DISCUSS WHY PRODUCTIVITY HAS INCREASED VERY SLOWLY IN

INDIA?
Vishnu K Venugopal

New Palgrave Dictionary of Economics defines Productivity as “some measure of output to

some index of input use.” The concept of productivity is widely used in Economics as some
measure of the state of technology that is used in the production of goods and services and
interpret the changes in the measure of productivity as changes in technology used or as a
shift in the production possibility frontier. The focus on economic growth as a policy concern
automatically leads to an obsession over productivity growth because it is the productivity
growth which can raise output growth more than proportionate to the growth in inputs
used in the production process. Economic growth depends both on the use of factors of
production such as labour and capital, the efficiency in resource use and technical progress.
This efficiency in resource use is often referred to as productivity. Productivity growth is
often understood as the route to improvement in standard of living and welfare through
appropriate redistributive policies. Many economists like Solow, Kendrick, Denison, Griliches
, Jorgenson and Timmer have made their contribution to the vast literature on productivity
measurement and interpretation.
The measurement of productivity has been subject to debates regarding the ideal measure
and what it represents. Total Factor Productivity (TFP) and Single/Partial Factor Productivity
are the commonly used measures of productivity.
The partial /single factor productivity is defined as the ratio of the volume of output (or
value added) to the quantity of factor of production for which productivity is to be
estimated (e.g., labour productivity or capital productivity or land productivity). The partial
factor productivity gives a distorted view of productivity because it is affected by changes in
composition of inputs. When capital-labour ratio is following an increasing trend, the
productivity of labour is overestimated and that of capital is underestimated. Despite these
limitations, the measure of labour productivity is crucial form welfare point of view.It is
argued that labour productivity measure is useful in measuring the savings achieved over
time in the use of input per unit of output (Kendrick, 1991). Balakrishnan(2004) argues that
labour productivity merits attention in its own right and serves as a measure of potential
consumption and its growth is necessary to for sustained increase in standard of living of
the population.
The alternative measure is Total Factor Productivity which has gained more acceptance
following the works of Abramovitz(1956) and Solow(1957). TFP measures the increase in
total output which is not accounted for by increase in total inputs. Kathuria, Raj and
Sen(2010) considers TFP as the broadest measure of productivity and efficiency in resource
use because it aims at decomposing the changes in production due to changes in quantity of
inputs used and changes in all the residual factors such as change in technology, capacity
utilisation ,quality of factors of production, learning by doing etc. Thus an increase in TFP
implies a decline in unit costs of production. There are a many measures for Total factor
Productivity. The two main techniques to measure TFP are frontier and non-frontier
approaches. These approaches are further subdivided into parametric and non-parametric
techniques. In the frontier approach the aim is to find the bounding function i.e., the best
obtainable positions given the inputs or the prices. Under frontier approach, TFP growth
rate has two components –outward shifts of the production function resulting from
technological progress, and technical efficiency related to movements towards the
production frontier. On the other hand, the non-frontier approach considers technological
progress as a measure of TFP growth rate. In parametric method an explicit functional form
is specified for the frontier and parameters are estimated econometrically using sample
data for inputs and output. In non-parametric technique it is parameter free and non-
functional form is assumed. But the problem with non-parametric approach is that no direct
statistical tests can be carried out to validate the estimates.
There has been numerous studies on the productivity growth in Indian economy especially
that of manufacturing sector. Much of the debates on productivity in India was focussed on
the methodology of productivity measurement and the limitations of the particular
methodology used. The only broad consensus that can be seen in these debates is regarding
the slow growth of productivity especially TFP in the manufacturing sector and other
sectors. There is a consensus regarding the decline in productivity growth in manufacturing
in the post-reforms decade and that it started improving in the next decade. Ahluwalia
(1991) discuss about marked acceleration in productivity growth in 1980s compared to
1970s. This finding had been criticised by Balakrishnan and Pushpangadan(1994) and
Pradhan and Barik(1998) on the grounds that Ahluwalia in her study had used single
deflation method of valued added and if double deflation method was used the findings
would have been reversed.Goldar(2002) then upholds the findings of Ahluwalia(1991) by
mentioning that it is the base year choice of deflation that lead to different findings when
double deflation method was used. The conflicting conclusions arrived at by various studies
regarding productivity growth in Indian manufacturing is because of the variety of
measurement issues such as use of single versus double deflation to construct estimates of
real growth in manufacturing value added(Goldar and Mitra,2004).Among the studies that
have analysed productivity trends in India’s organised manufacturing covering both pre and
post reform periods most have found a fall in the growth rate of TFP in the post reform
period.
Bosworth,Collins and Virmani(2007) performs a detailed growth accounting anlaysis to
understand the sources of economic growth and the role of productivity in it. Growth
accounting combines the production function with the assumption of competitive markets,
leading to the usage of income shares to measure the contribution of factor inputs. This
method focuses on identifying contributions of individual factor inputs and a residual,
typically called total factor productivity (TFP). Our analysis focuses on the periods de-
lineated by the survey benchmark years: 1960, 1973, 1983, 1993, 1999 and 2004 due to
concerns about India’s annual output data. We have argued that researchers should have a
reasonable degree of confidence in the GDP estimates for benchmark years. However, for
non-benchmark years, annual output data are based on interpolation and extrapolation of
the labor input data required to construct output measures for India’s large unorganized
sector. India’s output growth has doubled from just 3.3 percent per year during our initial
period of 1960-73, to over 6 percent per year during the past decade. In the initial period,
we find that growth can be fully attributed to increases in factor inputs – with nearly
twothirds accounted for by increased employment, and a third by increases in capital per
worker. Growth accelerated to 4.2 percent per year during the second sub-period, 1973-83.
Just over half of the gains are associated with TFP, and the remainder with employment.
The acceleration appears related to the green revolution, with gains accruing to both
increases in agricultural TFP and sectoral reallocation. Labor productivity declined in both
services and industry. There was a further, modest, acceleration of output growth, to 5
percent per year during 1983-93. This increase can all be attributed to increased TFP,
concentrated in services and industry. Output moderated somewhat during the most recent
period (1999- 2004) with growth slowing in all sectors, in part due to the severe drought.
Contributions from TFP and capital deepening slowed in both services and industry. Notably,
investment failed to keep up with the more rapid employment growth. The high
productivity growth in services sector seems to be puzzling because it is not confined to the
modern segment of service sector but it is broad based. So it might be because of
underestimation of services price inflation, particularly in the more traditional sectors.
Source: Bosworth,Collins and Virmani(2007)

Dougherty,Herd and Chalaux(2009) performs a study of factors that are holding back
manufacturing productivity in India. They note that resource shift out of low-productivity
agriculture into higher-productivity manufacturing boosts overall productivity in converging
economies. The major factors identified for slow growth in productivity in manufacturing
sector are:- Small scale of firms: The most dominant characteristic of India’s manufacturing
sector is the extraordinarily small scale of establishments relative to any OECD or major
emerging country when measured in terms of employment and output. About 87% of
manufacturing employment is in micro-enterprises of less than 10 employees, a smallness of
scale that is unmatched, with the closest comparator being Korea, where less than half of
employment is in micro-enterprises. While there is a fairly high share of very large
companies – making for a bimodal distribution – there are few enterprises of intermediate
size. The small scale of Indian industry arose in part by design: the pre-reform licensing
system meant that only one major company was allowed to operate in many industries,
while other industries were reserved (as “small-scale industries”). While these market entry
restrictions have been largely dismantled, their legacy continues to reduce competition,
scale and productivity in many sectors. In addition, other regulations persist, notably those
related to labour and administrative approvals, which also constrain firms’ growth. Given
the relatively small size of many manufacturing firms, India is reaping far smaller gains from
scale economies than many other countries. Larger establishments often use newer
technologies and thus achieve higher productivity, while smaller establishments are much
less productive. Even after controlling for technology, industry, region and firms’ age, total
factor productivity (TFP) is about twice as high in firms with more than 250 employees than
in those with only up to 10 employees. High capital intensity: While firms in India have
remained small, a large share of India’s manufacturing has been in sectors that usually
require a larger scale of production. Moreover, production has tended to be particularly
capital-intensive, with the labour share in value added at about a quarter and falling,
compared with a share of nearly two-thirds in many OECD countries. Such a pattern of
production appears out of line with revealed comparative advantage (RCA) estimates that
show less comparative advantage in skill-based industries relative to China.
Exit of inefficient firms: Most studies find a limited impact of firm exits on productivity.
Consistent with this observation, the exit/hazard rates for large industrial firms are very low,
at 3% per year for quoted corporations (from Prowess firm data) – many times smaller than
in nearly all OECD economies and most other developing countries. This low exit rate
reflects the great difficulty of closing a business in India where there is no bankruptcy code,
and prior permission of the government is required before laying off workers. Topalova
(2004), using a firm-level panel dataset from 1989 to 2001. She found that a 10% decrease
in tariffs resulted in a ½ per cent increase in TFP. Again, the gains accrue within existing
firms rather than as result of the demise of unproductive firms, as exit rates are extremely
low. Migration and labour mobility: Labour is highly immobile across states in India as a
whole, as well, impeding reallocation of human resources. Almost half of the migrants
across states are women moving for marriage while less than 10% move to find new
employment. The bulk of internal migration in India is short-distance, with 60% of the stock
of migrants changing their residence within the district of enumeration, over 20% outside
the district but within the state of enumeration and only 13% moving across state
boundaries. State ownership: Industries dominated by public-sector firms appear not to have
seen the same gains in efficiency as a result of foreign competition. The profitability of
public manufacturing firms have risen this decade, but the share of their operating surplus
in net value-added remains below that of private sector companies and the rate of return
on capital is even lower as public-sector firms tend to be more capital-intensive. Efficiency
may also be adversely affected in a limited number of industries due to very high
concentration and the presence of dominant public-sector firms.
Goldar and Kumari(2003) acknowledges that import liberalisation should have positive
impact on the productivity of manufacturing sector firms while in reality the TFP in
manufacturing declined in the post-reforms decade compared to the pre-reforms decade.
They attribute this decline to the decline in capacity utilisation rate. While the investment
boom of mid 1990sraised production capacities substantially, demand didn’t rise which led
to capacity underutilisation. The underutilization of capacity manifested itself first in
consumer durable and nondurable goods industries and then in capital goods and
intermediate goods industries (Uchikawa, 2002).The fact that capacity utilization in
industries was growing in the 1980s and falling in the 1990s can explain most the observed
difference in the growth rate of TFP between the two period.
Hashim,Kumar and Virmani(2009) uses a growth accounting approach tries to analyse the
impact of trade liberalisation on productivity. The BOP crisis that started in 1990 and
impacted the economy severely in 1991 had its greatest impact on the manufactured sector.
The manufacturing sector was also the one most directly affected by the trade and
exchange reforms of the 1990s. Thus the J curve hypothesis (Virmani,2005) is most relevant
for the path of TFPG in this sector. TFPG growth decelerated in the first sub-period because
of the combined effects of the BOP shock and the J curve effect arising from the dramatic
import liberalization (removal of QRs on capital goods and intermediates and tariff
reduction) and exchange rate reforms of the early 1990s (from fixed rate to managed float).
With the completion of the liberalization in the late nineties-early 2000s (removal of QRs on
consumer goods and further reduction in import duties), rendered certain types of capital
obsolescent, measured TFPG growth therefore became negative 0.14 % during the second
sub-period. As the dissemination of new technologies and products progressed from early
adopters to others, TFPG accelerated sharply during the third sub-period to 1.9% per
annum, almost 50% higher than the TFPG during the 1980s.
Conclusion
From the analysis of previous studies we can conclude that the growth of productivity in
manufacturing sector has been slow. Many studies came up with conflicting conclusions due
to differences in methodology. Broadly we can identify that the factors like restricted
resource reallocation across sectors, small scale of manufacturing firms, poor exit rate, high
capital intensity, poor capacity utilisation rate etc are the factors that have impeded the
faster growth of productivity in Indian economy. The agricultural sector still employing a
major proportion of work force while having lower productivity need to be looked at with
concern. The labour reallocation from agriculture to more productive sectors can help in
raising the productivity of Indian economy.

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