R&D underspending in India has no one cause. It’s systemic as well as cultural

The captive market and its seductions

Begin with the most structurally respectable explanation: India’s domestic market is vast, and vastness, paradoxically, can be an impediment. A large captive market insulates producers from the bracing pressure of export competition, which has historically been the driving force behind quality improvement and technological upgrading. This is the R&D equivalent of Dutch disease — the same abundance that appears to be an asset quietly erodes the competitive muscle that exposure to harder markets would build. Companies that can grow for decades by serving a billion-plus consumers without venturing beyond the Subcontinent have little incentive to invest in the costly, uncertain process of frontier innovation. Why develop a better product when the existing one sells readily?

The long shadow of colonial deindustrialisation

A second explanation reaches further back. Indian commercial communities have historically been trading rather than manufacturing communities, and while this characterisation admits exceptions, it reflects a genuine historical reality. Whatever manufacturing instincts and capabilities existed before colonial rule were, in many cases, systematically suppressed. The de-industrialisation documented by economic historians — the destruction of India’s textile industry, among others — was not merely an economic event; it reshaped the orientation of Indian enterprise toward commerce, intermediation, and arbitrage rather than production and innovation. The few families that retained or rebuilt a manufacturing identity stand as evidence of what might have been more widespread had history taken a different course.

Financialisation before its time

The third explanation may be the most consequential, and is the one with the richest empirical corroboration from other markets. India’s corporate sector underwent a degree of financialisation — a shift in priorities from productive investment to financial return — somewhat earlier than its level of industrial development warranted. This sequencing mattered enormously.

The empirical record from developed markets is sobering. William Lazonick’s research, published in the Harvard Business Review in 2014, documented how the shareholder-value doctrine drove American corporations toward stock buybacks and dividends at the expense of investment in capabilities. Between 2003 and 2012, the 449 companies that had been continuously listed in the S&P 500 spent 54 per cent of their earnings on buybacks and another 37 per cent on dividends, leaving precious little for R&D. The central argument was that “maximise shareholder value” had been operationalised as “maximise short-term stock price”, with predictable consequences for long-run competitiveness. The distortions introduced by executive stock option schemes compound this problem. Research by John Core, Wayne Guay, and David Larcker on equity-based compensation has shown that options tied to short-term stock performance create incentives to manage earnings rather than invest in projects with distant payoffs. R&D expenditure, by its nature, suppresses near-term profits while creating competitive advantage over a horizon of five to 10 years — a horizon that typically outlasts both the executive’s tenure and the vesting period of their compensation package. The gains accrue to the executive’s successors; the costs fall on the executive’s own balance sheet. John Asker, Joan Farre-Mensa, and Alexander Ljungqvist, in a widely cited 2015 study comparing investment behaviour between publicly listed and privately held firms in the US, found that public companies invest substantially less — and are significantly more sensitive to short-term stock price movements — than comparable private firms facing no such scrutiny. The mechanism was precisely the quarterly reporting cycle.

India’s corporate sector absorbed the structural features of financialised capitalism before it had fully developed the manufacturing depth and technological capabilities that American and European corporations possessed when they eventually succumbed to the same pressures. Germany, Japan, and South Korea financialised their economies only after generating decades of compounding returns on investment in real productive capability. India attempted the transition earlier, with less accumulated capability to draw upon, and is now paying a portion of the price in an R&D intensity that remains well below what its strategic ambitions require.

Democracy, uncertainty, and the discount rate

Competitive popular democracy in a large developing economy generates its own structural uncertainty about the long-term future. Reconciling the demands of a vast and diverse electorate, multiple levels of government, a hostile neighbourhood, and stakeholders with sharply competing interests makes confident long-run prediction genuinely difficult — not as an intellectual failure, but as a rational response to the environment. Businesses internalise this uncertainty directly: The greater the uncertainty about the conditions under which a long-horizon investment must eventually pay off, the higher the discount rate applied to it. R&D expenditure — which suppresses near-term profitability in exchange for competitive returns that may take a decade to materialise — is precisely the kind of commitment that suffers most when discount rates are high. The result is not irrationality; it is the correct pricing of genuine uncertainty. That it produces underinvestment in the capabilities India most needs is the tragedy of the situation, not its justification.

The writer is chief economic advisor, Government of India. This is the first article in a two-part series. The second article will appear tomorrow