12/10/2012 03:39 pm ET Updated Feb 09, 2013

Two Technologies Propelling India Forward

2012-09-24-Iqbal_Quadir.jpgBy Iqbal Quadir
Iqbal Quadir is the founder and director of the Legatum Center for Development and Entrepreneurship at the Massachusetts Institute of Technology.

The well-known success of information technologies (IT) in India is actually two successes, with two sets of implications and potential. To understand these two phenomena, it may be useful to think through what Joseph Schumpeter and Adam Smith have said about economic progress. Let me explain.

About 100 years ago, Schumpeter argued that a special type of people, called entrepreneurs--who stray from the beaten path, break the mold and create something new--are the ones who produce economic growth. In Schumpeter's vision, the main role of entrepreneurs is not to invent technologies, provide capital or manage businesses. Rather, they seize new opportunities by combining economic forces in new ways--by producing new products, employing new technologies, pursuing new processes, or addressing new markets. In Schumpeter's language, entrepreneurs provide "the will and action" to forge new reality. Empowered by new IT, that is exactly what Indian entrepreneurs like Narayan Murthy, Nandan Nilekani, Ajim Premji and Shiv Nadar began doing about 30 years ago, breaking through the Kafkaesque bureaucracy of the Indian License Raj. These entrepreneurs combined at least three economic forces: rapidly falling prices in computing technology; world-class programing talent in India at relatively low cost thanks to the country's then slow economic growth; and the rising costs of software production in high-income countries.

Their formula worked, spectacularly. Satellite connections in the mid-1990s and fiber optic connections by 2000 further propelled the digital entrepreneurs by allowing them to ship their exports without the impediments of poor physical infrastructures or overbearing bureaucracies. In short, entrepreneurs like Murthy, Nilekani, Premji, Nadar and others have successfully combined low-cost Indian skills with increasingly cheaper computers and communications to address a market eager to contain costs. Today, the Indian IT industry is valued at over $67 billion in 2000 constant US dollars, employing 3 million. The industry has given rise to ripple effects by increasing demand in housing, transport, insurance, entertainment and other industries, employing an additional 12 million and advancing Indian GDP by another $67 billion in 2000 constant US dollars.

There are larger effects of this success: India's IT infrastructure has improved with more than 25 million Internet connections providing access to 150 million; the younger generation has found meaningful role models in these exemplary entrepreneurs; and the industry has instilled in many Indians confidence and a can-do attitude. There is much to celebrate in this achievement that perhaps we can call the Schumpeterian effect of Indian IT.

Meanwhile, less than two decades ago in the mid-1990s, the relentless increase in processing power of microchips and corresponding price declines unleashed another form of IT, commonly known as mobile phones. Entrepreneurs like Sunil Mittal and industrialists like the Ambanis, among others, introduced this device with its first killer-app: voice communication. One beauty of this IT device is that it is fundamentally egalitarian. While the "regular" IT industry employed the successful graduates of elite universities, mobiles could be useful to millions in India who could not read or write, but had the same desire and need to advance as anyone else. While the regular IT industry catered to the global needs of cost-effective software and business processing, mobiles served the communication needs of average Indian citizens.

Mobiles provide a near universal means of advancement because better communication and coordination save time (which translates to saving labor), money, and opportunities. This leads to higher productivity and earnings, enabling people to purchase the service. People can spend pennies to make calls while advancing by dollars. The fact that millions of people subscribed to mobiles is evidence enough that they are economically empowering because low-income people cannot sustainably indulge in purchases that do not advance them economically.

The spread of mobiles is the modern-day proof of the "natural effort of every individual to better his own condition" that Adam Smith considered the cornerstone of a prosperous society. When Smith wrote The Wealth of Nations nearly 250 years ago to find ways to foster "universal opulence which extends itself to the lowest ranks of the people," he found this "natural effort" to be "so powerful...that it is alone...capable of carrying on the society to wealth and prosperity." Further, the low-cost and widespread means of communication embodied by mobiles furthers the process of specialization and exchange that Smith championed as the key means of increased productivity and efficient resource allocation.

In short, the "natural effort of every individual to better his own condition" found expression, affordably and universally, in a hand-held technology. People of all walks of life reached out for mobiles, even if some mobile businesses started by selling services to high-end customers. Mobile businesses soon found plentiful evidence for Smith's assertion that the "whole consumption of...those below the middling in every country much greater, not only in quantity, but in value, than that of the middling and of those above the middling rank." Though there were no mobile phones in India as late as 1995, there are 940 million today, equal to roughly 80 percent of the population. Although the mobile phenomenon also involved Schumpeter's entrepreneurs, let us call this second IT phenomenon the Smithian effect because it more readily contributes to the cause of "universal opulence."

Does the Smithian effect on Indian GDP compare to the $134 billion Schumpeterian effect of the regular IT industry? The answer is an emphatic "yes." When one adds up the small advancements made by a billion people, the resulting impact can be quite powerful. To roughly calculate, I build on a study of 120 countries by Christine Zhen-Wei Qiang of the World Bank that found that a 10 percent increase in mobile phone penetration correlates with a 0.8 percent average increase in GDP growth. I calculate, conservatively, that the increase of 0 to 80 percent mobile phone penetration in India over 15 years contributed on average an additional one percent annual economic growth from 1996, when GDP was $381 billion, to 2011, when GDP was $1,040 billion (both measured in 2000 constant US dollars). What would the Indian GDP have been in 2011, in 2000 constant US dollars, if it had grown one less percentage point each year? The answer is $903 billion: a $137 billion difference, in 2000 constant US dollars, in India's economy due to mobile phones. I consider this calculation conservative for at least two reasons. First, though the average penetration of all of India is 80 percent, higher-income pockets are likely to have higher penetration and thus a greater growth-boosting effect on larger incomes. Second, the assumption of one additional percent of growth over a 15-year period possibly overestimates the effect in the early years, but underestimates to a far greater degree in later years when the economy is larger, the penetration is higher and the network effect is greater.

In addition to their comparable effects on GDP, the two IT industries are also similar with regard to job creation and in terms of ripple effects in other industries. In fact, the mobile industry has also enabled Indian immigrant workers in high-income countries to better connect with their homes in India. Immigrants in high-income countries whose relatives have low incomes even by low-income country standards tend to send money home; they sent $53 billion to India in 2010.

While the aggregate GDP contributions of what I call the Schumpeterian and Smithian effects are comparable, and both have been important breakthroughs in the Indian economy, I believe the Smithian effect is more powerful for the country. First, it leverages India's greatest strength, namely, its own population. As communication facilitates more efficient collaboration within its population and greater specialization-and-exchange within its vast market, the Indian economy will move steadily towards greater optimization. While India's regular IT industry contributes to greater efficiency in the global economy, the mobile industry engenders greater efficiency within India itself. Second, the Smithian effect mitigates rising inequality in India, a serious issue: 48 billionaires in India own 10.9 percent of the GDP (in China, another country with significant inequality, 95 billionaires represent only 2.6 percent of GDP). Third, rising incomes in the poorest ranks spur greater innovations: entrepreneurs find markets with greater purchasing power, larger markets give greater economies of scale for producers, and production facilities search for labor saving innovations.

Mobile phones are in effect handheld and connected computers and hold great potential in this role, since businesses in promising areas such as payments and banking, healthcare, and entertainment require combining the services of multiple providers. Like computers, mobiles can connect multiple providers; store and process huge amounts of data in various forms (text, images, video, audio); and create and deliver complex services using intricate sets of logic. Businesses are being launched on the mobile platform to provide a wide range of services from medical advice and diagnosis, to pharmaceutical authentication, to payment and finance systems. Although NGOs and governments administer many of the emerging services, there are also myriad for-profit enterprises that, using mobiles as a platform, are meeting needs ordinarily considered appropriate for the state to provide. For instance, mDhil sells health tips to 18 to 25 year olds through text messages, conveying confidential information on issues from nutrition to various ailments for the tech-savvy age group for a monthly charge of 30 Rupees. A company called Beam is providing micro-payment services for customers without bank accounts or credit cards.

As mobiles gain greater computing power and smartphones further proliferate in India, the emergence of such services on the mobile platform, and their corresponding economic benefits, will accelerate. Expertise in developing apps and software for mobiles is gaining momentum, and, moreover, smartphones tend to loosen the hold of network operators on phones, allowing small entrepreneurs to create products on the mobile platform. A lack of other infrastructures strengthens "the natural effort to better ones conditions," leaving Indian citizens ready to embrace these new ideas and services if they indeed advance people.

India, a country of many strengths, has yet another in the Smithian effect of mobile phones. The country can serve as an example for other low-income countries in South Asia, Africa and Latin America, where innovations that work in India are likely to work as well. And, just as individual economic advances have added up to rival the effect of the formidable regular IT industry, these minute advances in total can create world-class business opportunities. The innovators and entrepreneurs currently working for multinational companies may do well to turn their attention to the several billions of people who lack many fundamental services but hold powerful computers in their hands.

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This material published courtesy of Singularity University.