Here's the Real Reason Why India's Economy Is Smaller Than China's


Without doubt, one of the modern world’s rising economic powers is India. Today, India is growing at a modest rate, despite some bumps, and is already the world’s third largest economy in purchasing power parity (PPP) terms. It is estimated to become the third largest economy in GDP by 2030.

For the past few decades, India’s economy has not grown as fast as it could, or as fast as China’s. Much of this is because of the economic policies of the Indira Gandhi government and the fact that India shied away from a manufacturing-based economy for a long time, instead focusing on a white-collar services sector. While India had a natural advantage in leveraging its educated English-speaking elite to become a destination for American outsourcing, this can only be a limited engine of economic growth for India. For a nation overwhelmingly comprised of peasants and farmers to grow, it needs to focus on industrialization and manufacturing. Despite numerous problems, this has been the underlying understanding of the Narendra Modi government and its economic policies. There is much resistance to this, however, since modern India has a historically conditioned wariness towards free trade and manufacturing induced partially in part because of India’s colonization by the British, led by the exploitative British East India Company (EIC).

One of history’s biggest questions is the underlying question of why India’s economy grew so slowly over the last two hundred years in the first place.

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The economy of India–or the collection of states that make up today’s India–was the second largest in the world from 1800 to 1870. India accounted for 22.6 percent of the world’s GDP in the 18th century. There have been times in history where India had the world’s largest economy, greater than that of China or the combined economies of Europe. India’s large economy was driven primarily by its huge population working in agriculture and manufacturing. The country additionally exported many products including cotton textiles, spices, and diamonds. However, India’s share of the global economy fell sharply during the 19th and 20th centuries, knocking it out of the top ten for a while (in raw GDP terms, the economy did grow but very slowly relative to industrialized countries). Why did this happen, and to what extent was British colonization a factor in this?

This question has inspired a lot of debate and there are multiple explanations. One of the most prominent and widely accepted in India is the Drain Theory. The Drain Theory was put forward by Dadabhai Naroji (1825-1917), the first Indian to sit in the British Parliament and a founding member of the Indian National Congress. It highly influenced Indian nationalism and the thought of Mahatma Gandhi and Jawaharlal Nehru.

According to Naroji, colonialism was unlike previous forms of imperialism because, for the most part, it did not result in the outright plunder and carting away of goods, Roman-style. He argued that instead, the British were draining the wealth away from India in the form of taxation: a large proportion of the yearly revenue raised in India was carried away to Britain, which resulted in diminishing wealth (capital) in India. Naroji compared this to the situation in medieval Europe where due to Church control of extensive lands and industries, wealth was being drained away from medieval European states to the Pope. Furthermore, while some Indian revenue was used to fund services in India, like the British Indian Army and railroads, these were often used to perpetuate the system of British drain. Finally, most bureaucrats and officers of the civil services and army were from Britain but paid from Indian taxes; when they retired, they would spend their incomes in Britain and not in India.

Naroji argued that the amount of revenue extracted by the British increased dramatically after the failed Indian Mutiny of 1857. Before the Mutiny, the British extracted two to three million rupees a year, but afterward, 20 to 30 million rupees a year, which is in the hundreds of millions of rupees in today’s terms. Naroji also argued that the Drain Theory led to a sort of “internal drain” that ruined the balance of wealth in India. This was because of regressive taxation that disproportionately impacted the peasants and poor. On the other hand, India’s princes were able to afford British taxation.

This theory was popular among Indian nationalists and seems to be broadly right in its basics tenets. However, modern economists and historians emphasize the fact that the British policy toward India’s economy was more nuanced and was more concerned with the British homeland’s trade policy than actually literally draining away wealth from India. For example, according to Sugata Bose and Ayesha Jalal, between 1870 and 1914, India’s “export surplus was critical for Britain’s balance of payments.” This was because of growing protectionism in Europe and the United States, which incentivized Britain to sell its manufacturing goods cheaply in India (which was not allowed to put up tariffs). This in turn slowed India’s transition to large-scale industrial manufacturing from cottage-industry manufacturing, as the Indian market was flooded with British goods (India’s situation is not altogether different today, as many goods from China are cheaper than Indian-made goods). In any case, Britain used raw materials from India to finance its deficits with other countries.

Some historians challenge this narrative, arguing that technology knocked out Indian artisans and not colonial inequality, pointing out that Europe’s artisans suffered similarly. Indian commentator and journalist, Gurcharan Das, who identifies as a Classical Liberal in the tradition of John Locke and Adam Smith argued the following:

Unlike nationalist historians, I do not think there was a British conspiracy to deliberately under-invest in India or sabotage Indian business interests. Bombay’s textile mills were built with the credit, technical assistance and machines from Britain although they were a competitive threat to the Manchester’s mills. I believe the industrial revolution did not occur because Indian agriculture remained stagnant, and you cannot have an industrial revolution without an agricultural surplus or the means to feed a rapidly growing urban population; second, the international trading environment turned hostile with protectionism after the First World War, followed by the Depression; third, the colonial government did not educate the masses, unlike the Japanese state; finally, a colonial mindset pervaded the Indian middle class–even the hardiest potential entrepreneur lacks confidence when he is politically enslaved.

All in all, it can be concluded that India’s economy and place in global economic rankings is smaller than it should be at least partially because of British action, though the extent and intent of this action is a matter of debate. More importantly, India must approach modern economic policy from the perspective of growth and not in a reactive manner. Many societies that were explicitly exploited in the past like South Korea, the Gulf States, or Ireland have managed to overcome poverty with reasonable economic policies suited to their circumstances. This is what India must do today, and not allow itself to remain a stagnant agrarian society because of political obstructionism.

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