India's Industrial Policy Buys Activity, Not Capability
What the C2i sale reveals about the design flaw in PLI and DLI: activity is the instrument, capability is the hope, and no clause makes it a condition.
C2i Semiconductors was founded in Bengaluru in June 2024, approved for support under the Design Linked Incentive scheme five months later, and last week agreed to be acquired by Infineon. It designs power management chips for AI data centres, where volatile GPU workloads place unusually hard demands on the power delivery stack. It raised from Yali Capital and then a $15 million round led by Peak XV, taking private funding to roughly ₹170 crore. Its first silicon had only recently come back from the fab.
The reaction was immediate and predictable. An Indian chip company, backed by public money, sold to a foreign multinational. Taxpayers had underwritten a German company’s R&D.
The money argument doesn’t survive contact with the numbers. DLI reimburses up to half of eligible expenditure with a ceiling of ₹15 crore per application, and disbursement is milestone linked, so against ₹170 crore of private capital the public contribution to a company at C2i’s stage was a small fraction of what it spent. C2i was not living on government money and did not sell because government money ran out.
It sold because there is no domestic customer for AI data centre power IP at Infineon’s scale, no deep pool of Indian late-stage capital willing to fund a decade of silicon toward a listing, and no Indian company with the balance sheet and global distribution to have entered a competing bid. Those are gaps in capital markets, customer markets and industrial depth. Reimbursing design expenditure touches none of them.
So the interesting question is not whether C2i broke faith. It’s what the Indian state asked for in return for its money, and the answer is close to nothing.
One clause, and what it wasn’t
DLI’s only real protection is a requirement that beneficiaries maintain domestic status for three years after approval. C2i sits inside that window, which makes the near-term question administrative: enforce it, waive it, or accept a transaction structure that satisfies the government’s own reading of domestic status. Roughly twenty other DLI-backed companies are watching, because whatever happens here sets the precedent the rest of the cohort will plan around.
But notice what that clause is. It is a restriction on ownership for a fixed period. It is not a requirement to do anything. It does not oblige C2i to license its IP to Indian firms, to keep its design team in India after a sale, to train engineers who then disperse into the wider ecosystem, or to give the state any equity that would let the public balance sheet participate when an acquisition happens.
The clause restricts without requiring, which is the worst of both worlds. Enforce it strictly and you obstruct exactly the successful exits that make investors willing to fund the next hard-tech company. Waive it when an attractive offer appears and it never meant anything. Either way, India ends up with no claim on the capability it helped create.
Every layer of abstraction hides the same trap
There’s a pattern in how software engineers describe what happens when tools get better. An IDE removes the need to remember how compilation works. A framework removes the need to understand the infrastructure underneath it. An AI coding assistant removes the need to type the implementation yourself. Each layer makes you faster. Each layer also lets you become productive before you become competent, because the tool absorbs exactly the difficulty that would otherwise have forced you to learn something.
The danger isn’t the abstraction. It’s that the gap between productive and competent is invisible for as long as the abstraction holds. You only discover what you don’t actually know at the moment the layer fails: the framework hits a case it wasn’t built for, the IDE can’t explain the error, the assistant generates something that compiles and is wrong. By then you’re the one holding the problem, with none of the underlying understanding the tool had been quietly standing in for.
An industrial subsidy is the same kind of layer laid over a country instead of a codebase. It lets a sector look productive, exports rising, factories running, chips taped out, without the country having done the harder thing underneath: learning to design the next node, financing the next decade of a firm’s life, building the customer base and capital markets that let a company grow up at home instead of getting acquired abroad. The subsidy absorbs the difficulty. It does not transfer the difficulty into anyone’s hands.
Nobody at a ribbon cutting can tell productive from competent by looking. The distinction shows up only when the abstraction runs out, when a company needs something the scheme was never designed to provide and finds nothing underneath. For C2i, that moment was a term sheet from Infineon. For Indian handset manufacturing, it’s a value-addition number stuck for years despite record output.
So the question worth asking of any industrial policy is not whether it makes a sector productive. Almost all of them do, that’s the easy part. It is whether the policy forces competence to form underneath.
Capability as hope: India’s own evidence
DLI is a small instrument inside a much larger family. The Production Linked Incentive programme spans fourteen sectors with an outlay approaching ₹2 lakh crore, and its showpiece, mobile phone manufacturing, is now far enough along to be judged on results.
On productivity, PLI delivered. Mobile phone exports rose from around ₹27,000 crore in FY20 to more than ₹1.2 lakh crore by FY24. Production under the large-scale electronics PLI crossed ₹5 lakh crore by mid-2024. Ninety-nine percent of phones sold in India are now made in India. India became a serious node in the global handset supply chain inside four years, which almost nobody predicted in 2020.
On competence, the picture is different. Domestic value addition in mobile manufacturing reached 23 percent in FY24, against an original ambition of 35 to 40. The government’s own more recent figure puts it at 25 to 28 percent as of this month, so the number is moving, but the distance to target has barely closed in years of trying. Raghuram Rajan and co-authors pointed out in 2023 that as imports of assembled phones fell, imports of components rose sharply: printed circuit boards, displays, cameras, batteries, semiconductors. India replaced importing finished phones with importing the parts of phones. That is a real gain in jobs and trade balance. It is the abstraction holding. It is not an electronics industry underneath it.
Two design details explain why the layer never collapsed into learning.
The first is where the money went. The largest beneficiaries have been Foxconn, Wistron and Pegatron, all Taiwanese contract manufacturers assembling for Apple, along with Samsung. That is not a scandal, attracting global manufacturers was an explicit goal, and their presence built supplier networks and trained workers that would not otherwise exist. But it clarifies what the instrument is: a payment for manufacturing activity physically located in India, made largely to firms whose core technology and customer relationships remain elsewhere. On the domestic side, an independent assessment by The India Forum found that four fifths of Indian applicants in mobile manufacturing failed to meet their thresholds at all, with only one domestic firm clearing both the investment and sales bar. The scheme was better at renting productivity from abroad than at building competence at home.
The second is that value addition was tracked throughout the scheme and never made a binding condition of payment. The government measured it, reported on it, and did not make the money depend on it. Payment triggered on incremental sales, so incremental sales is what the scheme bought. The harder problem was never the price of the money.
The government now appears to have absorbed the lesson. The next phase of smartphone incentives is reportedly being designed to link payouts to domestic value addition targets rather than treating value addition as a monitored but non-binding outcome. That is a deliberate attempt to force the abstraction to collapse earlier, closer to when the money is spent rather than a decade later when a policy review finds the gap. It is both the right correction and an admission about the first version.
The fair rebuttal, made by Ashwini Vaishnaw, is that value addition takes time, and that China needed roughly 35 years to reach around 38 percent domestic value addition on iPhones while India reached comparable levels in five. True, and it should temper the criticism. But it proves the argument rather than answering it, because China’s 38 percent was not the passive result of waiting. It came from joint venture requirements, technology transfer conditions and local sourcing mandates that forced learning into domestic firms whether they wanted it or not. Time alone doesn’t make an abstraction collapse into competence. Something has to force it.
There is a longer Indian record here too. Before PLI came M-SIPS, offering capital subsidies of 20 to 25 percent to electronics manufacturers, with over ₹10,000 crore in incentives approved by the time it closed in 2018, much of which never materialised beyond paper. The instruments keep changing. The habit of paying for the productive layer and hoping competence follows underneath it has outlasted all of them.
Capability as condition: what everyone else did
The countries India cites as models built the collapse into the policy itself. They made competence the entry fee.
Taiwan refused the turnkey plant. In 1976 ITRI signed a technology transfer contract with RCA for a 7-micron CMOS process, on the order of four million dollars, and insisted on a full manufacturing transfer rather than a working factory handed over ready to run. A turnkey plant is exactly the kind of abstraction a country can hide behind indefinitely: it produces chips without anyone inside the country understanding how. Taiwan refused it. It sent an initial cohort of 19 engineers to the United States for intensive training across design, process, verification and equipment handling, and then rebuilt the process at home rather than importing the output. By late 1977 ITRI’s demonstration fab in Taiwan was running at 81 percent yield, better than the RCA plant the process came from. Between 1976 and 1980 ITRI spent around $120 million acquiring foreign technology, then began handing it to the private sector. UMC was spun out in 1980 with the upgraded fab and its staff. TSMC followed in 1987 with fabs, equipment, process technology and 98 people, all of whom already understood what they were operating.
What that bought showed up years later, in a negotiation. Philips initially wanted half of TSMC in exchange for its technology. ITRI talked it down to a 27.5 percent cash investment by demonstrating that Taiwan had already mastered parts of what Philips was offering. That is the payoff: not independence from foreign partners, but leverage across the table from them, because you can no longer be sold something you already know how to build.
Japan forced five rivals to share the hard part. MITI’s VLSI project ran from 1976 to 1980 on roughly ¥70 billion, about ¥29 billion of it public. The condition of funding was that five bitter competitors, Fujitsu, Hitachi, Mitsubishi Electric, NEC and Toshiba, staff a joint laboratory and divide the microfabrication problem between them, rather than each quietly buying a shortcut and calling it proprietary. It produced over a thousand patents, around 16 percent of them joint inventions filed by engineers from rival firms. When it dissolved, the equipment was split among participants and the knowledge went home in people’s heads rather than staying locked inside one company’s black box. Japanese firms then took over 64K and 1M DRAM.
Korea made the exam un-gameable. Support to the chaebol during the heavy and chemical industry drive carried export performance requirements, and firms that missed them lost access to subsidised credit. An export target is peculiarly hard to fake, because the examiner is a foreign buyer with no stake in Korean industrial policy. You cannot satisfy it by relabelling imports or lobbying the ministry that set it, the way a firm can quietly satisfy an incremental sales target at home. Economists studying the programme’s long-run effects have since found that subsidised firms didn’t just sell more, they showed measurably higher productivity and better post-subsidy export performance than firms that weren’t subsidised, which is the closest thing to direct evidence that the discipline, not just the money, was doing the work. This is precisely what the mobile PLI declined to do when it monitored value addition without attaching a rupee to it.
China ran the experiment both ways, which settles the argument. The Special Economic Zone era from 1980 looks like an activity scheme on the surface, tax holidays, land, market access. But the incentives sat inside a structure with conditions: joint venture requirements, technology transfer as the price of entry, rising local sourcing obligations. Over three decades that forced proximity moved Chinese firms from assembling other people’s products to owning large parts of the value chain in electronics, batteries and solar. The abstraction was made to collapse early, on purpose, while the state still had leverage to insist on it.
The semiconductor Big Fund, launched in 2014, attached no comparable conditions and is the closer analog to DLI. Across three rounds it raised on the order of hundreds of billions of dollars, roughly $100 billion in the first phase, $41 billion in the second, a further $47 billion in 2024. Wuhan Hongxin promised a leap straight to 14 and 7 nanometre nodes on a $19 billion budget and collapsed in 2021 without shipping a commercial chip. Dehuai, HiDM, Tacoma and Quanxin stalled at land preparation or pitch deck stage. Jiangsu Advanced Memory went bankrupt in 2023. A GlobalFoundries joint venture fab in Chengdu was abandoned as an empty shell in 2018 and sat untouched for five years. In 2022 the fund’s own chief executive and several fund managers were arrested on corruption charges. The money was not entirely wasted, China’s ecosystem is genuinely larger than a decade ago, but its integrated circuit trade deficit nearly doubled between 2010 and 2020 while the subsidies flowed, and its leading fabs remain years behind at advanced nodes. Hundreds of billions bought a great deal of visible activity. Nothing forced it to become the thing it was named for.
Same country, same state capacity, same willingness to spend. The era that made competence the price of entry got competence. The era that paid for output on trust did not.
But shouldn’t we fix land and labour first?
The standard objection is that all of this is downstream of something more basic, and India should fix land, labour, capital and contract enforcement before engineering conditionality into subsidy schemes. That is half right, and the wrong half matters.
It fails as a sequencing claim. None of the countries above had working factor markets when they started. Taiwan built ITRI under martial law. Korea’s financial system in the 1970s was deliberately repressed, credit allocated by the state rather than by price, and liberalisation largely followed industrialisation rather than preceding it. China in 1980 had no land market, no labour market in any recognisable sense and no commercial legal system worth the name. If working factor markets were a precondition, none of these industries would exist.
What those countries built instead were enclaves where scarce factors could be directed at chosen sectors, and then used the enclave as a laboratory for reforms that spread outward. Shenzhen was not primarily a tax haven. It was a testing ground for land leasing, foreign ownership, labour contracting and price liberalisation, run in a controlled space so failures stayed local. Hsinchu did the same on a smaller scale, co-locating ITRI, its spinoffs and their suppliers so people, knowledge and capital circulated within a few square kilometres.
India tried this and got the design wrong instructively. The SEZ Act of 2005 created enclaves defined almost entirely by tax treatment rather than regulatory experimentation, then destabilised even that: minimum alternate tax exemptions withdrawn from 2011-12, the dividend distribution tax exemption for developers terminated, a sunset clause limiting income tax benefits to units operational by March 2020. Of 564 formally approved SEZs, only 192 were operational by 2014. All Indian SEZs together cover roughly 61,600 hectares. Shenzhen alone covers about 49,300. China’s SEZs now account for something like 22 percent of GDP and 60 percent of exports. India built many small tax enclaves and revoked the tax benefit. China built a few large reform laboratories and let the reforms spread.
Where the objection holds is on retention rather than creation.
Capability can be created in an enclave. It cannot compound in one.
A company that succeeds inside a protected zone still has to grow outside it, into an economy where land takes years to assemble, labour law makes scale manufacturing risky, power is unreliable, and a commercial dispute takes a decade to resolve. Those conditions decide whether a firm that succeeds puts its next plant and its next thousand engineers here or elsewhere. A subsidy offsets a bad factor market for exactly as long as the subsidy lasts, which is the same abstraction wearing different clothes.
It also matters which factor markets bind for which problem, since the phrase gets used as though it were one thing. For assembly and fabrication, land, labour, power and logistics are decisive. For fabless chip design they barely register. C2i needed almost no land and employed a few dozen engineers. What it lacked was deep late-stage risk capital and a domestic customer, which are capital and product market failures. Reforming labour codes would not have kept C2i Indian. A domestic pool of capital willing to fund a decade of silicon might have.
Subsidies and factor markets solve different problems. India has been using the first as a substitute for the second.
Turning the hope into a condition
None of this argues for scrapping these schemes. You have to fund productivity first, because there is no route to competence that skips getting companies founded and factories built, and India in 2020 had little of either. The mobile PLI created an assembly base that did not exist, and that base is the raw material any component ecosystem would stand on.
What forces the collapse is not mysterious, because other countries already wrote the clauses. Make value addition and technology localisation binding conditions of payment rather than monitored outcomes. Take equity in strategic programmes so the public balance sheet participates when an acquisition happens, the way ITRI’s stakes in UMC and TSMC gave Taiwan a return on the knowledge it had built. Attach perpetual domestic licensing rights to IP developed with public money, so the technology stays available to Indian firms regardless of who owns the company. Fund shared design infrastructure, IP libraries, EDA access, multi-project wafer runs, so knowledge pools in an institution the way it pooled inside MITI’s joint laboratory, rather than dispersing when a single startup is sold. Use public procurement to create the domestic customer that does not yet exist, since defence, railways, power utilities and telecom all buy silicon and none of them buy Indian. Treat enclaves as reform laboratories rather than tax arbitrage, which is the lesson from China that India copied in form and missed in substance.
Every one of these does the same thing an export target did for Korea or a shared lab did for Japan. It removes the option of staying productive without becoming competent, by making the money itself depend on the harder thing happening.
The real risk
Activity is politically attractive because it is immediate and countable. Capability runs on a slower clock, and its absence surfaces only years later: when value addition plateaus a decade short of target, when a promising company cannot find a domestic customer, when no Indian investor can fund the next stage, when the only credible buyer is foreign. By then the credit for the original announcement has been banked and nobody is accountable for the gap.
That is the danger in treating these schemes as ends rather than as scaffolding. Lowering risk while deeper capital markets, customer bases and industrial networks develop behind them is a legitimate function. But scaffolding is supposed to come down, and if nothing is being built to stand on its own once it does, the country discovers what it doesn’t know at the worst possible moment, in public, the way C2i’s shareholders discovered that no amount of activity had produced a domestic buyer willing or able to compete with Infineon.
C2i did not fail. It built real intellectual property, attracted serious capital, and became valuable enough for a global leader to buy, which for a hard-tech startup is success by any normal definition. Nor did Foxconn do anything wrong by assembling phones in India and collecting an incentive it was contractually entitled to. In both cases the private actors did exactly what the policy paid them to do.
The question is what India asked for in exchange. It did ask for things. PLI required incremental sales over a base year. DLI requires design milestones and turnover thresholds. These are real conditions, and firms that missed them went unpaid, which is why four fifths of domestic mobile applicants collected nothing. But look at what those conditions test. Every one of them is satisfiable by productivity alone. You can hit an incremental sales target by assembling imported components. You can hit a turnover threshold on a chip that is designed here and then leaves. Nothing in either metric requires you to know something at the end that you did not know at the start.
Now look at what the others demanded. Taiwan asked RCA for the process, not the plant. Japan asked five rivals to sit in one laboratory. Korea asked its champions to win orders from foreign buyers who owed them nothing, and pulled their credit when they lost. China asked for joint ventures and local content. Each of those is a condition you cannot satisfy without acquiring something you didn’t have before. They are tests of competence. India’s are tests of productivity, and productivity is the one thing you can buy without learning anything.
Activity is the instrument. Capability is the hope. And a country, like an engineer leaning on a tool it has never looked underneath, only finds out how much it was hoping for at the exact moment the tool stops being enough.