(FORTUNE Magazine) –

India's king of beer hunkers over the bar in the leather-trimmed lounge of his Boeing 727. Vijay Mallya's tie is askew, his eyes are rimmed with red, but he declares the past 23 hours "a great, great day." The 49-year-old liquor baron has been up since 3 A.M., flying from Mumbai to Calcutta to talk with investors and employees of Shaw Wallace, a rival acquired in March by his United Breweries Group. The $370 million purchase, ending a 20-year takeover struggle, has made UB second only to Diageo as the world's largest liquor company by volume. Earlier in the day Mallya had toured Shaw Wallace's headquarters like a conquering general, addressing shareholders and holding forth in a whirl of interviews with the local press.

Now, jetting back to Mumbai at 2 A.M., it's Mallya time. The secret of his success, he muses, swirling a goblet of red wine, is that he understands the aspirations of the modern Indian consumer. "The old 'Be Indian, buy Indian' nonsense doesn't cut it these days," he scoffs. "Indians are opening up, they're more assertive." So his UB brand is about "freedom of choice for a young and upwardly mobile India." The pitch is simple: "You only live once, so live the good times."

Few of India's 1.1 billion consumers live quite as well as Mallya, who owns two soccer teams, a stable of thoroughbreds, fleets of luxury cars and yachts, and three jets to shuttle among mansions in Bangalore, Mumbai, and Goa. But there is no question that these days many of his countrymen are living better than they were. Buoyed by rising exports, India grew by 8.1% in the April-June quarter, building on a 7.1% gain for the fiscal year ended in March. Economists expect the economy to perform at least as well in the current year, despite the jump in global oil prices. A rash of glitzy shopping malls rising on the outskirts of Bangalore and New Delhi attests to India's growing middle class. Suddenly analysts and investors are talking of India in the same breath as Asia's other emerging colossus. A recent report by brokerage CLSA lumps the two giants together into a single economy, "Chindia," and says that by 2020 the combined entity will consume half the planet's natural resources and serve as both factory and back office to the world.

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But comparisons with China aren't necessarily flattering for India. By a quirk of history, the two countries started down the path of economic reform at about the same time. In China, Communist leader Deng Xiaoping moved away from centralized planning after Mao's death in 1976, but it wasn't until 1992 that he consolidated sufficient power to open China to competition and foreign trade on a significant scale. For India the starting point was 1991, when the government of Narashima Rao averted default by promising to liberalize the economy in exchange for a bailout from the IMF.

As recently as 20 years ago the two countries were on roughly equal footing. Both were large, predominantly agrarian countries with GDPs of less than $1 trillion and per capita incomes of about $300. Both had effectively withdrawn from global commerce. Today China's economy is more than twice as large as India's and is posting average annual growth rates of 9% to 10%, compared with India's 6% to 7%. Per capita income in China is now more than double what it is in India. China has reduced the proportion of its population living on less than $1 a day to below 13%, compared with 31% for India. China takes in 12 times as much in annual foreign direct investment as India ($60 billion vs. $5 billion), and it exports almost six times as much each year ($600 billion vs. $105 billion).

Ask India's policymakers to account for their nation's weaker performance, and the conversation turns to politics. "We are an underdeveloped economy with an overdeveloped democracy and proud of it," says Commerce Minister Kamal Nath. It's a good line--until you think about it. Why take pride in underdevelopment? Finance Minister Palaniappan Chidambaram responds wearily to questions about his government's slow progress in restructuring unprofitable public enterprises or opening India to foreign investment. "We try. We try every day," he says. "But we are a democracy. We have a free press. We can only move at a certain pace, which may seem slow compared with China. To get anything done, I must carry my coalition partners and the opposition."

But scapegoating democracy for India's inability to grow more rapidly is a cop-out. "India's problem isn't too much democracy, it's too much socialism," says Prannoy Roy, the founder of New Delhi broadcaster NDTV. In fact, the problem is even simpler: bad government and an almost willful disregard for the fundamentals of developmental economics. China's economic miracle was achieved by getting the basics right--building good roads, educating women and young girls, loosening labor restrictions, and opening the economy to competition and foreign trade.

India, by contrast, is the global economy's idiot savant. It excels at the impossible, turning out hundreds of thousands of brilliant engineers a year. Its software houses manage complex data across thousands of miles of undersea cable for the world's most sophisticated clients. India has world-class business leaders and, unlike China, solvent banks. And yet India flubs the obvious stuff. The national roadway network is a shambles and the power grid even worse. Nearly a third of India's population--and more than half its women--can't read or write. India has moved grudgingly to lower tariffs and balked at turning money-losing state-owned enterprises over to the private sector. Red tape and corruption discourage foreign investment, as do restrictions on how firms deploy workers.

This bipolar development model is reflected in the crazy-quilt of wealth and squalor in cities like Mumbai, where billboards touting Mallya's Kingfisher beer and Standard Chartered Bank's investment-planning experts tower above sprawling slums, and urchins approach cars at gridlocked intersections hawking copies of Harvard Business Review. In Bangalore, executives visiting the immaculate campuses of software firms like Infosys and Wipro marvel that while their data can travel to the other side of the earth at the speed of thought, they must crawl along in bumper-to-bumper traffic for more than an hour to get back to their hotels.

Chidambaram's coalition is an improbable push-me-pull-you of his Congress Party, led by Sonia Gandhi, the Italian-born granddaughter-in-law of founding Prime Minister Jawaharlal Nehru, and an amalgam of communist parties known as the Left Front. When Congress triumphed over its pro-business rival, the Bharatiya Janata Party, in national elections in April 2004, India's stock market took a nosedive. Those apprehensions eased when Gandhi awarded the Prime Minister's job to Manmohan Singh, a Cambridge-trained economist who was the architect of liberalization in the early 1990s. The appointment of Chidambaram, a trade union lawyer with a Harvard MBA, was also hailed as a sign that the new government wouldn't reverse course. But Singh--beholden to Gandhi and her communist partners--has tacked left at every turn. Labor, pension, and banking reforms have ground to a halt. Plans to sell stakes in 13 state companies have been shelved.

Instead the Congress-led coalition has pushed through legislation that guarantees every rural household in India at least 100 days of paid employment a year. Chidambaram shrugs. If good economic policies could be enacted without controversy, he says, "this wouldn't be India." There's something to that, of course. India is the world's largest democracy, and possibly its messiest. French President Charles de Gaulle's lament about the impossibility of governing a nation with 246 kinds of cheese wins no sympathy in New Delhi. Singh is struggling to impose order in a country with 18 official languages, hundreds of dialects, four major religious traditions, ancient caste divisions, and at least 300 ways of cooking the potato.

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Of all India's failures, lousy infrastructure may be the most puzzling. The nation's highway network stretches just 124,000 miles, compared with 870,000 miles in China. Most of the roads are simple two-lane affairs, maintained badly if at all. In 1999 the government launched a national program that will build another 28,000 miles of highway at a cost of $38 billion. The first phase calls for construction of a Golden Quadrilateral Highway linking India's four largest cities. It's not enough. Morgan Stanley estimates that India is spending only about $2.5 billion a year building roads, while China is spending $25 billion a year. For goods sent by rail, freight costs are twice the average of other developed countries' and three times those in China. At India's ports, shipments often languish for days waiting for customs clearance and loading berths; goods typically take six to 12 weeks to reach the U.S., compared with two to three weeks for goods from China. Electric power in India costs twice as much as in China: Public utilities sock it to industrial producers to make up for the power they give away to farmers and the urban poor. The national grid is so bad that as much as 40% of the electricity generated is simply lost in transmission.

The result is that firms in India pay far more than rivals in China to produce, distribute, and export their products. Consider the plight of Bharat Forge, India's most successful auto-parts supplier. Bharat has the world's largest single-site forging facility. Over the past five years the company has become a trusted supplier of crankshafts, axle beams, and steering knuckles to top-tier clients such as Toyota, Ford, and DaimlerChrysler. Exports account for 40% of sales. But Bharat is located in Pune, an industrial city 75 miles from Mumbai. CEO Baba Kalyani says that, based solely on distance, his trucks should be able to travel to Mumbai's port and back two times each day. Instead, even with the recent completion of a new highway linking the two cities, a roundtrip typically takes three days.

Labor laws make things worse. Indian companies with more than 100 workers face daunting impediments to restructuring, forcing large firms to devise ever more elaborate means of circumventing the rules--typically in ways auguring poorly for job creation. At Bharat, Kalyani says his business hit a wall in 1996, when the Indian auto market suffered a downturn. The only way to survive, he concluded, was to increase foreign sales. But Kalyani, an MIT-trained engineer, discovered he couldn't compete simply by leveraging low-cost labor. He was working around the clock to raise efficiency on the factory floor but getting productivity gains of 20% at best.

The solution was to revamp the production model, abandoning Bharat's reliance on large numbers of low-cost laborers and switching to a system that used an elite cadre of highly skilled engineers to operate a factory filled with smarter machines. By offering buyouts of up to seven years' salary, he coaxed 600 of his 1,800 workers into early retirement. Then he set about recruiting college graduates with engineering degrees and spent heavily on computers and software. A decade later Kalyani's payroll is back up to 1,800, but 80% of his employees are degree-holding engineers, and his operation is four times more productive. "In India, our competitive advantage does not lie in cheap labor," he says. "It lies in cheap brainpower."

Across town at Bajaj Automotive, the story is much the same. Bajaj is India's second-largest motorcycle maker, commanding a 30% share of the domestic market. Like Bharat, it is pushing overseas. But it has encountered competition from rivals in Japan, South Korea, and increasingly China. Executive director Sanjiv Bajaj, who is leading the export drive, says the goal is to sell cycles vastly superior to those made in China for about 20% less than those made in Japan. But to do that Bajaj, too, is reinventing its production model. In the early 1990s, Bajaj built one million vehicles with 24,000 workers. Now it builds 2.4 million with 10,500 workers. Bajaj would run an even leaner operation if the government would allow it.

To break the grip of recalcitrant labor unions at its plant in Pune, Bajaj has curtailed investment there and built a gleaming new factory in Chakan, 25 miles away. The Pune plant is old India: Four thousand workers, few with college degrees, build low-cost scooters at a rate of 1,500 a day--though actual productivity is lower, because the plant runs only five days a week. Company officials won't even consider letting a reporter see it. The Chakan facility looks as if it has been transported whole from Japan, complete with Fanuc robots. Nine hundred employees, 90% of them college-educated engineers, turn out 2,600 motorcycles a day. All of them eat at the same canteen. There are no uniforms--engineers flank the assembly line in dress slacks and short-sleeved white shirts.

Nandan Nilekani, CEO of Infosys, sees the transformations at Bharat and Bajaj as the industrial equivalent of the "global delivery model" perfected by burgeoning Indian software-services houses like his own. Like Bangalore's IT stars, India's manufacturers are expanding overseas to escape the vagaries of India's domestic market, competing on quality as well as cost and leveraging brains, not brawn. In software, the global delivery model is a runaway success. From their origins in code-writing and call centers, India's leading services firms are climbing the value chain, competing with the likes of IBM and EDS for contracts to perform more complex--and more profitable--functions such as data management, market analysis, and computer-aided design. India's annual software exports have gone from nonexistent to $15 billion in barely a decade. Consultants at McKinsey predict that India's IT revenue will reach $87 billion by 2008.

But for all that growth, the industry isn't large enough to act as a locomotive for the rest of the economy. Add in the 140,000 Indians employed by foreign multinationals, and India's entire information technology services industry still accounts for no more than about a million jobs. And as it matures, the IT industry is moving further and further beyond the reach of ordinary laborers. True, India graduates more than 300,000 qualified engineers a year, and universities award 2.5 million more degrees. But India has an ocean of unskilled laborers, and in places like Bihar, an impoverished northern state where three in four are illiterate, that ocean is especially deep.

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So where will the jobs come from? Deregulation is one answer. India's civil aviation and telecommunications industries demonstrate what can happen when the state makes way for new market players. Until the early 1990s, Indian travelers were limited to choosing between two cosseted state-owned carriers, Indian Airlines and Air India. The government has since granted licenses to a spate of newcomers, including SpiceJet, Deccan Airlines, and Mallya's Kingfisher Airlines. The big success is Jet Airways, which now flies 51 planes and by the end of the year will offer connections to London and Singapore as well as a host of Indian cities. CEO Wolfgang Prock-Schauer, lured away from a top post at Austrian Airlines, says Jet's goal is to achieve "the service of Singapore Airlines with the operations efficiency of Lufthansa." It's getting there. Flights leave on time, crews are unfailingly polite. Many Indian business travelers say they won't fly anything else.

Increased foreign investment could also help close the gap. In September 2004, over lunch at the New York Stock Exchange with executives from 17 U.S. firms, Singh declared his determination to make a "quantum leap" in attracting foreign investment. So far there have been few takers. Foreign interest in India remains as keen as ever, but Singh's left-wing allies have scuttled Chidambaram's efforts to lift investment caps in the insurance sector and thwarted efforts by Wal-Mart and Carrefour to end the complete ban on direct foreign investment in retailing.

Even some communists, however, have begun to recognize the absurdity of the party's position. This summer, while the leader of the Communist Party of India (Marxist) decried the perils of privatization and imperialist domination of the corner grocery, the chief minister of West Bengal--his party's heartland--was touring Southeast Asia to drum up foreign investment. The minister, Buddhadeb Bhattacharjee, stopped first in Singapore, where he invited business leaders to invest in Calcutta's river ports and help fund a new airport. In Jakarta he met with representatives of Indonesia's largest business conglomerate to finalize a $10 billion investment in his state. "We know that it will take some time to convince people we are serious, but we are sincere in our desire for more foreign direct investment both in industry and infrastructure," Bhattacharjee says, honing his pitch a few weeks later in his Calcutta office. "This is a safe place to do business."

Bhattacharjee's party has ruled West Bengal without significant opposition since 1977 and is revered for pushing through bold land reforms that empowered low-income farmers. But over the years the party's dogmatic approach to business drove private industry away. Now Bhattacharjee--a silver-haired playwright with a penchant for traditional white dhoti kurtas and the novels of Gabriel García Márquez--is trying to coax the capitalists back. "China has taken the correct stand," he says. "They have learned from the mistakes of the Russians, where we have not. They have seen that socialism can be compatible with markets and that state ownership need not be the only model for development. Now they are an economic power, and they are bargaining from a position of strength."

Bhattacharjee--"Buddha," as he is known in the Indian press-- has plenty of detractors. In Jharna Pramanik, a settlement of 5,000 families encamped along the railway tracks near Lake Calcutta, residents charge that the Communist Party has sold them out. "How come this government of so-called Marxists is giving away land to rich foreigners but can't manage a few acres to resettle people like us?" demands one squatter, Koshalya Chatterjee.

Indian politicians often profess affinity for the elephant--huge and plodding, but capable of movements that shake the earth. If Buddha has his way, the tiger--fearless and quick, the mascot of choice in Asia's other economies and all but extinct in India--may soon be making a comeback.

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