How a long stock market boom has doomed India's & America's competitiveness

It is no coincidence that China's manufacturing boom started exactly at the same time as the US stock market boom of 1981-82

I am gliding through the IIT Madras campus. Black bucks laze around the woods that dominate the 650-acre campus. Their laziness is infectious. My mind begins wandering. Nehru ji’s vision created these magnificent campuses. The aim was to make India a tech powerhouse.

 

My lazy mind floats across to America. Nehru ji’s inspiration came from the American tech institutes. America built incredible tech from talent that emerged from those portals.

 

Pre-1980 was the most fecund era of American core tech innovation. And this golden era was driven primarily by government investment in research. Take a look:

 

* Nasa, Defense Advanced Research Projects Agency (DARPA), National Science Foundation (NSF), et al – catalysed by the Cold War and space race.

 

 

* The Manhattan Project and subsequent nuclear research, material sciences, etc. Again, state funded.

 

* In computer science, the development of the first programmable computers, Advanced Research Projects Agency Network, or ARPANET, (the precursor to the internet), and the foundations of artificial intelligence.

 

Of course, some corporate research labs in the mid-20th century (such as Bell Labs, Xerox PARC, IBM Research) made fundamental contributions to research. 

 

But breakthrough tech continued to come largely from state funding or massive state business support, with involvement.

 

Even semiconductors, which came from the private sector, were supported usually by the demand for integrated circuits (ICs) from the military, Nasa, and DARPA.

 

But things started changing dramatically from 1982 onwards.

 

Reagan-era policies, in order to tighten the federal budget, reduced government R&D funding in favour of private sector-led research.

 

And hence, things became more about applied research, and less core scientific breakthroughs.

 

Core research, even in the private sector, suffered as industrial America withered away: Bell Labs and Xerox PARC, for instance, disappeared like vapourware.

 

From the ’80s to present day, the focus of innovation moved from fundamental science to software and consumer technology (e.g., smartphones, social media, cloud).

 

Refinements. But not really leaps.

 

A word about DARPA: It’s arguably the best in the history of tech hotspots. Its innovations became the fountainheads of subsequent private sector products – right from fabless chips to AI robots, internet, TCP/IP protocol, wearable sensors, autonomous vehicles, speech recognition, drones, mosaic web browser, cloud computing, et al.

 

And all these, in some form or the other, were picked up by the likes of Microsoft, Apple, Amazon, and made into massive commercial successes.

 

But the high-risk cheques were written by the State. 

 

I have just finished my speech at IIT Madras and I wander outside to the deer just as my mind flits across to Indian innovations.

 

We start from 1947 onwards.

 

* Bhabha Atomic Research Centre, or BARC (1954): India’s nuclear reactors, fuel cycle tech, isotope research.

 

* Indian Space Research Organisation, or ISRO (1962-69): Indigenous satellites (Aryabhata, Indian Remote Sensing, or IRS), launch vehicles.

 

* Defence Research and Development Organisation, or DRDO (1958): Missile systems (Integrated Guided Missile Development Programme, or IGMDP 1983), radars, electronic warfare, defence avionics.

 

* Council of Scientific & Industrial Research, or CSIR: Network of labs, innovated in materials, chemicals, metallurgy, leather, drugs, agriculture.

 

* Indian Council of Medical Research (ICMR), Indian Council of Agricultural Research (ICAR), vaccine institutes: Drove innovation in medicine, agriculture, vaccines.

 

* Bharat Heavy Electricals Ltd, or BHEL (1964): Indigenous boilers, turbines, transformers.

 

* Bharat Electronics Ltd, or BEL (1954): Defence electronics, military radars, communication systems.

 

* Centre for Development of Telematics, or C-DOT (1984): Created rural telecom switch and indigenised telephone exchanges.

 

* Centre for Development of Advanced Computing, or CDAC (1988): Built PARAM 8000 (1991), India’s first supercomputer.

 

My mind shakes off its ennui: I detect a pattern. American core innovation went comatose from the ’80s onwards (save for some exceptions, of course). Indian core innovation died from the 1991 liberalisation.

 

The common link?

 

The start of the stock market boom in America from the early ’80s, and ours, from 1991.

 

America since then has been the best performing stock market in the world. And India has been number 2.

 

Most know this. But ever wonder why? The answer is intriguingly simple: Both countries have little manufacturing and are predominantly services-driven economies. India, in fact, is the outlier from the emerging world: The only country that has taken the services path to growth.

 

And we all know how markets detest manufacturing. That’s why all Asian, Latin American and most European markets have been long-term dogs.

 

India’s market boom really started when large parts of the services economy, like banking, telecom, etc, were opened up to the private sector in the ’90s, and then, of course, IT services took our services dominance to otherworldly levels.

 

The pattern was exactly the same in America: Industrial America died away from the late ’80s. It became consumer plays that drove the bull market: Coke, Toys”R”Us, Walmart, etc. From the ’90s, tech, largely consumer tech, services boomed, with, of course, some exceptions like semis.

 

Wall Street and Dalal Street’s lust for services drove capital away from manufacturing and into services. And that too into services that were more consumer-centric (Amazon, Google, even Apple) or more predictable (Infosys, HDFC Bank, etc).

 

Innovation got the short shrift because innovation is risky. Markets don’t have the stomach for endless R&D budgets without visible returns. 

 

This led to virtually no innovation in India after 1991, and only largely consumer tech in America right until present day (barring recently, AI).

 

It all became a game of market cap through body shopping, branch banking, mobile services (built on Chinese tech), clicks, likes, shares, and nonsense like that.

 

Capital withdrew from manufacturing. In America, this drove manufacturing into China. It is no coincidence that the manufacturing boom in China started exactly at the same time as the US stock market boom of 1981-82. That boom simply reflected the death of industrial America and the birth of industrial China. Walmart started buying from China from... you guessed it...1981!

 

It is not just capital that withdrew from manufacturing and core R&D. Talent withdrew, too. Scientists who were supposed to make rockets went on over to Wall Street to find ways to shave seconds from stock execution. In India, all our IITs did were to become giant recruitment machines for US tech companies doing precisely consumer tech.

 

Now, our IIT engineers, with computer science degrees, build algo trading models instead of advanced computers. Or even worse, our IIT engineers sit and figure out how to shave minutes from pizza deliveries.

 

All because of this giant machine called the stock market. This machine does efficient capital allocation. And hence, it efficiently allocates capital to businesses with high valuation potential. No manufacturing or core research business can ever match up to services in terms of returns on equity (ROEs) and predictability.

 

My mind now levitates across to China. It has never had any durable stock market boom. Many on Indian social media point this out proudly.

 

True. But could it be that the Chinese never wanted a strong stock market to begin with because it is nothing but a distraction to core research and manufacturing excellence and, hence, to overall competitiveness? Is it by design?

 

Think of how Xi Jinping cracked down on big Chinese tech a few years ago. He probably figured out that their market caps would drive people towards consumer tech and away from core research like AI, robotics, chips.

 

Remember that he passed regulations limiting the time to a few hours per week for youth to spend on gaming? We laughed then. But China is laughing now because that youth then went on to build world-beating tech.

 

That is because the unstated Chinese national vision has been: “Our competition is the US, and we want to beat it.” Their demographic dividend playing computer games, trading F&O, or making YouTube videos on investing was not going to get them to that monumental goal.

 

In fact, so great has been the dominance of the stock market in American life that almost all capital flows only to just a handful of companies, eg, the Magnificent 7. If you remove these companies from 2010, the performance of the S&P 500 becomes very Europe-ish. And the fact that only seven companies dominate the discourse, itself tells you how discriminatory the capital allocation of the market has been. It's turned America into a wasteland, ex-Mag 7. The Russell 2000 says it all.

 

Indian companies have done precisely zero in global markets again for the same reason: Stock markets do not want risky ventures overseas. Managements understand this and shape their strategies based on what the market wants. National goals can take a hike.

 

The inescapable verity remains that stock market booms in these two countries have bred long-term uncompetitiveness. The markets have hollowed out core research and manufacturing in these countries.

 

Let’s face it: Only the state has long-term patient capital to fund long-term research. Both countries have starved research over democratic populism.

 

Stock market capital, including private equity and venture capital, is neither cheap nor patient. It views excessive research spending the way Indian batsmen view green tops.

 

Both countries, with amazing historical bull markets, now descend into a future of uncertain greatness and more certain mediocrity.

 

China has little such problem, and, hence, five years after Xi’s crackdown, we see the emergence of a China that is years ahead of America. Decades ahead of India. And the gap widens daily.

 

Ah, I forget. The topic of my speech at IIT Madras: It was how to pick 4 am stocks.

 

Nothing captures the supreme tragedy postulated above as this lowly topic at this august venue.

 

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The writer is a prominent investor, investment philosopher, and founder of GQuant Investech, an AI firm