Illustration by Concepción Studios for TIME
September 18, 2014 11:14 AM EDT

It takes a village. nestled in a remote corner of India’s eastern state of Odisha (formerly known as Orissa), not far from its coast on the Bay of Bengal, Dhinkia is a ramshackle collection of thatch-roof huts and crumbling concrete homes surrounded by malarial bogs. Sisir Mohapatra, 60, and his fellow villagers subsist on what little rice they cultivate in small paddies and the few thousand dollars they earn each year selling betel leaves—a local favorite that, when chewed, offers a stimulating buzz. So you’d have thought that when steel giant POSCO came to town pledging to invest $12 billion in the undeveloped region, the people of Dhinkia would have welcomed the South Korean multinational as their ticket out of poverty.

Yet nine years after POSCO announced its investment plan, Mohapatra is still tending his betel vines in a dusty lungi and evading monsoon downpours in thatch-topped hovels. He and his fellow villagers have ferociously resisted POSCO with protests and blockades. The only indication that POSCO was ever supposed to build a steel mill here is two rows of forlorn container-offices, looted bare by angry villagers and eerily abandoned on a mud flat not far from Dhinkia. “Everything the company does will be for the company, not for us,” says Mohapatra.

Such opposition to development—not just from poor farmers but also bureaucrats, regulators, politicians and unionists—has shackled what should be the world’s most promising emerging economy. India possesses everything it needs to make it: a large and youthful population of more than 1.2 billion, a flourishing democracy, highly skilled managers and bankers, and some of the developing world’s best-run companies. Only a few years ago, India was rivaling China for the title of world’s fastest-growing major economy.

But that potential has been squandered. Growth in fiscal 2013–14 tumbled to 4.7%, a rate far too slow to lift the 400 million Indians still trapped in desperate poverty. Once heralded as a proud member of the BRICs—the four emerging economies poised to dominate our future—investors last year dumped India into the “fragile five,” the developing nations deemed most vulnerable to battering headwinds in the post­crisis global economy.

POSCO’s ransacked container offices stand as a sad testament to India’s unfulfilled promise—as well as to a fractious, active civil society willing to resist developers. Across the nation, factories, mines and roadways ready to be built are instead knotted up like POSCO’s steel mill in red tape, political wrangling or public protest. According to the Project Monitoring Group of the central government’s Cabinet Secretariat, 287 investment projects worth $258 billion—bigger than the entire GDP of neighboring Pakistan—were awaiting permits or stuck in the courts by early September.

Some investors, weary of the never-ending delays, have given up. Last year, POSCO canceled a $5.3 billion mill it had intended for the state of Karnataka, while ArcelorMittal, the world’s largest steel company, scrapped its $9 billion project in Odisha, first announced in 2006. “The biggest reason for the decline of the growth rate has been sheer administrative bottlenecks,” says Ajay Chhibber, director-general of New Delhi’s Independent Evaluation Office, which assesses government programs.

India, however, has new hope in the form of a new Prime Minister. In May, Narendra Modi claimed the country’s top political job after his Bharatiya Janata Party (BJP) cruised to a landslide victory in spring elections. Modi campaigned on a promise to get India moving again, and his bold talk has raised the hopes of India’s beleaguered businesspeople that their new leader will finally break apart the chains fettering the economy. Modi “is on the right track,” says Sanjay Bhatia, managing director of New Delhi–based Hindustan Tin Works, which makes metal cans.

Modi, 64, will need to take on entrenched interests that have successfully thwarted change in the past, from the recalcitrant bureaucracy to militant unions. Some of the most critical reforms, like reducing the costly subsidies straining the nation’s finances, may be wildly unpopular and could risk voter backlash. Most of all, Modi has to remake the relationship between government and business in India. Ministries and regulatory agencies that distrust and seek to control private enterprise must be transformed into facilitators that support investment and development. “The country has changed, but the bureaucracy has not,” says Rahul Kacker, a co-founder of Dynamic Industries, which produces plastic parts for cars and appliances near New Delhi. Also, with Europe and Japan in protracted downturns and other emerging economies from Brazil to Russia also sputtering, the world badly needs a new growth engine. The Modi government insists that it aims to free India’s entrepreneurial energies. “We need to get growth back into the economy,” says Arvind Mayaram, India’s Finance Secretary.

License Raj Redux

India’s politicians and civil servants have failed to heed the lessons of the country’s history. After India gained its independence from Britain in 1947, its policymakers, influenced by the Soviet Union and the anti­colonial struggle, implemented a state-heavy economic model. This tied up private enterprise in a web of controls that came to be nicknamed the License Raj. The system failed miserably at alleviating the nation’s pervasive poverty and developing world-class industry. While Japan, South Korea and China capitalized on global trade to spark growth, India isolated itself and fell badly behind.

India finally woke from its slumber in 1991. Pressed to the wall by a looming debt crisis, a team of free-market reformers led by the Cambridge-trained Finance Minister Manmohan Singh began dismantling the License Raj. The results were spectacular. India’s GDP surged, while the percentage of the population living on less than $1.25 a day—the standard international poverty line—fell below 33% in 2010 from 51% two decades earlier, according to the World Bank. India is now the world’s 10th largest economy.

But the reforms didn’t go far enough. Many controls and regulations remained in place, allowing the bureaucracy to maintain too much leverage over business. The nation’s fractious political system, meanwhile, became gridlocked. Even the once gutsy Singh got mired in political bickering and allowed reform to stall during his tenure as Prime Minister from 2004 to 2014. Instead, the government approved new and expensive welfare programs that taxed the national budget. “It wasn’t clear if we were going toward socialism or capitalism,” says Kacker of Dynamic Industries. Growth plunged, inflation soared, investment stagnated, and the trade deficit widened. By mid-2013, global investors panicked and fled, depressing the value of the Indian rupee to all-time lows. India’s economic miracle had slammed into a brick wall.

Men of Steel

Posco got sucked into this quagmire like a city slicker in a sticky Odisha paddy field. The POSCO story is a case study of the trials investors face when doing business in India. It also reflects how the country is struggling to strike the right balance between the necessity for rapid development and the pursuit of civil liberties and inclusive growth. In 2005, POSCO inked a memorandum of understanding with the Odisha state government to build the steel mill and develop a mine to supply the required iron ore. The project is the largest foreign investment ever pledged to India and seemed like a no-brainer for all sides. A rapidly growing India was an obvious choice for a company like POSCO looking for new sources of profit, while Odisha’s political leaders, managing one of the country’s poorest states, badly needed foreign investors to jump-start development. POSCO estimated that its investment would create 48,000 new jobs.

But the steel mill instantly met fierce public resistance. POSCO required some land from eight villages to build the mill. Though some families were willing to exchange their land and betel vines for cash and other benefits from POSCO, many refused the offer. (Last year, independent human-rights experts called for a halt to the project, out of concern that it would displace thousands.) The farmers were organized by a senior member of the Communist Party of India, Abhay Sahoo, who helped form the Anti-POSCO Struggle Committee in 2005. Sahoo believes that big-ticket industrial projects like POSCO’s mill will in the end impoverish, not uplift, India’s poor by stripping them of their land while offering few jobs in return. The government, he argues, should invest in programs to support local agriculture, not replace it with factories. “If you take away their livelihood, soil, water—the families are left with nothing,” Sahoo says.

The authorities and POSCO eventually decided to exclude Dhinkia and other villages in the vicinity from the initial project site, but the protests have continued. Land technically owned by the government and allocated to POSCO is being used by the farmers to grow betel vines, and they have fought efforts to clear it for construction. In authoritarian China, the state often pushes aside such opposition; in democratic India, public opinion cannot so easily be dismissed. There’s a cost to China’s complaisance with big industry, one paid in polluted skies and a sickened populace. But India’s grassroots resistance exacts a price on the economy. “You have to be together with the people” to undertake such big investments, says Ramesh Mahapatra, president of the Utkal Chamber of Commerce and Industry in Bhubaneswar, Odisha’s capital. “That is fundamental in a country like India.”

The protests have complicated the already convoluted process of gaining the necessary government permits POSCO requires to start the project. For instance, the critical environmental clearance issued by the central government has been held up by a stream of investigations, reviews, hearings and complaints from environmentalists. In January, POSCO thought the clearance was at last finalized—after more than eight years—only to discover it was being challenged yet again by social activists. POSCO is also still awaiting the prospecting license necessary to begin its iron-ore operation, without which the company says the mill is not viable. POSCO believes it has tried hard to minimize the mill’s impact on the community and, despite the delays, says it remains “committed” to the project.

Running the Maze

Trouble obtaining government permits is only one bureaucratic hurdle holding back private enterprise. Among the most damaging of India’s many regulations are those governing labor. India boasts a bewildering amalgam of 44 labor laws, enacted at the central level alone, with some dating to the British Raj. The most notorious is the Industrial Disputes Act, promulgated back in 1947, which forces a business manager to get approval from the government and union before dismissing workers. That makes it so difficult and costly to lay off staff that executives are reluctant to hire. A March report from the investment bank Goldman Sachs blames such laws for suppressing job creation. Goldman noted that in recent years India has generated only 2 million new jobs annually, down precipitously from 12 million in the early 2000s.

The labor laws also make it difficult for India to compete in the mass manufacturing that helped drive Chinese growth. The average factory in India employs a mere 75 people, compared with 191 in China. By simplifying and loosening labor laws, combined with other pro-employment reforms, Goldman figures India could create 110 million new jobs over the next decade, more than in any other economy in the world.

The bureaucratic burden on business doesn’t end there. CEOs are required to get government permission to close ailing operations, another statute that inhibits investment, while other outdated regulations require managers to whitewash their factories regularly and provide workers with a sufficient number of spittoons. With so many rules to follow, companies are subjected to constant reviews by regulators—what’s become known as the Inspector Raj. The inefficiency caused by the nation’s sagging infrastructure also strains India Inc.’s bottom line. Bhatia of Hindustan Tin complains that it is more expensive to ship his products from factory to port within India than to export them to another country. “Either I have to reduce my margins or I lose the competitiveness of my business,” says Bhatia.

The Burden of Expectations

Modi is credited with transforming Gujarat into one of India’s most investor-friendly states during his 12 years as its chief minister, and now the business community expects him to re-create that effort on a national scale. Modi’s critics say his contribution to Gujarat’s well-being is overblown. But since his BJP has a majority in the lower house of Parliament—the first earned by any party in 30 years—Modi should have greater freedom to push ahead with tough reforms than his predecessor Singh, who was trapped in an unwieldy coalition.

Modi got to work immediately upon taking office. He announced that he would replace the Planning Commission, which Modi sees as an outdated vestige of the old controlled economy, with a new organization that would decentralize development to the states. He has pressured the bureaucracy to increase its efficiency and improve its performance. In August, Modi issued new guidelines for civil servants that urged them to “make choices, take decisions and make recommendations on merit alone” and “act with fairness and impartiality and not discriminate against anyone.”

To start tackling the nation’s troublesome labor laws, Modi has moved to expand an apprenticeship system to bolster job training and remove restrictions that prevent women from working at night to add flexibility to the workforce. The government pledged to ease restrictions on foreign investment in the railway, defense and insurance sectors. To unclog the bottlenecks to investment, his administration has begun moving the cumbersome application process for necessary permits online—including the environment clearance that has given POSCO such headaches. “The procedures that held up projects are being dismantled systematically,” says the Finance Ministry’s Mayaram.

Modi has picked some low-hanging fruit but not chopped away at the regulations that scare off investment. The administration’s first budget, released in July, was long on vague pledges to reduce state subsidies and support manufacturing but short on real initiatives. Modi also blinked at the first sign of public resistance to his reforms. In June he partially rescinded a hike in train fares, introduced to bolster the cash-strapped railway system, after irate commuters took to the streets. Such unexpected caution has left some economists wondering if Modi possesses the will to confront the country’s most politically sensitive problems. “There is no reason to be confident yet that Modi is the man to change India,” says Daniel Martin, Asia economist at research firm Capital Economics in Singapore.

In the meantime, India’s business­people, and the entire global investment community, will be watching and waiting for Modi to live up to the lofty expectations he has created. Despite Modi’s electoral mandate, he doesn’t control Parliament’s upper house, and he needs support from state leaders. “[The government is] building the ground floor very well,” says Sidharth Birla, president of the Federation of Indian Chambers of Commerce and Industry in New Delhi. “The question is, When do we get the first floor and the second floor?” If Modi fails, India will remain trapped, like its millions of poor villagers, in a bygone age. —with reporting by Kalpana Pradhan/Bhubaneswar and Nilanjana Bhowmick/New Delhi

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