J-Curve of Productivity and Growth: Indian Manufacturing Post-Liberalization By Arvind Virmani and Danish A. Hashim, IMF Working Paper
The Indian economy’s growth rate surged in the 1980s, after the first attempts at liberalizing the economy, but the major reforms of the 1990s did very little to add to growth during that decade. That is a paradox economists have been hard put to explain.
There is a similar conundrum in the Indian manufacturing sector, where several studies have found that productivity growth in the 1990s was lower than in the 1980s. Surely the unshackling of Indian industry from the licence-permit raj should have resulted in higher productivity? Could it be that it took some time for the productivity improvements to happen? Are we on an S-shaped learning curve, where the initial improvements fizzle out after reaching a threshold? Arvind Virmani and Danish A. Hashim provide answers to these questions.
The authors find that total factor productivity (defined as the variable that accounts for the effect on total output not caused by inputs, or a measure of higher efficiency) in Indian manufacturing was 0.61% per annum during the period 1981-82 to 1990-91, dipped to 0.25% per annum during 1991-92 to 1997-98, went down further to -0.09% per year during 1998-99 to 2001-02 and then expanded sharply to 1.41% per year between 2002-03 and 2007-08. The growth of productivity in manufacturing, therefore, follows a J-curve pattern, slowing down in the initial years after liberalization, but picking up steam later.
Why is the curve J-shaped? Virmani and Hashim say that total factor productivity growth was slow during the early and mid-1990s because of the dramatic import liberalization, the balance of payments deterioration and the exchange rate reform, all of which came as a shock to industry. Moreover, with the removal of import restrictions on consumer goods, certain types of capital goods were rendered obsolescent, which led to lower capacity utilization in the late 1990s and early 2000s, and even lower productivity. As firms learned to cope and the benefit of new technologies and products became widespread, productivity improved dramatically from the mid-2000s.
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But the story is by no means uniform across sectors. In food products and beverages, chemicals and chemical products, rubber and plastic products, and in basic metals, total factor productivity during 2002-03 to 2007-08 was lower than in the 1980s. In the machinery and equipment sector, in electrical machinery and in fabricated metal products, productivity was higher in the 1990s than in the 2000s, which suggests that their growth curve is S-shaped. In automobiles, where the technology gap was high before liberalization, productivity growth has been very strong. Of the 22 manufacturing sub-sectors studied in this paper, eight followed a J-curve pattern, 10 a hybrid J-cum-S curve, while for three sectors growth was S-shaped. And, one shows continuous decline in productivity.
The differences among industries are to be expected, as reforms were carried out piecemeal rather than in one big bang.
Much also depends on whether the sector was dominated by the public sector before liberalization. Efficiency in the private sector being higher, allowing the entry of private players would have led to increased productivity for the sector as a whole. On the other hand, some industries that enjoyed protection earlier may not be viable at all in an open economy and will show consistently declining productivity.
While the study does account for the initial fall in productivity after liberalization, it leaves the big question unanswered. Now that the jump in productivity has occurred, will we see a levelling off? In other words, is the J in danger of becoming an S?
Illustration by Jayachandran/Mint
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