 (Coalgate). Both cases alleged non-transparent allocation without competitive auction, paralyzing government decision-making as bureaucrats feared investigation. Supreme Court judgments available through official records.
* Agricultural Employment - India’s agricultural workforce share declined from approximately 60% in 1991 to approximately 42% in 2020. In contrast, China’s agricultural workforce share fell from approximately 60% in 1990 to approximately 25% by 2020, illustrating India’s failure to move workers from agriculture to manufacturing. World Bank and ILO data. https://data.worldbank.org/indicator/SL.AGR.EMPL.ZS?locations=IN-CN
