President Bush got a glimpse of both Indias on his recent visit -- the modern, well-educated society that now boasts a growing and substantial middle class, and subsistence farmers tilling the ground by hand as they and their ancestors have done for thousands of years.

Understanding that dichotomy is key to understanding India's economy -- both its current limitations and its near-limitless potential.

Economist Barun Mitra, writing in the " 2006 Index to Economic Freedom," notes that Indians live in a society that is, in many ways, ungovernable in a country that is, in many ways, dysfunctional. It supports a law-enforcement system that doesn't enforce and a court system that does not fairly judge. It's somehow built an economy that is 12th in the world and third in Asia, yet maintained a per capita income of just $550 per year.

Indians, especially those at or near the bottom of the socio-economic ladder, survive because they are resourceful. Racked by regulation, plagued by grinding poverty, a disjoined society and tremendous economic inequity, they, better than their government, have managed to adjust, adapt and succeed. As Mitra says, India's government can do little that its people haven't proven the ability to overcome.

Saddle them with inadequate public schools, and entrepreneurs build a private system that outperforms the public one. Deal them a hopelessly inadequate power grid, and they set up generators and sell electric power priced by the light socket. Place exorbitant taxes on the manufacture and sale of cars, and they literally make their own. They'll weld 9- to 12-horsepower engines to homemade chassis, add a gearbox and a bench for a seat and, voila, they bring not-quite-street-legal transportation to the common man.

Slap 300 percent to 400 percent tariffs on personal computers, as India did during the 1980s, and Indians respond with a "grey" market for PC assembly. Even today, with the tariffs gone and the hidden tax burden reduced to between 10 percent and 15 percent, unbranded PCs assembled from spare parts account for nearly 70 percent of the Indian market.

The Indian black market, which flourished in the 1950s, when the dominant political party decided to pursue "a socialist pattern of development," continues to account for upwards of 40 percent of the economy. In a country with 3½ times the United States' population and one-third the space, the edicts of ideologues in New Delhi carry little weight in the countryside.

What does this all mean for U.S.-India policy? A healthy India that reduces regulations and red tape, embraces free-market policies and encourages investment and rule of law can be an important strategic ally of the United States and a needed counterweight to China's growing influence in the region. India's government could expand prosperity and grow its trading opportunities with the United States if it would lower taxes and tariffs, open up financial markets to foreign capital, slash regulations and improve courts and law enforcement to protect property rights.

In many ways, the Indians already are on the right track. They've renounced their overtly socialist ways and begun to make what the Index calls "slow progress" toward free-market principles. They've eliminated quotas on 1,420 consumer imports in 2002 and plan to continue to remove restrictions. That growing middle class now outnumbers the entire United States in population, and the country's GDP growth rate, 8.6 percent, ranks among the highest in the world.

But India can do much better still. Nearly two-thirds of her people earn their living in agriculture -- a reliable indicator of an impoverished society. There are reasons they remain impoverished and tied to the land. The Economic Intelligence Unite characterizes India as a difficult market for foreign companies." Bank regulations, for example, drive up costs for business, slowing the availability of loans for starting businesses. China attracts 17 times as much direct foreign investment. The government runs huge annual deficits and added $123 billion to its foreign debt in 2004 alone.

Labor regulations and the government's practice of reserving production to the small-scale sector keep India from becoming a manufacturing giant like China. Despite some baby steps in the right direction, large sectors of the economy, particularly in key industries such as energy, remain under government control.

The power grid is but one example of a key service India's government can't deliver adequately. It also sustains huge losses on mass transit systems because its roads can't accommodate modern commerce and travel demands. A sign on a road that carries traffic over an 8,500-foot-deep cavern in the Himalayas says it all: "Weak Bridge."

India has great potential, including a huge, young, innovative, relatively well-educated workforce, a well-developed private sector, a stable democracy and freedom of speech. Yet the World Bank rates it worse than heavily bureaucratic China in terms of excessive regulation and government inefficiency.

India could be so much more. American policy should help India open its markets, realize that potential, and be all it could be.

Marc A. Miles is director of the Center for International Trade and Economics at The Heritage Foundation (heritage.org).