Why India Missed the Manufacturing Bus: Revisiting the ‘Dutch Disease’ Argument

Despite starting the 20th century from economic positions comparable to several East Asian economies, India’s development trajectory has diverged sharply. Countries such as China and South Korea built large, competitive manufacturing sectors that powered growth, exports and employment. India, by contrast, saw manufacturing’s share of GDP stagnate — and, in recent years, lose ground to services. Why did industrialisation fail to take off?

In a recent discussion of his book “A Sixth of Humanity”, economist “Arvind Subramanian” offered one explanation: India may have suffered a form of “Dutch disease”, not from natural resources, but from its own policy choices.

The puzzle of India’s stalled industrialisation

Manufacturing has long been central to structural transformation. It absorbs surplus labour, raises productivity, and creates export capacity. China and South Korea followed this path decisively. India did not.

Instead, manufacturing’s share of GDP remained broadly flat for decades, while services expanded rapidly. This unusual leapfrogging — from agriculture to services — left a large section of India’s workforce stuck in low-productivity employment, with limited wage growth.

What is the Dutch disease?

The “Dutch disease” describes a situation where a boom in one sector harms others through price and wage effects. The term originated in the Netherlands after the discovery of the Groningen gas fields in 1959. Gas exports raised wages and appreciated the currency, making Dutch manufacturing less competitive both at home and abroad.

The logic is simple:

• A booming sector bids up wages across the economy.
• Higher incomes raise domestic prices.
• The currency (or real exchange rate) appreciates.
• Manufacturing exports become expensive, while imports become cheaper.

The result is deindustrialisation — not because manufacturing is unviable in principle, but because it is priced out.

Applying Dutch disease to India’s public sector

Subramanian extends this framework to India’s large public sector. Instead of a natural resource boom, India experienced relatively high and stable government salaries.

The argument runs as follows: public sector wages pulled workers away from manufacturing, raised economy-wide wages and prices, and made Indian manufacturing uncompetitive at its existing levels of productivity. Even without a nominal currency appreciation, domestic price inflation would appreciate the “real” exchange rate, increasing imports and hurting local industry.

In this view, the Indian State inadvertently crowded out manufacturing through its wage-setting power.

The limits of this explanation

There is an important conceptual problem. The Dutch disease was designed to analyse windfalls — unexpected discoveries of oil or gas — not deliberate policy decisions by democratic governments. A natural resource endowment and a politically chosen public sector wage structure are fundamentally different phenomena.

Still, one could argue that outcomes matter more than origins: if both raise wages and prices, both can hurt manufacturing. But this only shifts the question, rather than settling it.

If wages were high, why didn’t technology respond?

Turning the argument around reveals a deeper puzzle. Economic theory suggests that high wages should encourage firms to innovate.

The idea of “induced innovation” holds that labour scarcity and rising wages push firms to adopt labour-saving technologies. Historian Sir John Habakkuk argued that Britain’s early industrialisation was driven by high wages. Economist Robert C. Allen similarly shows that Britain’s wage structure made mechanisation profitable, triggering the Industrial Revolution.

More recently, Nobel laureate Daron Acemoglu has argued that ageing, high-wage economies like Germany, Japan and South Korea used automation to raise productivity, while labour-abundant economies did not.

If public sector wages in India were high, why did manufacturing not respond with technological upgrading?

Cheap labour and technological stagnation

One possible answer is that Indian manufacturing became reliant on abundant, cheap labour rather than investing in productivity-enhancing technology. Even as markets expanded and the State retreated in many areas, private sector growth did not translate into sustained wage growth.

This is visible even in India’s celebrated services sector. Entry-level salaries in major IT firms have barely risen since the early 2000s. Many of India’s new-age platforms — from food delivery to ride-hailing — rely less on technological breakthroughs than on vast pools of low-paid labour.

A different diagnosis of India’s development trap

If public sector wages once kept wages relatively high, the failure lies not in wage policy alone but in the absence of sustained technological change. The central question is whether Indian manufacturing was constrained by regulation and state intervention — or whether it chose a low-wage, low-productivity path because cheap labour was always available.

The answer matters for policy today. If stagnation came from distorted incentives, reform must focus on technology adoption, skills, and productivity growth — not wage suppression. Without that shift, India risks remaining stuck between a high-growth services enclave and a vast workforce excluded from its gains.

The Dutch disease lens may illuminate part of India’s story. But the deeper challenge lies in explaining why high wages did not trigger the innovation that industrialisation demands.