India needs to build IP-driven companies to escape middle-income trap

New Delhi

India will soon become the third-largest economy overtaking Japan and Germany. However, the journey from the third largest to the second largest or the largest is going to be extremely difficult given the large gap (The US at 7 times and China at 4.5 times the current size). Now, in order to bridge the gap with existing poles of the global economy and geopolitics, India has to focus more on the structure of the economy than size. The structure of the Indian economy remains shallow as we are dependent on foreign countries for most critical parts of the value chain and these vulnerabilities get reflected from time to time - most recently during Covid when API imports stopped.

India remains at the lower end of the value chain in the majority of the sectors. Among the 10 largest companies in the United States, 9 are IP-driven technology/Product companies, and the 10th is an investment firm with stocks of technology companies around the world. These companies are at the forefront of innovation and enjoy a premium in the market valuation based on their ability to be at the top of the game in their respective sectors.

On the other hand, none of the 10 most valued Indian companies are IP-driven. Most of the Indian companies are banking or technology service providers. Innovation is not at the core of any Indian companies among the top 10. If the structure of the economy remains the same, a few decades down the line, the Indian economy will become stagnant just like the European economy.

The story is the same for European countries despite the fact these countries have lost in the innovation game in the last two decades. Among the top 10 European companies, Novo Nordisk, SAP, ASML, and Siemens are IP-driven product companies. What this tells us is that all the countries that escape the middle-income trap do it on the back of IP-driven product companies, not with process innovation-driven service companies that dominate the Indian economy today. 

What makes the move from middle-income status to high-income status so difficult? 

One reason is that as they move through middle-income status, countries cannot leap all at once from investment-driven growth to innovation-driven growth. (From WB’s World Development Report 2024)

So, to become a developed nation, we need our existing companies to transition from a process innovation-driven revenue model to a product-driven innovation model. And for this, we need next-gen products because it is extremely difficult to beat the incumbent in the current-gen products. Be it India's UPI for payments or China's EVs, the countries and companies have been able to defeat the incumbent only by focusing on the next-gen products and offering solutions that are 10X better than the existing products.

Coming up with next-generation products also needs to bring some of our diaspora back, which is doing cutting-edge R&D in American universities and firms. These researchers won't come to the current CSIR setup for obvious reasons (some left this setup to go to the US). The Rs 1 lakh crore fund, announced during the interim budget, can be used to do pre-commercial research at universities (Institute of Brain Sciences at IISc model), academic institutions and firms (corporate labs like Bell Labs, Xerox PARC) and startups.

In the last few years, we have succeeded in building the first generation of IP-driven product companies in some sectors. In telecom equipment, there is Tejas Networks, in vaccine development, we have Bharat Biotech, in making trains, we have also made some progress with Vande Bharat, which was developed at the Integrated Coach Factory in Chennai shows that the private and public sectors can both develop IP-driven products that will be globally competitive. The mindset of the government as well as the private sector needs to change for this. 

Services companies can be built without significant government involvement, it is extremely difficult to build a product company without the support from the government on the day. The product companies need a large sum of money for pre-commercial investment before the product hits the market. Moreover, these companies also need market access, preferably from the government at an early stage, in order to iterate and improve the product. 

In most of the products, the government acts as a safe buyer. The government will buy only if the product has been used by the private sector before and the trials will be on No-Cost-No-Commitment (NCNC) basis. These steps have been taken to prevent corruption and cronyism in public procurement. For the product companies to succeed, the government needs to act as a first buyer to mitigate risk and spur innovation. 

Moreover, the government needs to fund pre-commercial research at corporations and startups instead of doing it as autonomous labs where the researchers are employed full time without any accountability on outcome. Throughout the world, the product companies, from America’s defense industrial complex to China's new energy domination, were built by public funding for private innovation. 

India also needs to bank on public funding for private innovation and government buying to build its IP-driven product companies. The public funding should be designed in a way that it could spur private investment in R&D, which has been abysmally low at 0.3% of GDP.  What propelled India to become 5th and soon to be 3rd largest economy in the world from 17th in 1991 will not enable it to compete with the United States and China. We need a new way of thinking on political economy that could change the structure of the economy from shallow services and manufacturing to an IP-driven economy. It will enable the country to overcome the middle-income trap and set the path to overtake the United States and China in the coming decades. 

Disclaimer: The views of the writer do not represent the views of WION or ZMCL. Nor does WION or ZMCL endorse the views of the writer.