Recent budgets have increased capital expenditure substantially. The rationale for such hike has been the multiplier effect of capex. It is believed that increased capex outlay will lead to higher growth in future, as these investments can increase capital formation, a major factor in increasing production. While there may be a delay in achieving this growth through public investment, the potential for higher growth ahead may also attract more private investment. However, such an investment-driven growth strategy will fail to realize its full potential unless it is accompanied by increased productivity. This is a challenge that India needs to address if it is to embark on a sustained high growth path over the medium term.
A recent study published in the RBI Bulletin of January shows that large productivity gaps exist across sectors. The study examined the time period between 2001 and 2019, which was divided into two sub-periods, 2001–10 and 2011–19. This time period is important because it includes periods of both high and low economic growth rates. Furthermore, it is an era that has seen constant structural change as well as external shocks such as the global financial crisis and internal shocks such as demonetisation. For these reasons, productivity trends in this phase can be an ideal testing ground 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 should take a closer look at productivity trends in this sector, although the RBI study presents different economy-wide estimates. There are wide variations in productivity growth across sectors. Sectors that may be important in driving industrial growth, such as electrical equipment, refined petroleum, machinery and chemicals, saw a decline in productivity in the second period compared to the first. Such recycling, with a low share in overall value addition, has registered high productivity growth since 2010. Two important conclusions can be drawn from the data. First, wholesale sectors that saw a decline in productivity growth tend to be capital-intensive, while sectors with higher productivity growth are labor-intensive, except in transportation equipment and parts. It questions the nature of capital productivity and technological change. Second, sectors with potential to increase exports, other than textiles, have not been able to register high productivity. Since the role of productivity growth in enhancing global competitiveness does not need exaggeration, the contribution of these sectors to export growth may also be limited in the coming years.
The findings of the RBI study are in line with a 2021 World Bank report, which states that “productivity levels in the SAR [South Asia Region which includes India] Shortest stays in EMDE [emerging market and developing economies] The World Bank report argues that “despite strong productivity growth over the past three decades, the average level of labor productivity in the SAR during 2013-18 was still only 5 percent of the advanced economy average and the average productivity level of the industrial sector in the SAR in 2017″. had EMDE less than two-thirds of the median.” However, it should be noted that within South Asia, India stands out with higher growth of productivity.
Although India is increasing outlay on physical infrastructure, its trends in productivity growth highlight the need to increase investment in strengthening human capital. As the economy has already achieved results in terms of increasing life expectancy, reducing mortality and increasing access to education, significant potential exists for human capital development. There is ample evidence to show that a better educated and healthier workforce can access better and more stable jobs and be more productive. Investment in physical infrastructure, therefore, needs to be complemented with a commensurate outlay in human capital improvements. This involves a two-pronged approach. First, we provide access to the factors that contribute to human capital formation and ensure that these are inclusive. Second, we must ensure continuous quality improvement in human capital. Both of these should be taken forward together.
Total productivity, when divided into within-industry effects and reallocation effects, reveals a marked difference in the composition of the sources of total factor-productivity growth in the two sub-periods. Resource reallocation was a driver of total productivity during 2001–10, with labor and capital reallocation accounting for 82% of total productivity growth, compared to only 42% for 2011–19. This implies that the latter sub-period was a story of productivity gains within the industry.
India’s policy challenge is to increase the pace of reallocation of resources. Productivity gains can be increased by regional reallocation of resources from less to more productive areas if local services and urban planning are improved. This calls for renewed efforts to promote the reallocation of capital and labor to more productive firms within regions. Such interfirm reallocations can unlock major gains. Productivity-enhancing inter-firm resource reallocations can be encouraged by policies to promote competition and reduce regulatory burdens that discourage firm growth. This requires continuous reforms.
These are the personal views of the author.
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