Last week’s column looked at some of the classic indicators of overheating and suggested that India did not fully display the signs that were evident in East Asian countries, for example, before the Asian crisis. Even the current account deficit looks innocuous when we exclude gold imports. But, regardless of present overheating concerns, the key question for the future is whether India’s recent surge was merely a case of the economy being fed with more inputs, or more than that. Both the savings rate and investment spending are growing. Plenty of workers are going to be available. To succeed in delivering prosperity to many, India must combine labour and investment to produce more output than it has in the past. If that is achieved, then India’s total factor productivity (TFP) will have arrived.
TFP is the portion of economic growth that is not explained by labour and capital inputs going into the economy and their direct productivity. If workers produce more per hour of work because the shop floor has better lighting, that’s not TFP. The increase in output is explicable. Some examples will illustrate the point.
If all the cities in the country had better traffic management, output would grow as people waste less time on the roads, inhale less noxious fumes and, hence, spend less time visiting clinics. They would reach their destinations faster and could do more work and produce more. That is one simple example of TFP. The computerization of railway reservations has increased productivity of not just the ticket issuing officer, but also of all those who would wait endlessly in queues and run around for tickets. Mint (16 February) reports that railways and the postal department plan to use RFID (radio frequency identification) systems to track wagon movement and postal articles. Not just their productivity would rise, but that of their users, too. This is technological change that could lead to a quantum jump in TFP and economic growth.
The good news is that we have merely scratched the surface. Yet, the country clocks 9% GDP growth. It shows that with a more systematic approach, higher growth could be both attained and sustained. The examples also highlight that it is easier to see TFP in action, but harder to measure. In 1997, Jesus Felipe, an economist with the Asian Development Bank, wrote that the theoretical problems underlying the notion of TFP were so significant that the whole concept ought to be discarded.
Nonetheless, the above anecdotal examples seem to add up to something. Investment bank Goldman Sachs recently updated its Brics report first published in 2003. It notes that India could sustain a growth rate of 8% and, with more reforms, could nudge it up to 10% annual real GDP growth. It now acknowledges that its estimate of 5.7% real GDP growth assumed in the 2003 edition was conservative. The report notes that TFP surged to around 3.3% since 2003 from 2.5% in the previous two decades and that this is mainly thanks to the manufacturing sector.
The glass is still less than half-full. TFP in India is estimated to be one-third to 40% lower than what it ought to be, given its institutional mechanisms—democracy, free media, independent judiciary and even joint families—to manage growth and social conflicts.
We must never forget that just as countries can catch up in productivity and economic growth, they can also regress. Many Latin American countries are examples of that. Further, it is still an open question if the Indian private sector could sustain its act without the government doing the hard work in critical areas like labour reforms, education and health provision.
There is room for optimism. A survey of Indian corporate firms over the period 1980-2002 led to the conclusion that the sector needed close monitoring and that the potential for non-performing loans remained high. Amen.
Anantha Nageswaran is head investment research, Bank Julius Baer (Singapore) Ltd. These are his personal views and not do not represent those of his employer. Comments are welcome at firstname.lastname@example.org