"If the British were such good rulers, why is India so poor?" I asked.

Why is India so poor? This is a question that has haunted two generations of India leaders. But India was not always poor. In fact, it had one been fabulously wealthy and this had set the Europeans on their voyages of discovery. In high school we had all read that Columbus had gone in quest of the riches of India and found America instead. By 1700, according to the respected historian, Angus Maddison, India had 22.6 per cent share of the world’s GDP (when the whole of Europe had 23.3 per cent.) In 1830, India enjoyed almost 18 per cent of the world’s industrial production while Britain’s share was less than 10 per cent.

After a long pause, my grandfather admitted that he did not know. "For that you must speak to your uncle, Sat Pal."

My uncle Sat Pal had always been my grandfather’s favourite. He dreamed of a brilliant career for him until one day, to his horror, he discovered that Sat Pal had become a Marxist. It was a great blow to our family, whose bourgeois hopes of prestige and wealth were shattered.

After independence, Sat Pal became a respected labour leader, loved by the workers and feared by industrialists. Welcoming me into his austere two-room home, Sat Pal painted for me the then-conventional explanation of India’s poverty. The English began by robbing and plundering soon after they took over Bengal in 1757. Their Lancashire mills threw millions of our handloom weavers out of work. Our textile exports plunged from world leadership to a fraction of what they had been. Without tariff barriers. Indian consumers also shifted to cheaper English mill-made cloth. British colonial rule "de-industrialised" India, and from an exporter of textiles. India became an exporter of raw cotton. Sat Pal quoted Sir William Bentinck, "the bones of the cotton weavers were bleaching the plains of India."

Vimla, my uncle’s attractive Kashmiri wife, entered the room with two steel tumblers of buttermilk. She too was an ardent activist and a member of the state legislature. In their charmed leftist circle. Vimla was admired for her good looks, deep convictions, and glamorous background. Her father worked for the BBC. Sat Pal’s marriage to her was something of a coup. I thought, when she must have been coveted by so many...

"In that case," I said, "now that we are free and England has lost its colonies. India will become richer and England will become poorer, right?" Sat Pal nodded.

Sat Pal was far from alone in his thinking. Most scholars and economists at the time confirmed his analysis of India’s poverty. A new generation of historians has emerged, however, who have challenged this account. True, the machines of Britain’s industrial revolution wiped out Indian textiles, they said, but this was no different than the rest of the world. Traditional handmade textiles disappeared in Europe and the rest of the world. Fifty years later Indian textile mills would also destroy them. After 1850, Indian entrepreneurs did in fact begin to set up modern textile mills. By 1875, India started to export textile again and slowly recaptured the domestic market. In 1896, Indian mills supplied only 8 per cent of total cloth consumed in India in 1945, on the eve of Independence, Indian mills supplied 6 per cent. By 1914, India had to world largest jute industry, the fourth largest cotton textile industry, the largest canal system, the third largest railway network. 2.5 per cent of world trade and an experienced merchant class hungry to become industrialists. Indeed manufacturing output did grow 5.6 per cent a year between 1914 and 1938, well above the world average of 3.3. All this should have brought about an industrial revolution. Why didn’t it happen?

My father’s English boss used to blame India’s poverty on the other worldly spirituality of Hindu life. Max Weber blamed the caste system. Swedish economist Gunnar Myrdal attributed it to contempt for manual work, lack of punctuality and ambition, low aptitude for cooperation, and superstition, brought on in part by India’s enervating heat.

I am, however, skeptical of easy cultural or geographic explanations. In my experience, successful Hindu entrepreneurs can be both extremely religious and aggressive in business. The Indian farmer responds quickly to market incentives. Brahmins will plow their own land in traditional Uttar Pradesh if they have to, and conservative Rajput Thakurs in Rajasthan will shed their feudal ways for a commercial opportunity. Tropical Singapore has achieved prosperity despite the unfairness of nature.

My own economic education began when my family moved to Washington in the mid-1950s. The Indian government had posted my father as a part of a team of engineers to negotiate the division of the Punjab rivers with Pakistan. Like many of my classmates in high school. I got a job delivering the Washington Post before school. At 5 a.m. in the freezing cold of winter that required a lot of willpower.

My paper route taught me that the customer is the most important person in American. I also learned that Americans did not think as we did in India that you had to snatch something from your neighbour in order to succeed. Both could get ahead for there was enough to go around. In contrast, middle-class Indians at this time had to put up with enormous scarcities and were forced to cultivate "contacts" and "influence" for their most basic needs. They had to become "political".

Three years later, my family returned to India, but I won a scholarship to Harvard. So I stayed on. At Harvard, I found that I was caught up in another sort of optimism: "development economics," which in that heady time believed poor nations could rise out of poverty — and quickly at that. The model was simple and elegant: growth was a function of the savings ratio divided by the marginal capital-output ratio. Thus, a poor country could accelerate its development if it could raise its savings by means of taxes or foreign aid — no one thought of foreign investment in those anticolonial days — and invest them in such a way that it got the most production out of its savings. India was then the favourite laboratory among the world’s economists because it seemed to be following their prescription.

After winning freedom, Nehru and his planners did, indeed, attempt an industrial revolution. They did not trust private entrepreneurs, so they made the state the entrepreneur: The state would raise domestic savings and invest them in public-sector companies to accelerate economic growth and achieve what Walt Rostow had called "takeoff" in his recent book. They Stages of Economic Growth.

As the model played out in India, I later realised, we primarily focused on the numerator, that is, how to raise savings. We ignored the denominator — capital productivity. Indian policy makers naively assumed that once the government forced the savings and made the investments, the returns from the capital would come automatically.

Economists at the time were also pessimistic about the ability of poor countries to export. The number of Indians who were taken in by "dependency theory" amazed me. This unfortunate proposition, which swept the Third World in the 1960s, argued that poor countries would remain permanently imprisoned in a state of dependency to rich countries because of unequal terms of trade. The prices of the manufactured goods of the rich countries would continuously rise, while the prices of the agricultural commodities would continuously go down. Thus, there was no hope in trade for the Third World.

Under British rule, India had progressively become an exporter of raw materials and importer of manufactured products. India’s leaders took this to mean that foreign trade and foreign capital were responsible for poverty. So, after independence, they closed our economy, turned against trade, and pursued a policy of self-sufficiency or "import substitution". Thus, we became pessimistic about our ability to compete in the world economy and regain our historic pre-eminence as a great trading nation. And our share of world trade declined from 2.4 per cent in 1947 to 0.4 per cent in 1990. We learned the wrong lessons from history...

As I look back on my four years at Harvard, I am shocked that we ignored the whole subject of wealth creation. Caught up in the fashions of the time, I did not read enough of the great Austrians: Schumpeter, Hayek, and von Mises. Thus, I missed the romance of "creative destructions", overshadowed in my mind by Marx’s brilliant critique of capitalism. As undergraduates, we also looked with contempt at the Harvard Business School across the Charles River...

After independence, the goal of democratic socialism was embraced by a wide consensus. The Gandhians loved the protection for cottage industry. Socialists welcomed the emphasis on a heavy industry and the expansion of the public sector. The Indian intelligentsia was mesmerized by the apparent success of the USSR. It wanted big steel plants and not small factories which made clothes, shoes, toys, and bicycles — the sorts of things that the masses could use, and which might have been exported. Some years later we would find out that tiny Hong Kong earned more from its exports than the whole of India.

In India even the capitalists were socialists. In 1944, the giants of Indian business produced what came to be known as the "Bombay Plan" for rapid and self-reliant industrialisation. Although the industrialist recognized the need for foreign capital and technology, they wanted it to be under the strict control of the state. They genuinely believed that Britain’s laissez-faire policies had aborted India’s industrialisation, and they were willing to put up with an interventionist state. Moreover, they had gained enormously from high tariffs on imported goods since the 1920s. Ominously, they were willing to accept "important limitations on the freedom of private enterprise," and they agreed that "rights attached to private property would naturally be circumscribed." They accepted a vast area of state control — in fixing prices, limiting dividends, controlling foreign trade and foreign exchange, in licensing production, and in allocating capital goods and distributing consumer goods. Without realising it, the Indian capitalists had dug their own graves.

Large business houses set up parallel bureaucracies in Delhi to follow up on their files, organise bribes, and win licenses. If the entrepreneur did finally make a success of his enterprise, he was again in trouble. It was illegal to manufacture beyond the licensed capacity. We became the only country in the non-communist world where the production of goods sorely needed by people was punishable by law. In many cases the basic entrepreneurial decisions, such as the choice of technology and the size and location of plants, were taken away from risk-taking businessmen and made by bureaucrats. We, thus, killed at birth any hope for an industrial revolution.

B.K. Nehru, the Prime Minister’s cousin, who was also a senior civil servant at the time, admitted in his autobiography that "with the benefit of hindsight it seems totally absurd that a country wanting to develop its industry should prescribe for its establishment conditions which were guaranteed to strangle it. The underlying assumption remained that business was dishonest, and that "to ensure honesty and eliminate profiteering, private business should operate under strict government control." In a society where everyone is programmed to think that "my success can only come at the expense of your failure," and "I can only get more land by taking it from you," the government is "mother and father," protecting me from my rapacious brother. In such a society the madness of governmental controls was a natural development.

The tragedy of modern India is not that we made mistakes in the 1950s but that India did not change course in the 1960s and 1970s under Indira Gandhi. I still remember how my leftist friends were euphoric that day in 1969 when Mrs Gandhi nationalised India’s fourteen largest banks. They regarded the banks as "monopoly capitalists," controlled by a handful of big business houses, who made loans only to their cronies. Years later, I chanced to meet the manager of one of the rural branches of these nationalised banks, on the night train between Delhi and Amritsar. He was a sincere young man, deeply concerned, and he wanted to unburden himself about his day-to-day problems. Neither he nor his staff decided who qualified for a loan. The local politicians invariably made this decision. The loan takers were often cronies of the political bosses and did not intend to repay the loan. He was told that such and such a person was to be treated as a member of the "deserving poor." But without exception, they were rich. When the loan turned bad, the political bosses disowned any knowledge of the loan or the recipient. At the time of the default it was the bank manager’s head on the chopping block.

The bank manager, moreover, did not run his own office. The trade union representative decided who did what who got promoted and who was transferred. He tried to promote a female clerk who was doing exceptionally well, but he was vetoed by the union leader. "Of what use am I?" he asked me sadly.

Barring a few exceptions, no one in the political class — bureaucrats or politicians — was truly enthusiastic about the changes. There had been no radical change in personnel. They had not publicly admitted that the Nehru-Indira Gandhi path had failed. There was no national soulsearching about the causes of our poverty disease. The nation did not internalize the drastic need for restructuring.

Today, ten years after the reforms, India is a changed country. It has become one of the fastest growing economies in the world — having grown at a smart 6.4 per cent a year during the decade of the 1990s. Second, its population growth has begun to slow down for the first time in decades — against a 2.2 per cent growth rate it had come down to 1.67 by 1998. Third, literacy growth doubled in the nineties — from its historic climb of 0.7 per cent a year to 1.4 per cent — hence, literacy rose from 52 to 65 per cent during the decade, with the biggest gainers being women and the backward states. Fourth, a 110 million Indians rose out of poverty as the poverty ratio declined from 36 to 24 per cent — this is almost the same pace as China’s in the 1980s.

The commercial spirit is not limited to the cities. The smallest village has found it. On a visit to Pondicherry from Madras a few years ago, I stopped at a roadside village cafe, where 14-year-old, low caste Raju was hustling between the tables. He served us good South Indian coffee and vadas. Raju told us that this was his summer job and it paid $12 a month — enough to pay for computer lessons in the evenings in the neighbouring village. For the next summer, his aunt in Madras had arranged a job for him in a computer company.

"What will you do when you grow up?" I asked. "I am going to run a computer company," said Raju. He had decided this when "I saw it in TV, where this man, Bilgay (sic), has a software company and he is the richest man in the world."

Forty years of socialism was not able to destroy India’s real strengths. Our commercial castes have enormous financial acumen, an austere lifestyle, a propensity to take calculated risks, and an ability to accumulate and manage capital. For the past fifty years, the Birla companies had monitored performance of their numerous enterprises across the globe on a daily basis. The Ambanis had single-handedly created the "equity cult" in India by building a base of more than two million shareholders — one of the largest for any company in the world. Because many Indian industries had been under severe price controls in the socialist raj, companies had been forced to become low-cost producers in order to survive. These constituted significant strengths and provided a basis for competitive advantage as India joined the global economy.

The transformation of the world from an industrial to a knowledge economy means that jobs, exports, and economic activity with the highest value added will come from the knowledge sectors of the economy, and countries that participate vigorously in these sectors will be rewarded with a growing and higher standard of living. In business terms, the nation’s leading sector reflects its competitive advantage. Over the last 50 years India has struggled to find its leading sector. Now, it may have found it in the knowledge sectors, particularly in information technology.