Ijser 5 3 005

International Journal of Social and Economic Research Vol. 5, No.
3 (July – Sept) 2015

Doi: 10.5958/2249‐6270.2015.00041.0
5.Nexus between Total Factor Productivity Growth of Manufacturing
Sector, Growth Rate of Output and Exchange Rate: Does Exchange Rate
Play a Significant Role?
Nilesh A. Pandya
Senior Lecturer, Amity Global Business School, Ahmedabad
And
Dr. Ashir S. Mehta
Associate Professor
Department of Economics, The M.S. University of Baroda, Vadodara.
Abstract
Downloaded From IP - 122.180.105.90 on dated 25-Mar-2016
Using Indian organised manufacturing data to investigate whether exchange rate

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depreciation resulted in an acceleration in productivity growthand output growth of the

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manufacturing sector. This paper presents a set of estimates of TFP growth in Indian
manufacturing in the last three and half decades, which have largely been made following
the methodology of input and output measurement by Tourniquet Productivity index. The
paper run Granger causality test among three variables, namely, total factor productivity,
growth rate of output and real effective exchange rate. This paper documents the evidence
of exchange rate play a significant role to increase the industrial total factor productivity as
well as industrial production.
I: Introduction
“Movement of productivity” has been both curiosity and concern for development
economists and policy makers. The realization of productivity growth 1 in the industrial
sector continues to drive the overall economic performance of the Indian economy. The
Indian economy has witnessed more than two decades of wide ranging economic
liberalization surrounding many sectors. In order to make India’s industrial sectors; both,
internally efficient and globally competitive, liberalization of international trade and
industrial policies was endeavored. Encouraging results have been seen in the industrial

1
Measurement and analysis of productivity is being researched more and more along with productivity growth
due to increased application of factor inputs, within the foundation pioneered by Solow (1957).
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International Journal of Social and Economic Research Vol. 5, No. 3 (July – Sept) 2015

productivity performance; from a turnaround in the mid-1980s to improved performance in
the 1990s (Alhuwalia, 1991). Cost and price-competitiveness of companies and industries
of a country are determined by productivity, among other major factors. This subsequently
influences the competitive strength of global market exports by these companies and
industries. As per this concern, to make the manufacturing sector vigorous, every effort is
put into enhancing India’s productivity performance in broad industrial sectors. Monetary
and exchange rate policy behaviors cannot be decided independent of the economy’s
productivity performance. Magnitude and direction related questions still exist within
estimates of productivity growth. For the aforementioned reasons, it is important to
measure both, the levels of productivity and its growth rate.Although it is widely
acknowledged that exchange rate, particularly through manufactured components, play an
important role as a potential source of productivity growth, the relationship between
exchange rate and productivity growth is still ongoing.

Before the trade liberalization policies of 1991, Indian industries failed to compete in the
global market due to uneven resource allocation by government policies such as high
custom tariff rates, domestic trade tax and excise duty structure, reservation of production
etc. These misleading trade policies and tax strategies of the Government caused shutting
down of India’s industries through limitation of productivity in Indian manufacturing sector
and buckling under pressure of normal competitive market forces. The phase of
industrialization starting after Indian Government’s 1991 policy of trade liberalization; has
changed the situation, slowly boosting productivity. In order to make the Indian industrial
sector a strong competitor in the international market, various positive alterations have
been made in technology-import policy and foreign direct investment policy.
Following the reforms of 1990s, the Indian economy has enjoyed a strong growth with the
average annual growth exceeding 8 per cent since 2003. Even amidst the global slowdown,
its real GDP grew by 8.8 percent in 2010. Indian industry accounts for 26% of GDP and
employs 22% of the total workforce. According to the World Bank, India's industrial
manufacturing GDP output in 2012 was 10th largest in the world on current US dollar basis
54


($239.5 billion), and 9th largest on inflation adjusted constant 2005 US dollar basis ($197.1
billion). Unlike the experience of other developing countries, the industrial sector does not
appear to be the core of India’s growth dynamics. Although the industrial sector’s
contribution to total output remained more or less the same, this does not imply that the
sector did not contribute to the growth process. In fact, it grew fast but not as fast as the
services sector. From 2000-01 to 2010-11, agriculture grew on an average 2.2 per cent
annually, industrial sector at a rate of 7.7 per cent and services sector at a rate of 8.7 per
cent (Banga and Das 2012).
After two consecutive years of moderation, GDP growth improved marginally in 2013-14
due to a rebound in the growth of ‘agriculture and allied activities’ and electricity, besides
buoyant activity in ‘financing, insurance, real estate and business services’. While the value
added in mining and manufacturing contracted, services sector growth remained

unchanged. The low overall growth reflected contracting fixed investment and slowing
consumption, though there was an improvement in export growth aided by rupee

depreciation and contraction in imports due to subdued demand conditions and policies to
dissuade gold imports. In 2013-14, the Indian manufacturing sector has shown a mixed
performance with increasing FDI inflows and exports, offset by declining manufacturing
output. Total FDI inflows in manufacturing sector increased by 24.5 percent to reach to $
7,458 billion in 2013-14. Also, the manufacturing sector exports increased by five per cent
to $192.2 billion in 2013-14 contributing 61.5 per cent to the total exports of India and
financial year 2014-15, contribution of the manufacturing sector in total export increase to
65.8 per cent. Despite increased exports and government initiatives, contribution of the
manufacturing sector in GDP declined by 0.7 per cent compared to 2012-13.
Effect of Trade Liberalization on Industrial Productivity
Positive effect of trade liberalization on Industrial Productivity can occur through various
means:
55


I. Trade liberalization leads to cheaper imported capital goods which helps
enhance technology and also allow allocation of labour compared to invested
capital. The firms will have better opportunity for utilizing imported goods as
well as intermediate inputs. Improved TFPG will lead to improvement of
productivity performance of the industrial firms;
II. Lowering of tariffs will provide industrial firms cheaper availability of
intermediate inputs, which will enable them to improve their productivity
performance;
III. Greater availability of imported intermediate goods will enable the firms to
exploit better the productivity enhancing potential of imported technology;
IV. Effective use of resources will be encouraged with the advent of domestic and
global competition. As a consequence, efficient management, labour utilization,
capacity building and organized production will result.

V. Competition will also lead to shutting down of inefficient industries giving way
to the firms that use their resources appropriately.

VI. As the competitive business environment forces inefficient firms to close down,
the average level of efficiency of various industries should improve;
The rest of the paper is organized as follows. Section II contains a literature review. Section
III outlines a theoretical framework for the empirical analysis and the database for the
variables used to calculate the total factor productivity indexes, growth rate of output and
REER are discussed. The empirical findings of the TFP, GRO and REER is provided in
section IV. Finally, section V offers some concluding remarks and possible extensions of
the current work.
II: Literature Review
Ahluwalia’s (1991) extensive study attempts to analyse the long-term trends in total factor
and partial factor productivities in the organized manufacturing sector in India over the
period from 1959-60 to 1985-86. Ahluwalia, in her 1991 study on productivity and growth
in Indian manufacturing, came to the conclusion that there was a marked acceleration in
56


total factor productivity growth (TFPG) in Indian manufacturing in the 1980s. According to
her estimates, the growth rate of TFP in Indian manufacturing was 3.4 per cent per annum
in the period 1980-81 to 1985-86, as against an estimated growth rate of -0.3 per cent per
annum for the period 1965 to 1979-80. Her estimates of TFP growth rate were based on the
single-deflated value added method, Balakrishnan and Pushpangadan (1994) and Rao
(1996) have pointed out the inadequacies of TFP estimates based on the single-deflated
value added measure of output, and have given strong arguments for using the double-
deflated value added method or the gross output function framework.
Dholakia and Dholakia (1994) found fault on a number of points in the empirical exercise
reported by Balakrishnan and Pushpangadan, e.g. (1) the study is based on the ASI data,
but remains silent on the adjustments for the non-reporting units; (2) presence of
aggregation bias in using weights from input-output transaction table which is further
aggregated to form 19 input groups that may distort the results; (3) while the Balakrishnan
and Pushpangadan study considers at best a large part of the registered manufacturing
sector only, the I-O table is based on the inputs and outputs of entire manufacturing sector
which can introduce significant biases and distort the deflator used, etc. They have
identified 19 input groups as the components of the overall material input for the organised
manufacturing sector and have obtained their respective weights from the input-output
transactions matrix prepared by the CSO for the reference year 1973-74 by reclassifying
various categories into these 19 groups but as we have seen input-output transaction matrix,
different industries using different types of material input so 19 input groups is a very small
group to using weight in deflating the material input.
A study by Balakrishnan et. al. (1998) investigates the trend in productivity growth by
adopting two approaches i.e. growth accounting as well as econometrics, two equally
mainstream approaches for estimation which may yield significantly different results. They
used a sample of 2300 firms and 11009 observations, spanning the period 1988-89 to 1997-
98 and found no evidence of acceleration in productivity growth since the post reform
period but this study observed a shift in productivity growth from the year 1991-92 to
1997-98. However, this period is too short for investigating the impact of trade
57


liberalization on productivity of manufacturing sector. Krishna and Mitra (1998) in their
study covering four Indian industries found that in the post-reform period, markup declined
significantly in three of the four industries, using the structural regression approach of Hall
to study the effect of economic reforms on markups in Indian industries and employing a
post-reform dummy variable.
A relatively slow growth in TFP in Indian manufacturing in the post-reform period, as

compared to the pre-reform period, has also been reported in a study undertaken recently
by the Goldar and Kumari (2002) major industry groups for the period 1981-82 to 1997-98.
This study has focused on the impact of trade reform on productivity growth of Indian
manufacturing sector. Chand and Sen (2002) in their studies found the effect of trade
liberalization on the TFPG in Indian manufacturing using panel data on 30 industries which
accounted for 53 percent of gross value added and 45 percent of employment in

manufacturing over this period over 1973-74 to 1988-89.

A study by Goldar and Kumari (2002) on productivity and import liberalization, using
industry level data from Annual Survey of Industries (ASI) and incorporating some trade –
related variables explicitly into the econometric analysis, estimates that there was
substantial liberalization of imports in India in the 1990s under the economic reforms
programme. Since the Goldar and Kumari study takes only a seven years period, the
results/impact may not be reliable or conclusive.
Ghose and Biswas (2009) in their study tried to explain the intra-industrial differences in
TFPG, considering the effect of real effective exchange rate along with some other trade-
related variables and also some other determinants of TFPG, bearing in mind that the effect
of real effective exchange rate on a specific industry group will jointly depend on
movement of trade related variables and industrial characteristics of that particular industry
group.
Harris (2000) argued that, within a macroeconomic framework, productivity treat as an
endogenous variable, in which the exchange rate regime is either fixed or floating. The
competitiveness approach highlights that real exchange rate depreciations accelerate
58


productivity growth in certain circumstances. Richard Harris (2001) gave evidence for
panel model that supports the competitiveness view of the positive short run effects of
exchange rate depreciation on productivity i.e. in the short run the results are consistent
with the competitiveness hypothesis which suggests that exchange rate depreciations boost
productivity growth in the short run and the long term negative supply consequence as a of
undervalued exchange rates affects productivity growth i.e. real exchange rate depreciation
have negative consequences for long term productivity growth.
Parida, Kamaiah and Mathiyazhagan (2001) study the effects of productivity differences in
the traded and non-traded sectors 2 on real exchange rate in the context of India and Japan
during the period of 1974 to 1998. By applying the cointegration technique, the study
concludes that in addition to the unit labour costs differentials, the differences in
productivity in the traded and non-traded sectors have a stable long-run equilibrium
relationship with real exchange rate. The results support the B-L hypothesis in the
framework of India. Drawback of the study is they are not included many traded goods in
the traded sector for the analysis.
In the McLeod and Mileva (2011) study, estimates country fixed effects panel model of
TFP growth on the real effective exchange rate and several standard control variables for
58 developing countries for the period 1975 - 2004. According to the country fixed effects
panel data estimates, 10% depreciation of the real exchange is associated with a 0.2%
increase in the average annual TFP growth rate. Hsieh (1982) explaindeviations of
exchange rates from purchasing power parity with the differences between countries of the
comparative growth rates of labor productivity between traded and nontraded sectors. He
finds that the price gap between traded and nontraded goods in Japan with an extraordinary
productivity growth in the Japanese traded goods sector.
Ray (2012), in her study assesses the impact of various determinants that affect total factor
productivity growth in seventeen manufacturing industries during the period of 1980-81 to

2
They take manufacturing goods were consider as traded goods and non-manufacturing goods are treated as
non-traded goods.
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2001-02. In her analysis, she found trade variables as well as macro-economic variables
have relevant significant impact on TFPG of those industries.
III: Research Methodology
The Translog Index of Total Factor Productivity (TFP) is a discrete approximation to the
Divisia Index of Technical Change. Translog Index Number is symmetric in data of
different time periods and also satisfies the factor reversal test approximately. The
Tornqvist index of TFP has been used for the TFP estimates presented in the study, as done
earlier by Alhuwalia (1991), Rao (1996), Pradhan and Barik (1998) Das (2003), Goldar and
Kumari (2003), Goldar (2004), Das and Kalita (2009) Das et.al. (2010) and Virmani &
Hashim (2011). The Tornqvist index of TFP has been used for the measurement of TFP
and the methodology assume perfect competition and constant returns to scale, further, the
revenue share of the factor inputs sum to unity. This study concentrates on individual
industry productivity rather than aggregate productivity. Consider an aggregate production

function with four factor of production.
Y = F (L, K, R, E, T) Equation (1)
Where, ‘Y’ denotes aggregate output, ‘L’ denotes labour input ‘K’ denotes capital input,
‘M’ denote consumption of raw material, ‘E’ denote energy input and ‘T’ denote time. It is
assumed that ‘F’ characterized by constant return to scale. These aggregates are taken as
function of their components.
Assuming the condition of competitive equilibrium, the above mention Translog

production function that is equation (1) can be used to derive the Translog measure of Total
Factor Productivity Growth.
Ln =
Equation (2)
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Causality Test between Total Factor Productivity, Growth Rate of Output and Real
Effective Exchange Rate
As mentioned before, the purpose of this study is to establish if the real effective exchange
rate influences in any way the total factor productivity and growth rate of output of
manufacturing industry or if total factor productivity has an impact on the real effective
exchange rate and growth rate of output or growth rate of output has an impact on the real
effective exchange rate and total factor productivity. In order to empirically do this, a series
of tests will be used. These tests are described in the following in the order they are
employed.
The first step is to examine the time-series property of stationarity. To do this the
Augmented Dickey-Fuller (1979) unit-root test will be used with the null hypothesis of
non-stationarity i.e. existence of unit-root. In addition to the regular ADF test I will use the
Elder & Kennedy strategy, 3 in which a trend component and an intercept will be included.
In case one or more of the series is not stationary it will be further tested to check if there is
a stochastic or deterministic trend. In the augmented Dickey-Fuller test it is assumed that
the error terms (εt) are correlated and the main principle of the test is that it is conducted by
augmenting the Dickey-Fuller test using k lags of the dependable variable. The model can
be written as:
ΔYt = α + β t + γ Yt – 1 + δi∑δ t–i+ εt
Where αis a constant, β is the coefficient on a time trend, k is the lag of order of the auto-
regressive process and εtis a pure white noise error term. The numeric value of kis
determined using Akaike Information Criterion.

3
Elder and Kennedy (2001) present a simple testing strategy that avoids double and triple testing for the unit
root that can occur with other testing strategies, and discusses how to use prior knowledge about the existence
or not of long-run growth (or shrinkage) in variable.
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When testing for unit roots it is necessary to have a testing strategy. In this study the Elder
and Kennedy strategy will be employed. Moreover this strategy rules out some types of
unrealistic or implausible outcomes for economic time-series processes such as the co-
existence of a unit root and a deterministic trend. The null hypothesis of this test is that a
unit-root exists, meaning that γ= 0. The alternative hypothesis is that no unit-root exists in
the series which implies γ < 0. If the test statistic is less than the critical value then the null
hypothesis is rejected, no unit root is present and the time-series is stationary.
In case that all the variables are integrated of the same order a cointegration test should be
used in order to check if any cointegrating relationship exists between the variables.
Because the variables utilized in this study have different integration orders, it is not
necessary to apply this test.

Since the purpose of this study is to analyze aspects of the relationships between real
effective exchange rate influences in any way the total factor productivity and growth rate
of output of manufacturing industry, the multi-variate Vector Autoregressive (VAR) model
is appropriate to use since it represents the correlations among a set of variables. The first
step in estimating a bivariate VAR model is to determine the optimal lag-length order. In
order to do so I employed the Akaike Information Criterion. Even though we have used
AIC and SC to aid in the choice of lag length, we have estimated the model using several
different lag structures to ensure that results are not sensitive to the choice of the lag
length.The general formula that is going to be used for the multi-variate VAR (k) model is
as follows:
TFPt = c1 + α11TFPt – 1 + α12TFPt – 2 +…..+α1kTFPt – k + β11 GROt – 1 + β12 GROt – 2+…..+ β1k
GROt – k + δ11 REERt – 1 + δ12 REERt – 2 +…..+ δ1k REERt – k + ε1t

Equation (3)
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GROt = c2 + α21TFPt – 1 + α22TFPt – 2 +…..+α2kTFPt – k + β21 GROt – 1 + β22 GROt – 2+…..+
β2k GROt – k + δ21 REERt – 1 + δ22 REERt – 2 +…..+ δ2k REERt – k + ε2t
Equation (4)
REERt = c3 + α31TFPt – 1 + α32TFPt – 2 +…..+α3kTFPt – k + β31 GROt – 1 + β32 GROt – 2+…..+
β3k GROt – k + δ31 REERt – 1 + δ32 REERt – 2 +…..+ δ3k REERt – k + ε3tEquation (5)
Where k is the order of the VAR, a is the constant term, ε is an error term, TFP is Total
Factor Productivity of manufacturing sector, GRO is the Growth Rate of Output and REER
is the Real Effective Exchange Rate in India. The model above explains the relationship
between the real exchange rate and one of the four proxies for economic growth.
After estimating the model we need to make sure the residuals are white noise. If there is
white noise, the residuals are completely randomly scattered with no systematic pattern
which means that the model is correctly specified and the residuals do not include any
information that is not included in the regression. To establish if the residuals are white
noise the proper-ties of autocorrelation and normality are tested.
To examine if there is autocorrelation the Breusch-Godfrey serial correlation Lagrange

multi-plier test is used. The test will establish if there is any autocorrelation in the errors of
the regression model. The null hypothesis is that there is no serial correlation of any order
up to the specified number of lags and the alternative hypothesis states that there is
autocorrelation be-tween the residuals.
In order to see if the residuals are normally distributed the Jarque-Bera normality test is
employed. It tests whether the data has skewness and kurtosis matching a normal
distribution. The null hypothesis is a joint hypothesis of the skewness being zero and the
excess kurtosis being also zero, in other words the null hypothesis states that the data
follows a normal distribution. Of course, the alternative hypothesis is that the sample data
does not follow a normal distribution.
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The next step after estimating the models and checking the residuals is to test the direction
of the causality using Granger causality test (Granger, 1969). By doing so, the relationship
between the variables when they are causing each other can be observed. When we run the
Granger causality test, there are four possible outcome can be anticipate (Gujarati, 2004) 4 .
Yearly data have been used for analyzing causality between Growth Rate of Output, Total
Factor Productivity Growth and Real Effective Exchange Rate. To begin with, we convert
them into natural logarithmic form for reducing variations in them.
Then five different criteria viz. LR (Sequential modified Likelihood Ratio test statistic
(each test at 5% level), FPE (Final Prediction Error), AIC (Akaike Information Criterion),
SC (Schwarz Information Criterion) and HQ (Hannan-Quinn Information Criterion) have
been used to select the appropriate lag order. For the lag order thus selected, pairwise
Granger Causality test has been performed with a pair of Null Hypotheses viz. REER does
not Granger cause GRO, GRO does not Granger cause TFP, TFP does not Granger cause
REER and other way around. This analysis is carried out for three time period- 1975-76 to
1990-91, 1990-91 to 2012 and 1975-76 to 2011-12. The study follows the construction of
variables on the basis of Deb Kusum Das (2003) who analysed Total Factor Productivity
Growth. The data is obtained from Annual Survey of Industries. Depending upon the
values of F-statistic and the associated significance levels, appropriate conclusions are
drawn. The entire data analysis was done using the software ‘E-views 7.0’
IV: Empirical Finding: Granger Causality Test:
Pearl defines “Causality” as the relationship between cause and effect. Basically, the term
‘causality’ suggests a cause and effect relationship between two sets of variables, say, Y
and X. Recent advances in graphical models and the logic of causation have given rise to
new ways in which scientists analyze cause-effect relationships (Awe, 2012). Prior to
testing causality, testing for order of integration for each variable is necessary. The unit

4
For more detail of Granger Causality Test and four possibilities of the results, read “Basic Econometrics” by
Damodar N. Gujarati, The McGraw-Hill Companies, Inc., New York.
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root test is used to detect the stationarity of the three variables under study. The test is
undertaken for two rational reasons. First, to avoid the problem of spurious regression.
Second, a basic assumption underlying the application of causality test is that the time
series in question should be stationary. In order to implement this test the Augmented
Dickey–Fuller test is applied to detect the stationarity of the three variables.
Tests for Stationarity (Unit Root Tests)
The tests for unit roots are closely related to the investigation of stationarity in a time
series. Unit root test like Augmented Dickey-Fuller (ADF) is employed to detect the
stationarity of the three variables. The test is undertaken for two rational reasons. First, to
avoid the problem of spurious regression. Second, a basic assumption underlying the
application of causality test is that the time series in question should be stationary. The test
is applied to both the original of the data and to the first differences of the data. Further,
both the models with intercept, with intercept and trend and with no intercept are
attempted.
If the absolute value of the calculated t-statisticsexceeds the absolute critical value, then the
null hypothesis that the level of the series is not stationary must be rejected and accept the
alternative hypothesis i.e. series is stationary. If the calculated t-statistics is less than the
critical value, the null hypothesis of unit root cannot be rejected. It implies that the time
series is non-stationary at the level and therefore it requires taking first or higher order
difference of the level data to establish stationarity. The truncation lag parameters are
determined following Schwarz procedure. Total period is divide into three phases: (i) 1975
to 1990 (Pre-liberalization period), (ii) 1991 to 2012 (Post-Liberalization period) and (iii)
1975-76 to 2011-12. The results are reported in Table 1 to 3.
Table: 1 - Augmented Dickey-Fuller unit-root test results

Period of Study: 1975 to 1990 (Pre Liberalization Period)
Variables t - Statistics
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Intercept and
Intercept No Intercept
Trend
Levels
Growth Rate Output -5.569736 -5.290296 * -0.914922
Real Effective Exchange Rate * -0.470773 * -0.963997 * -1.930881
Total Factor Productivity Growth * 0.891772 * -1.66356 6.989629
1st Difference
Growth Rate Output -3.245082 -3.972006 -3.446313
Real Effective Exchange Rate -3.216644 -5.337596 -3.090369
Total Factor Productivity Growth -3.547225 -3.84351 -1.987916
*denotes that the null hypothesis of unit-root could not be rejected at the 5% and 10% significance level.
The choice of optimum lag for the ADF test was decided on the basis of minimizing the Schwarz Information
Criterion.
Source: Compiled by the authors.

Period of Study: 1991 to 2012 (Post Liberalization Period)
t - Statistics
Variables Intercept and
Trend
Levels
Real Effective Exchange Rate * -1.779694 -4.403376 * -0.138849
Total Factor Productivity Growth * 0.36767 * -1.786913 6.592878
1st Difference
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Criterion.
Period of Study: 1975 to 2012
t - Statistics
Variables Intercept and
Trend
Levels
Real Effective Exchange Rate * -1.966573 * -0.955503 * -1.44324
Total Factor Productivity Growth -6.054984 -6.151405 * -0.821495

1st Difference

Criterion.
Unit-root test results
The results of the Augmented Dickey-Fuller test suggest that all of the series (GRO, REER
and TFP) are not stationary - hence they are integrated of order zero I(0). As we see from
the Table 1 (1976 to 1990) indicates the values of the t-statistic obtained for each time-
series both in level and in first difference, when we run ADF unit root test with no
intercept, results show series is not stationary in case of GRO. The REER series is non-
stationary in all the cases and TFPG time series is non-stationary with intercept and
intercept with trend. But present study takes the first difference I(1) of all the time series
data, all the series are stationary which is shown in table 1.
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Table 2 (1991-2012), GRO series with no intercept is non-stationary at I(0), REER series is
non-stationary at intercept and no intercept and TFPG series is non-stationary at intercept
as well as intercept with trend. As time series of all variables after 1991, if they are
converted into first difference I(1), all series are stationary. Table 3 (1976 to 2012), results
shows with no intercept all the time series data are non-stationary and the series REER is
non-stationary in all the cases. Here also first difference I(1) is use to convert all non-
stationary series to stationary series.
In the multi-variate VAR models that are going to be estimated further in this research all
the variables will be taken in their first difference. Selecting an optimal lag cab be arbitrary
since different criteria do not always suggest one and only one optimal lag. The Granger-
causality test is very sensitive to the number of lags included in the model, in order to
determine the optimal lag length the sequential modified LR test statistic (LR), Final
Prediction Error (FPE), Akaike Information Criterion (AIC), Schwarz-information

Criterion (SC) and Hannan-Quinn Information Criterion (HQ) will be employed. The
values and their significance level of VAR lag length order selection criteria are presented
in following tables. The three most common information criteria are the Akaike (AIC),
Schwarz-Bayesian (BIC) and Hannan-Quinn (HQ). The AIC criterion asymptotically
overestimates the order with positive probability, whereas the BIC and HQ criteria estimate
the order consistently under fairly general conditions if the true order p is less than or equal
to pmax. But this study using all five criterion 5 .
Table 4: VAR Lag Order Selection Criteria

Endogenous variables: DLOGTFP DLOGGRO DLOGREER
Sample: 1976-1990
Lag LogL LR FPE AIC SC HQ
0 -23.11194 NA* 0.015600* 4.351990* 4.473217* 4.307108

1 -16.48987 8.829432 2.51E-02 4.748311 5.233218 4.568782

5
For further classification, see Dave and Rami, 2008 and Gaurang Rami, 2010
68


2 -6.12125 8.640515 0.030549 4.520208 5.368795 4.206031*
* indicates lag order selected by the criterion

LR: sequential modified LR test statistic (each test at 5% level); FPE: Final prediction error; AIC: Akaike
information criterion; SC: Schwarz information criterion; HQ: Hannan-Quinn information criterion

Sample: 1991-2012
0 24.77333 NA 1.79E-05 -2.419258 -2.270863* -2.398797
1 31.05733 9.775111 2.47E-05 -2.117481 -1.523899 -2.035634
2 34.28966 3.950631 5.22E-05 -1.476629 -0.437862 -1.333397
3 42.32592 7.143347 7.80E-05 -1.369547 0.114406 -1.16493

4 74.62024 17.94129* 1.20e-05* -3.957805* -2.028666 -3.691802*


Sample: 1976-2012

0 -62.16861 NA 0.021097 4.654901 4.797637 4.698537
1 -40.58659 36.99775 0.008638* 3.756185 4.327130 3.930728
* *
2 -38.09561 3.736461 0.014122 4.221115 5.220269 4.526566
3 -25.13887 16.65868 0.011375 3.93849 5.365852 4.374849
4 -18.97907 6.599787 0.0159 4.141362 5.996932 4.708628
5 -5.555947 11.50553 0.014714 3.825425 6.109204 4.523599
6 0.652399 3.99108 0.027284 4.024829 6.736816 4.85391
69


7 8.094575 3.189504 0.065153 4.136102 7.276298 5.096091
8 54.20008 9.87975 0.023051 1.485709 5.054114 2.576606*
*

It can be seen from table 4 of VAR log order selection criteria that 4 out of 5 criteria (viz.
LR, FPE, AIC and SC) indicate selection of lag order 0 and HQ criteria suggest selection
lag order 2. To run the Granger Causality test for the period of 1976 to 1990, this study
take 2 lags and estimate a Granger causality test. Table 5 show the VAR log order selection
criteria for the period of 1990 to 2012. 4 out of 5 criteria (viz. LR, FPE, AIC and HQ)
indicate selection of lag order 4 and SC criteria suggest selection lag order 0. To run the
Granger Causality test for the period of 1991 to 2012, this study using optimal lag length of
4. Table 6 show the VAR log order selection criteria for the period of 1976 to 2012, result
indicate that 3 out of 5 (LR, FPE and SC) indicate selection of lag order 1 and 2 out of 5
(AIC and HQ) indicate selection of lag order 8. For the period of study form 1976 to 2012,
I will estimate a Granger causality test with the optimal lag length of 8.
Following Table 7, Table 8 and Table 9 shows the results of the Granger Causality tests for
the period of 1975-76 to 1990-91, 1990-91 to 2012 and 1975-76 to 2011-12.
Table 7: Pairwise Granger Causality Tests
Sample: 1976-1990
Lags: 2
Null Hypothesis: Obs F-Statistic Probability
GRO does not Granger Cause TFP 12 1.29317 0.3327
TFP does not Granger Cause GRO 0.02083 0.9795
REER does not Granger Cause TFP 12 0.60994 0.5699
TFP does not Granger Cause REER 1.06498 0.3946
REER does not Granger Cause GRO 12 0.16962 0.8474
GRO does not Granger Cause REER 0.38458 0.6943
Note: GRO: Growth Rate of Output; TFP: Total Factor Productivity Growth Rate and REER: Real Effective
Exchange Rate. All the series, first converted into Natural Log form and then take first difference to
converted them into stationary.
70


Sample: 1991-2012
Lags: 4
Exchange Rate
All the series, first converted into Natural Log form and then take first difference to converted them into
stationary.
Sample: 1976-2012
Lags: 8
Exchange Rate
All the series, first converted into Natural Log form and then take first difference to converted them into
stationary.
71


The results of Granger Causality test are given in Table 7, when testing if there is any
relationship between these variables, F-statistics is statistically insignificant i.e. the results
suggests that there is no unidirectional causality or bidirectional causality running between
TFG, REER and GRO in pre liberalization period.The results of Granger Causality test are
given in Table 8, according to which there is no unidirectional causality or bidirectional
causality running from GRO and TFP or REER and TFP or other way around. But in post
liberalization phase I found the unidirectional causality form REER to GRO, here F-
Statistics is statistically significant at 5% level.The results of Granger Causality test are
given in Table 9, according to which there is no unidirectional causality or bidirectional
causality running from GRO and TFP or GRO and REER or other way around. But I
found, at 5% statistically significant level, the unidirectional causality form REER to TFP.
V: Conclusions
The results of the analysis point to the following conclusion:

1. During the pre-liberalization period 1976-1990, REER had no impact whatsoever as
either TFP or GRO. During pre-liberalization period, exchange rate play a minor
role and little impact on Indian manufacturing sector.
2. During the post-liberalization period 1991-2012, REER had a positive impact on
GRO. Here we can say that exchange rate depreciation increase the production of
Indian manufacturing sector after 1991.
3. The overall impact of REER on TFP is observed to be positive and statistically
significant. This shows that the REER impact on TFP during the post-liberalization
period has a predominant influence on the overall results.
A major limitation of the present study is that it does not include the service sector in the
analysis. It is possible that the service sector may have contributed to manufacturing sector
productivity growth over the long term. However, future research may include the service
sector and extend the analysis farther.
References:
72


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International Journal of Social and Economic Research Vol. 5, No.

5.Nexus between Total Factor Productivity Growth of Manufacturing

Using Indian organised manufacturing data to investigate whether exchange rate

depreciation resulted in an acceleration in productivity growthand output growth of the

exchange rate and productivity growth is still ongoing.

added in mining and manufacturing contracted, services sector growth remained

consumption, though there was an improvement in export growth aided by rupee

Effect of Trade Liberalization on Industrial Productivity

capacity building and organized production will result.

to the firms that use their resources appropriately.

II: Literature Review

A relatively slow growth in TFP in Indian manufacturing in the post-reform period, as

accounted for 53 percent of gross value added and 45 percent of employment in

manufacturing over this period over 1973-74 to 1988-89.

the traded sector for the analysis.

III: Research Methodology

industry productivity rather than aggregate productivity. Consider an aggregate production

Y = F (L, K, R, E, T) Equation (1)

Assuming the condition of competitive equilibrium, the above mention Translog

ΔYt = α + β t + γ Yt – 1 + δi∑δ t–i+ εt

necessary to apply this test.

GROt – k + δ11 REERt – 1 + δ12 REERt – 2 +…..+ δ1k REERt – k + ε1t

To examine if there is autocorrelation the Breusch-Godfrey serial correlation Lagrange

IV: Empirical Finding: Granger Causality Test:

Tests for Stationarity (Unit Root Tests)

Table: 1 - Augmented Dickey-Fuller unit-root test results

Source: Compiled by the authors.

Table: 2 - Augmented Dickey-Fuller unit-root test results

Total Factor Productivity Growth -6.054984 -6.151405 * -0.821495

Growth Rate Output -6.097412 -6.068512 -6.202892

Prediction Error (FPE), Akaike Information Criterion (AIC), Schwarz-information

Table 4: VAR Lag Order Selection Criteria

Lag LogL LR FPE AIC SC HQ

0 -23.11194 NA* 0.015600* 4.351990* 4.473217* 4.307108

* indicates lag order selected by the criterion

Table 5: VAR Lag Order Selection Criteria

3 42.32592 7.143347 7.80E-05 -1.369547 0.114406 -1.16493

4 74.62024 17.94129* 1.20e-05* -3.957805* -2.028666 -3.691802*

Table 6: VAR Lag Order Selection Criteria

* indicates lag order selected by the criterion

The results of the analysis point to the following conclusion:

6. Balakrishnan, P. and Pushpangadan, K. (1998), “What Do We Know about

No. 33/34, Aug. 1998, pp. 2241-2246

16. Ray, Sarbapriya (2012), “Determinants of Total Factor Productivity Growth in

Selected Manufacturing Industries in India” Research and Social practices in Social

Sciences, Vol. 7, No. 2, February 2012, pp 25-43.

Inc., New York.

Analysis of Selected Economic Indicators”

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