India must raise productivity for sustainable and inclusive growth

While India’s manufacturing productivity growth is at 5.7%, the sector is notable for its low returns, which explains why it attracts a relatively low share of capital. (Photo: Mint)
While India’s manufacturing productivity growth is at 5.7%, the sector is notable for its low returns, which explains why it attracts a relatively low share of capital. (Photo: Mint)


  • We must focus on improving manufacturing processes and capital expenditure deployment to increase productivity. Quick digitization of supply chains and operations can earn significant benefits for companies.

Productivity is not everything," economist Paul Krugman famously commented, “but in the long run, it’s almost everything." Higher productivity is essential for India to create good jobs and improve quality of life. It is through productivity too that the economy can generate the wealth that government can use to invest in social welfare and environmental progress. Higher productivity is essential to fuel India’s journey towards sustainable and inclusive growth.

It is good news then that India’s productivity has risen an average of 5.6% a year since 1997, according to recent research by the McKinsey Global Institute (MGI), more than twice the global average of 2.3%. Only China was faster. To put it another way, India’s gross domestic product (GDP) per worker rose from $6,200 in 1997 to $21,800 in 2022. The challenge is to keep it up, or preferably, do even better. This cannot be taken for granted.

One big issue is investment, or capital formation. MGI estimates that 70% of India’s productivity improvement is explained by growth in capital per worker, a figure that almost quadrupled from 1997 to 2022. And yet, at about $38,000, India’s capital stock per worker is still less than half that of China and a third of the level of Central and Eastern Europe.

Also read: States have a large role in ensuring capital formation

Another way to look at this is how well Indian companies use their capital. Again, the conclusion is that they could do better. A McKinsey analysis of India’s 1,000 biggest public companies found that only 56% earned a return on invested capital (ROIC) greater than the weighted average cost of capital (WACC) in 2023. 

That is more than in 2014, when it was 43%, which is one reason why the capital intensity ratio has risen over this period. The trend is encouraging. Still, the fact that more than four out of 10 companies are not creating enduring value is sobering.

And it is troubling that ROIC has declined in recent years, from an average of 11.3% in the period 2009-13 to 10.2% in 2019-23; that is slightly less than the WACC. Net profit margins also declined over the same period, from 8.4% to 7%. At best then, on average, the top 1,000 Indian corporates are just about breaking even on the shareholder expectations of return and on WACC.

It’s important to note that some sectors (software, pharmaceuticals and automotive) have done much better than others (apparel and energy). It’s also true that 1,000 companies form only a subset of the Indian economy. But it is a critical subset, accounting for more than 90% of India’s market capitalization and about half of the corporate revenue as a percentage of GDP. And the ROIC performance for mid- and-small companies is worse.

What do all these numbers add up to say? Without improving ROIC, capital formation will falter. And without improved capital formation, India cannot achieve its productivity potential. In short, India needs to improve how it deploys capital. This is urgent, considering that most of India’s infrastructure and factories are still to be built, industry by industry, over the next couple of decades.

At the same time, while India’s manufacturing productivity growth is also high, at 5.7%, the sector is notable for its low returns, which explains why it attracts a relatively low share of capital. That also helps explain why the sector accounts for only about 12% of employment, just one percentage point more than in 1997. In other high-productivity-growth countries such as China, Poland and Vietnam, the figure is around 20%. This is an opportunity to be seized.

McKinsey estimates that manufacturing could generate more than $1 trillion of GDP by 2030, or double the figure of 2020, and provide a significant share of the well-paid jobs needed for the many people leaving farms. One approach to consider is building manufacturing clusters near ports, with free-trade warehousing zones, faster approval processes and more flexible labour laws.

Improving manufacturing processes and capital expenditure deployment could increase productivity three to five times. Smart project planning, procurement and design could improve capital productivity alone by 20-25%—a number that would translate into jobs and competitiveness. For example, building a lithium-ion cell gigafactory can cost anywhere from $55 million to $90 million per gigawatt hour. That large range shows that there is efficiency to be captured through benchmarking and project execution.

Companies that rapidly digitize their supply chains and operations can earn significant benefits: Greater throughput and quality, less wastage and better collaboration among workers, companies and supply-chain partners. Investing in centres of excellence and digital capabilities could reduce operational costs by 15-25%.

Another productivity opportunity for Indian manufacturers is to make higher-value goods, adopt better packaging and address markets with stronger brands. Food processing, capital goods, steel and steel products are areas of high potential. Such efforts can be instituted without massive investment; indeed, higher profits and ROIC mean that these companies could reinvest their capital surpluses rather than seek external investment.

Also read: Industrial policy is back with a vengeance everywhere

India’s productivity record since 1997 is strong. The challenge is to build on this momentum. There is considerable room for improvement to create sustainable and inclusive growth for the many millions who have not yet benefited from our remarkable progress.

Nikhil Malhotra contributed to the article.

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