India’s Innovation Gap: Where R&D, Capital And Industry Fall Short

There has been a lot of talk around innovation or perceived lack of it, in Indian enterprises in general and the IT services companies in particular. These discussions have been accentuated by the rapid strides that AI has taken which have resulted in declining valuations for IT majors in India giving rise to widespread speculation on the future of these companies.

Much has been written about that but let us take a step back and attempt to understand “innovation” and the Indian enterprise. We have also attempted to take a nuanced view on the systemic, cultural and sociological issues that impact innovation.

The Global Innovation Index (GII) prepared by WIPO is an oft-cited barometer for ranking countries for their ‘innovative-ness’, but these composite indices can conceal sectoral weakness and differences in country size.

This improvement in ranking is quite indicative of the fact that India has been doing well in the last decade and data around patents filed during this time supports it. A large part of this improvement in ranking is due to the vibrant technology startup ecosystem built in India led by young entrepreneurs solving complex problems using technology.

India has demonstrated that it can redesign products, processes and delivery systems leveraging its core competence and market dynamics.

Examples include the Global Delivery Model in IT services, low-cost generic pharmaceuticals, digital public infrastructure, low-cost space missions and precision engineering for automotive and aerospace. These are not trivial accomplishments. They combine technical competence with deep understanding of cost, constraints, social and business problems.

Notwithstanding the above, India has produced fewer, globally leading, domestically owned firms in research-intensive industries than its talent base and economic size might suggest.

It has struggled to convert scientific research into products; to sustain long manufacturing learning curves; to provide funding for moonshot ideas that may take decades to commercialise, to build dense supplier ecosystems around frontier technologies and others.

It needs to be added here that these indicators do not reflect on the ability of Indian talent as one can see that several global corporations have research centres in India and/or Indian talent working in global MNCs are contributing significantly to their Innovative quotient.

It is therefore clear that Indian talent is hamstrung by certain structural constraints and there needs to be a concerted effort to solve these if we have to elevate our ranking further.

A major part of the problem is India’s persistent underinvestment in R&D relative to countries such as China, South Korea and Israel, which started from broadly similar levels of economic development but have since invested significantly more in building R&D capabilities.

In the backdrop of these statistics, let us delve a bit deeper to understand the structural and systemic issues that have manifested in this underwhelming outcome.

Evolution of Indian Industry

Indian industry, until 1991, when the nation was liberalised, was held back by a licensing regime. “Connections” with the government of the day were instrumental in getting licenses to set up factories.

Capacities were determined by the government and hence the DNA of Indian industry was never to innovate but use their “good offices” and procure these licenses. Several industries had regulations on capacity and the government regulated prices at which the produce could be sold in most industries (like DPCO for pharmaceuticals) so there was no incentive to innovate.

Why would companies innovate when the revenue cap (pricing) was determined by the government? In addition, our taxation regime was onerous, to put it mildly, in the seventies and eighties with corporate taxes going up to 94% in one instance.

These usurious taxes certainly would not motivate any entrepreneur to innovate when almost all the profits were appropriated by the government. Since independence, until 1991, for a good 44 years, the mindset of the Indian industrialist was therefore solidified to either run rent seeking businesses or work in an environment where their capacity to produce was limited and hence, they were able to sell whatever they produced.

Further, the Indian political and business environment was not conducive to get foreign companies and create competitive pressure on the Indian enterprise. The mindset of the government was that they will decide what Indian consumers want. 

IBM and CocaCola are classic cases where MNCs exited India after setting up shops. This socialistic and convoluted thinking was completely flawed and made Indian enterprises complacent and inward looking. Fierce competitive pressures push enterprises to innovate and this was woefully lacking.

Once a certain behaviour or culture sets in, it is hard to change that. As Drucker famously put it, “culture eats strategy for breakfast”. After liberalisation, industrial groups which already were established, consolidated their positions because they had the wherewithal to compete in a liberalised environment. 

However, reticence of old age businesses to innovate is a deep-rooted behavioural issue, since these entrepreneurs created their wealth, either in commodities or rent seeking businesses. There have been exceptions, of course, but very few and far between.

Education System And Its Lack Of Connect With Industry

The Indian Education System has its thrust on rote learning rather than encouraging students to think laterally and reward them for it. Scoring in exams largely depends on test of memory rather than testing conceptual understanding.

Success is measured purely on the marks that are secured in examination. Further progress in terms of higher education is predicated on these marks and grades and hence there is more thrust in maximising this. 

Answering set questions is at a premium than posing new questions or venturing into uncharted territories. Further, taking bold bets, thinking out of the box and failure is often stigmatised.

India and China produce by far the most STEM graduates. But on researchers per million, India is the clear laggard while Korea, Japan, the US and Israel are far ahead. The active researcher population, knowledge-intensive workforce and industrial research base remain woefully inadequate, relative to India’s population and graduate output. 

‘Brain drain’ only compounds this shortage, with many researchers migrating abroad – Indian-born engineers are the largest foreign-born STEM workforce in the US, UK, Canada, and Australia.

One of the key areas that India is disadvantaged is the connection between industry and academia. In developed countries, industry actively funds research in universities that results in researchers and their thesis aligning with market / industry needs and aids commercialisation.

On the other hand, Indian enterprises have a dismal track record of doing fundamental research or funding research. As a consequence, researchers are not integrated and aligned with the industry needs. Contrast this with China’s new law that was passed in 2024. 

When they realised that pages of theory, research papers and citations were not being read, they identified select universities to award engineering doctorates based on physical prototypes, new techniques or major installations instead of traditional papers.

The rule is to build something that works in real life and at scale. The goal is to bridge the gap between theory and what works in the industry. In sum, it is imperative that policy makers, industry and the research academia collaborate on ways and means to pump prime research.

There are enough case studies, globally, which can be leveraged to achieve these objectives.

The Mindset of the Indian Consumer

Let us delve into the behaviour of the Indian consumer. The Indian consumer, is euphemistically called a “value buyer” or is “price sensitive”. In other words, if you do not price the product “right” you will not have a market. 

An average Indian consumer, even from affluent backgrounds, will have no qualms buying pirated books from the footpath or pirated movie or music. The fact that someone has used his/her creative mind to write a music or make a film and hence there is a violation of the IP, never crosses his mind.

As a nation, we have our own social and economic constraints but it does not promote spending money on research and building cutting edge products. To illustrate, let us understand the pharmaceutical industry.

In developed markets, regulation allows pharma companies to price their new molecules freely and monetise it for 20 years. This is a solid incentive for pharma companies to invest heavily in their R&D.

Can this happen in India? firstly, no government will have such laws as it will be perceived as a capitalist (which goes against our grain to be seen as socialistic) and the political backlash will be terrible.

Secondly, even if some company does innovate and comes up with a better product, there will be cheaper clones / spurious products available in no time and Indian consumers who do “value buying” or are largely uninformed, will buy those products.

Indian courts and their abysmal track record in addressing IP protection, leaves the innovator with nothing more than a fig leaf. In sum, Indian consumer behaviour, to a large extent, does not motivate enterprises to be innovative.

Hence, we see Indian pharma market dominated by companies making generic drugs (make no mistake that this is extremely value adding and gets us export revenue). However, one would struggle to find an Indian pharma giant coming up with a new molecule to solve a chronic health issue.

India’s consumers and enterprise buyers being intensely value-conscious, has pushed firms to innovate around affordability, packaging, distribution, access and operating efficiency. This explains many of India’s successes around generics, sachetisation, low-cost telecom, UPI adoption, frugal healthcare, two-wheelers, low-cost engineering services etc. India is for instance, the largest global supplier of generic medicines, accounting for around 20% global supply.

Attitude Of Regulators And Their Overreach

Another critical factor that aids innovation is the attitude of regulators and by corollary, the accompanying legislation that aids innovation. A strong, proactive and forward-looking regulator(s) can pump prime innovation. The regulations governing Pharma companies who come up with new molecules, in developed markets, are enunciated earlier. 

We will give you one example of how regulation can stifle innovation. Take the case of the draconian “angel tax” in the start up space. If a founder entrepreneur has a great idea and starts a venture and if it catches the fancy of an investor, it is but natural that the founder asks for a premium and the investor would give the same if he perceives value creation. 

Bear in mind, this premium was for the founder and the unique idea that he/she conceived and a view that this idea can become big. This agreement was between two matured parties. But what did the government do? They imposed “Angel Tax”, which essentially meant that the share premium was treated as revenue and taxed.

Such regressive regulations (this continued for a few years before it was rightfully scrapped) often cause untold harm to the innovator and his/her spirit. Despite much noise about “ease of doing business”, much remains to be done.

Simple processes like starting a company and more importantly shutting down a company involve a lot of paperwork and is exasperating. Any innovator who finds that his idea doesn’t work and wants to move on to build something new, is often spending his bandwidth in unwinding his old business.

Such regulations, among the many, need to be revisited with a different mindset. The last thing any innovative entrepreneur wants is to get involved in protracted bureaucratic maze that will dampen his enthusiasm.

Having said that, the government of India deserves praise for committing capital to fund of funds so that they can propel innovation by being LPs in VC Funds. Similarly, the RDI Fund having a corpus of ₹1 Lakh Cr is a step in the right direction to encourage cutting edge innovation.

Shareholder Mindset And Lack of Patient Capital

Let us understand the R&D spending between India, China and Emerging Markets. We are not considering developed markets for obvious reasons.

This brings to reflect on the mindset of Indian shareholders. Are our shareholders mature to let a company invest in building the next molecule and commit capital and resources which will deprive them of dividends and bonus for 10 years?

We know the answer. If Indian entrepreneurs have to deliver EPS, quarter on quarter, since shareholders will not accept anything else, then how will companies innovate? Contrast this with the amount raised by Elon Musk in SpaceX.

The shareholders have almost given a carte blanche to Musk and they have little rights in the governance of the company. Yet, they subscribed to its shares. Such risk capital which aids innovation is not there in a capital starved country like ours.

If we study frontier technology companies in India and juxtapose them against US, the contrast is stark. Infosys, for example, returns ~85% of free cash flow to shareholders, each 5-year cycle (~63% dividend payout ratio; ₹55,500 Cr in dividends over the decade to FY25) because that is what its shareholders want. 

Does Infosys have the firepower to innovate and build long term competitiveness? Of course, it does. However, try explaining this to its shareholders to not take dividends for next 10 years and allow the company to plough back its profits into cutting edge research, which may or may not pay off. The answer is obvious.

Contrast this to US big tech, which recycled retained earnings into R&D for 20 years. Alphabet paid zero dividends from 2004 until 2024; Amazon never has; Meta’s first was 2024. 

Companies have not paid dividends for two decades to build and invest in audacious ideas and concepts. And their shareholders have stood by them, without flinching.

In the US, Pension Funds or Endowments fund ventures which they know will take a decade or more to deliver. Such capital is not available in India. As discussed before, the government’s RDI Fund along with FOF is a step in the right direction but the sheer size of such capital available in the US or the state support in China is staggering.

Even the country’s VC ecosystem appears reluctant to allocate capital towards cutting-edge frontier technologies. Though India’s tech startups raised the third-highest amount of funding globally, only 4% of this—$0.6 Bn out of $16 Bn—went to AI startups in 2025 according to a Bain report. The contrast with the US is stark: more than $150 Bn was invested in AI alone.

Historically, we have seen that nations have innovated in areas where they either had an existential issue or where they wanted to build long term competitiveness. 

China, for example, has created a global supply chain of such scale and competitiveness that it is well-nigh impossible to displace them. Their economies of scale, reliance on automation and productivity have been built on great execution capabilities and supported by the state. 

The country realised that they need to control raw materials and they have taken a stranglehold, globally, in accessing minerals and rare earths. They were net importers of oil and they have achieved a dominant position in Li Ion batteries that power EVs. Chinese automakers have taken rapid strides and today, more than 70% of vehicles sold in China are EVs. 

This has made the country resilient to oil shocks. China has also taken rapid strides in AI and their foundation models cost much less and are perhaps as advanced as the ones built in the US.

Israel is also a classical case on how the country has innovated in various areas including agriculture and defence technology. Similarly, Taiwan, another small country, has built a formidable ecosystem around chips and semiconductors that has made the world dependent on them.

There are several playbooks which are out there and we need to identify and double down on areas where it is imperative for us as a nation to innovate. In sum, innovation does not happen in a vacuum and it does not happen overnight. There are systemic issues, both structural and behavioural which a nation inherently possesses, and those need to be addressed.

In fact, the often use word “jugaad” is perhaps the bane of innovation. While some of us take pride in saying we are a “jugaadu” nation, it also means that we do not wish to persevere and do the long yards to solve problems. It essentially means that we are happy to have quick workarounds that can solve for the immediate need. This needs to change.

We also need to reflect that as an ecosystem of consumers, regulators, employees and shareholders, are we doing enough to create an environment that fosters innovation. It is the overall maturity and long-term thinking of a nation and its stakeholders that is responsible to build an Innovative society. Unless we change our mindset and work on fundamental issues, we cannot aspire to be Innovative as a nation. There will be a few exceptions, but they will remain, exceptions.

It does take a village to rear a child and here also, it is no different.

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