India's productivity gap widens: Manufacturing woes under strong GDP growth

Productivity Gap Beneath the Boom

India's economy has maintained rapid growth in recent years, drawing global attention. However, a research report from Equirus Securities reveals an alarming reality: the labor productivity gap between India and China has widened by over $30,000 (in per capita output terms) since 2000. Although India's per capita GDP has more than tripled since 1995, productivity gains have fallen far short of those of its Asian peers. This means India has not yet experienced the "industry-led productivity leap" that China, South Korea, and Vietnam enjoyed during their high-growth periods.

Limitations of the Service Sector Boom

The main driver of India's productivity growth has been IT and services, a model that delivered annual productivity growth of 5.3% in the 2000s. But by the 2010s, the growth rate slowed to 3.4%, due to a series of economic shocks—the 2016 demonetization, the disruption from the 2017 GST rollout, and the shadow banking liquidity crisis—all of which severely weighed on India's vast informal economy. The report particularly notes that the pandemic hit India's productivity the hardest among the sample (a 12.3% decline in 2020), directly reflecting the country's reliance on the informal sector and migrant labor, as well as the consequences of strict lockdowns.

While the service sector is highly efficient, its capacity to absorb employment is limited, leading to severe unevenness in India's overall productivity. If services are excluded, productivity growth in the goods-producing sector is much more modest. This "services-manufacturing divide" means that the most dynamic parts of the Indian economy can only provide high-productivity jobs for a minority, while the majority of the labor force remains stuck in low-productivity areas.

PLI and China+1: Local Progress, Unchanged Overall

The Indian government's Production Linked Incentive (PLI) scheme and the "China+1" trend in global supply chain restructuring are seen as key drivers for manufacturing upgrading. The report acknowledges that output growth is real in electronics, pharmaceuticals, and auto components. However, the share of manufacturing in GDP has not shown a structural rise. In other words, PLI and foreign inflows have not yet changed the industrial landscape of India's economy. The manufacturing sector is still too small to serve as an engine of productivity growth like it did in China.

Structural Problems Remain Stubborn

The report points out several hard constraints on further productivity growth in India. First, labor market rigidities, particularly employment regulations and skill mismatches, inhibit business expansion and efficiency gains. Second, high logistics costs—India's logistics costs account for about 13%-14% of GDP, compared to only 8%-9% in China. This directly undermines manufacturing competitiveness. In addition, slow land reform progress and commodity price pressures also hinder India's transition to a high-productivity model.

Fundamental Strengths and Reform PrioritiesDespite the above challenges, India's long-term fundamentals remain favorable: a young demographic structure, mature capital markets, sustained foreign capital inflows, and increasingly sophisticated digital infrastructure. However, the report emphasizes that capital expenditure and incentive programs alone are far from sufficient. Sustaining higher productivity growth requires deeper structural reforms, including transportation costs, land reforms, and others. Only by making breakthroughs in these areas can India translate its rapid economic growth into genuine total factor productivity gains and narrow the gap with China.

India's economy is at a crossroads: either continue to rely on services-driven uneven growth, or unleash the potential of the manufacturing sector through bold reforms, embarking on a path of industrial upgrading similar to East Asian economies. Policy choices in the coming years will determine whether India can escape the "middle-income trap" and achieve lasting prosperity.