India’s decline to a 5.7% growth rate in April-June 2017 (Q1) has evoked much consternation and debate. The decline has been attributed to internal “black swan” events like demonetization, as also to global macro factors such as slower growth in advanced economies. These factors, while explaining the recent developments in Indian gross domestic product (GDP), can be considered transient factors in addressing the growth challenges. These challenge need to be viewed from a radically different perspective—that of facilitating the development of regional powerhouses within the economy.
To put this in context, India, with its $2.3 trillion nominal GDP in the year ended December 2016, is the sixth largest economy in the world. Yet, the US’ richest state—California, with a GDP of $2.5 trillion in 2015 and with only 3% of India’s population—was significantly ahead of India’s GDP of $2.09 trillion even in that year. In fact, if ranked as an “economy”, it would have ranked sixth in the world, ahead of even France. Similarly, if they had been separate countries, three US states—California, Texas and New York—would rank in the world’s 11 largest economies.
China presents a similar story, with three of its provinces—Guangdong, Jiangsu and Shandong—accounting for GDPs of more than $1 trillion each. If considered as stand-alone entities, much like the three largest US states, these three provinces would also rank among the world’s biggest emerging market economies.
The stories of the US and China have one common thread running through them—a large part of economic growth is fuelled by provincial/regional powerhouses. Further, when adjusted for the size of the workforce, such provincial powerhouses—especially those in the US—present a picture of high productivity, measured by the output per worker.
Maharashtra, with a GDP of $0.25 trillion, is the richest state in India, followed by Tamil Nadu ($0.17 trillion) and Uttar Pradesh ($0.16 trillion). However, Maharashtra’s GDP equals that of Connecticut ($0.26 trillion)—a state ranked 23rd in the US by GDP. To further put things in perspective, Maharashtra’s area is 21 times larger and it has a population 31 times Connecticut’s.
Recent reports suggest that India—with a GDP of $6.84 trillion—will emerge as the third-largest economy in the world by 2030, surpassing four developed nations—Japan, Germany, Britain and France. It is clear that India’s trajectory to the “world’s top three largest economies” will be shaped by the movement of the output of India’s top states. In particular, it is the transformation of these Indian states into provincial powerhouses and trillion-dollar economies, akin to those in the US or China, that will shape the country’s destiny going forward.
We authored a report (Ficci-SPJIMR Report) as part of the Ficci Progressive Maharashtra 2017 to understand how India’s richest state, Maharashtra, could contribute to the growth story by leapfrogging to a trillion-dollar economy by 2025, at about the same time as India is poised to become the third-largest economy in the world.
Maharashtra reported a nominal gross state domestic product of $0.29 trillion in 2015-16 (bit.ly/2fuUdUU). Thus, Maharashtra needs to grow by $0.71 trillion in the next nine years, i.e. over 2016-25, to achieve the $1 trillion-state status. The state would have to grow at a compound annual growth rate (CAGR) of 14.4% in real terms to attain this mark by 2025. Compare this to the real rate of growth achieved in 2015-16 of 8.5%, and the challenge becomes stark.
More importantly, the growth rate of an economy (g) is related to its savings and investment rate (I) and its capital–output ratio (k) through the Harrod-Domar growth equation, g= I/k. Thus, the growth rate of an economy is positively correlated to its investment, and negatively to “k”—also called the incremental capital output ratio (Icor).
Calculating the Icor for the period over 2008/09-2014/15, we found that Maharashtra has a strong average incremental capital output ratio of 0.85—which is to say, 0.85 units of capital are required to produce one unit of output. However, the Handbook Of Statistics On Indian States (bit.ly/2xCjsed) reveals that the investment growth rate in Maharashtra in 2014-15 was only 3.5%.
For Maharashtra to achieve 14.4% growth by 2025, given the average Icor of 0.85, investment in the state will need to grow to 12.24% per year from the current investment rate. If the Icor is taken at the highest value over the period 2008-09 to 2014-15, i.e. 1.91, the required investment to achieve the 14.4% growth rate would increase to 27.5%.
Thus, investment appears to be the largest challenge to growth for the richest state in the country. Such challenges get compounded when studying the investment across the six divisions of Maharashtra, with the Konkan and Pune regions accounting for the highest investments, as also gross state domestic product (GSDP).
This story is likely to repeat across different Indian states/regions. It becomes imperative that state governments boost investment across different regions within their respective states. They should also identify challenges to reducing the Icor, essentially dependent on the ease of doing business, in their respective states.
India’s growth story needs to be seen as one of growth of regional powerhouses, fuelled by investments.
Tulsi Jayakumar is professor of economics and programme head, PGP—family managed business at the SP Jain Institute of Management and Research, Mumbai.
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