The country must work at raising productivity growth
4 min read . Updated: 01 Mar 2023, 11:22 PM IST
PremiumIndia displays wide gaps on this between sectors and we have data that can help shape a policy response
Recent budgets have hiked capital expenditure substantially. The rationale for such increases has been the multiplier effects of capex. It is assumed that increased capex outlays would lead to higher growth in future, as these investments could enhance capital formation, thereby boosting a major factor of production. Though there could be gestation lags in realizing this growth through public investments, prospects of higher growth ahead might also attract more private investments. However, such an investment-driven growth strategy would fail to realize its full potential unless it is accompanied by corresponding increases in productivity. This is a challenge that India must address in the medium term in order to move to a sustained higher growth trajectory.
A recent study published in January’s RBI Bulletin shows the existence of large productivity differences across sectors. The study examined the time span between 2001 and 2019, dividing into two sub-periods, 2001-10 and 2011-19. This time span assumes significance as it encompasses periods of both high and lower economic growth rates. Further, it is an era that witnessed external shocks such as the global financial crisis and internal shocks such as demonetization, along with continued structural transformation. For these reasons, productivity trends in this phase could be an ideal test bed for assessing the future growth potential of our economy.
As India’s manufacturing sector has been the focus of policy attention in recent years, we must take a closer look at productivity trends in this sector, though the RBI study offers disaggregated economy-wide estimates. Wide variations are found in productivity growth across sectors. Those which could be crucial in accelerating industrial growth, such as electrical equipment, refined petroleum, machinery and chemicals, witnessed a productivity decline in the second time period, compared to the first. Those with a lower share in overall value addition, such recycling, have registered higher productivity growth since 2010. Two important inferences can be made from the figures. First, the bulk which saw a decline in productivity growth are capital-intensive sectors, while those with higher productivity growth are labour-intensive, barring transport equipment and parts. This raises questions on capital productivity and the nature of technological change. Second, sectors with the potential to enhance exports, other than textiles, have not been able to register higher productivity. As the role of productivity growth in enhancing global competitiveness needs no overstatement, the contribution of these sectors to export growth could be limited even in the years to come.
The RBI study’s findings are in line with a 2021 World Bank report which observed that “the level of productivity in SAR [South Asia Region which includes India] remains the lowest among EMDE [emerging market and developing economies] regions, in part reflecting widespread informal economic activity and struggling manufacturing sectors." The World Bank report argues that “despite strong productivity growth over the past three decades, the average level of labour productivity in SAR during 2013-18 was still only 5 percent of the advanced economy average and the median productivity level of the industrial sector in SAR was less than two-thirds of the EMDE median in 2017." However, it should be noted that within South Asia, India stands out with higher growth of productivity.
Although India has been increasing outlays on physical infrastructure, its trends in productivity growth highlight the need to enhance investments to strengthen human capital. As the economy has already achieved outcomes in terms of raising life expectancy, reducing mortality, and expanding access to education, there exists significant potential for human capital development. There is ample evidence to show that a better-educated and healthier workforce can access improved and more stable jobs, and be more productive. So investments in physical infrastructure needs to be complemented with commensurate outlays in human capital improvements. This involves a two-pronged approach. First, let us provide access to factors that contribute to human capital formation and ensure that these are inclusive. Second, we must ensure continuous quality improvements in human capital. These two must be pursued concurrently.
Aggregate productivity, when split into within-industry effects and reallocation effects, reveals remarkable differences in the structure of sources of aggregate total-factor-productivity growth in the two sub-periods. Resource reallocation was the driver of aggregate productivity during 2001-10, with labour and capital reallocation accounting for 82% of aggregate productivity growth, while for 2011-19, it accounted for only 42%. This implies that the latter sub-period was a story of within-industry productivity gains.
India’s policy challenge is to enhance the momentum of resource reallocation. Productivity gains from sectoral reallocation of resources from low to more productive sectors can be increased if accompanied by improved local services and urban planning. This calls for a renewed effort to promote the reallocation of capital and labour to more productive firms within sectors. Such interfirm reallocation could unlock major gains. Productivity-enhancing inter-firm resource reallocation can be encouraged by policies to foster competition and by reducing regulatory burdens that discourage firm growth. This requires continued reforms.
M. Suresh Babu is an advisor to the Economic Advisory Council to the Prime Minister and professor of economics at IIT Madras.
These are the author’s personal views.