Investment Led Growth in India: Fact or Mythology?

Author(s): PETER E ROBERTSON

Source: Economic and Political Weekly , OCTOBER 2-8, 2010, Vol. 45, No. 40 (OCTOBER
2-8, 2010), pp. 120-124
Published by: Economic and Political Weekly

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 Investment Led Growth in India: Fact or Mythology?
PETER E ROBERTSON
India's investment rate has increased fourfold since 1950
and has risen sharply this decade to 35% of its gross
domestic product. Nevertheless, contradictory views
have been expressed regarding the importance of this
investment pattern for India's economic growth. This
paper evaluates the impact of the rise in India's
investment rate on its economic growth, using the
neoclassical growth model. It finds that the increases in
the investment rate have been a secondary source of
growth, contributing less than 1 percentage point to
India's overall growth rate of gdp per worker of 2.7%. It
also shows that the current investment boom will have a
very small effect on future growth rates and that the
benefits from further increases in the investment rate
are also likely to be small.
I am grateful to Rod Tyevs for helpful discussions, to Barry Bosworth
who kindly made his data available, and to an anonymous referee. The
project was supported by the Australian Research Council, DP0984811.
Peter E Robertson (peter.robertson@uwa.edu.au) teaches economics at
the School of Business, University of Western Australia, Perth.
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In the last decade, India's investment rate has burst into the
dizzy heights of the east Asian miracle. Having quadrupled
since 1950, investment as a fraction of the gross domestic
product (gdp) is now in the 30%-40% range. What impact has
this had on India's growth, and what does the acceleration in
investment imply about growth over the next decade? In attempt
ing to answer these questions, many studies, including Athuko
rala and Sen (2002), Bardhan (2006), Basu and Maertens (2007)
and Basu (2008, 2009), have pointed to the key role of invest
ment in understanding India's past and future growth prospects.
A rather different perspective is given by Bosworth et al
(2007). They describe the contribution of capital growth as dis
appointing, and suggest that it has been a constraint on growth.
This view is reiterated in Bosworth and Collins (2008), where the
authors compare India, east Asia and China.
Clearly it is unsettling to have two such different views on what
would appear to be a simple issue. Nevertheless there appears to
be a greater consensus on the policy front. The Economist (2010),
Shome (2006) and Mohan (2008), for example, have all sug
gested that further increases in investment rates are desirable in
order to sustain higher growth rates. Likewise, Bosworth et al
(2007) argue that reforms in the business environment are
needed to improve the rate of investment.
In what follows I aim to explain how growth accounting results
and how the rising pattern of investment rates give such different
impressions of India's growth record. I shall argue that, notwith
standing Bosworth et al's (2007) muted assessment, the pattern
of investment and capital accumulation has indeed been very
healthy. This assessment is based on the neoclassical growth
model, rather than traditional growth accounting.
I shall also argue, however, that a policy focus on further in
creases in investment would be misguided. To see this point, one
need only recall Krugman's (1996) satire of savings and investment
economic policy in Singapore, where he compared it with Stalinist
collectivisation. Too much investment will inevitably mean the
funding of projects with poor rates of return. For India, this may be
at the expense of consumption for basic needs and spending on use
ful social projects.1 It follows that, at some level, further increases in
investment rates must be harmful. But how much is too much?
1 Perspectives on India's Investment Record
Figure 1 (p 121) shows an index of gdp per capita for India, in logs,
since 1950. The graph indicates acceleration in the growth rate since
the mid-1970s or early 1980s. Differing views regarding the timing
of this acceleration and their relation to reforms have been ex
pressed by Rodrik and Subramanian (2004), Panagariya (2004) and
Sen (2007). As noted by Sen (2007), the timing of the acceleration
120 October 2, 2oio vol xlv no 40 [3359 Economic & Political weekly
 ==__ _ __ _ SPECIAL ARTICLE
technological
Figure 1: Logarithmic Index of Real GDP (Constant externalities.
1999-2000 Prices)There is also some empirical suppo
1.25"
for the proposition from prominent studies such as De Long
Summers (1991) and Levine and Renelt (1992).
Nevertheless, the link between equipment investment an
productivity growth is much more of a hypothesis than an es
lished fact. Specifically, the theoretical links between investmen
and growth are widely debated. Prescott (1998), Hall and Jon
(1999) and others, for instance, have argued that the role
investment or capital accumulation in understanding differen
in income levels across countries, is very small.2 So, without n
essarily discarding the link between investment and productiv
growth, it is useful to begin with the more fundamental issue
1950-51 1960-61 1970-71 1980-81 1990-91 2000-01
sorting out how the increasing share of income devoted to inves
Source: Reserve Bank of India (2010).
ment has had an impact on the growth rate in the context of
standard
depends on whether the year 1979, in which there was an oil priceneoclassical growth model.
shock and a drought, is regarded as an outlier. Most analysts
agree, however, that the higher growth rates have been sustained
2 A Balanced Growth Path?
As Reserve
by the widespread reforms of the 1990s. Data from the highlighted in the introduction, the evidence of large
creases
Bank of India (rbi) thus show that India's growth rate of in the investment rate, emphasised by Basu (2008) a
per cap
ita income over the 50-year period, 1950-2000, was 2.2% Sen (2007) and others, contrasts strongly with Bosworth a
per year.
Collins
But since 2000 the average growth rate has been 5.8% per year. (2008) and Bosworth et al (2007), who find only a ve
modest
Figure 2 shows India's gross domestic savings rate, gross capital contribution to India's growth. The data used
fixed in
vestment rate and net fixed investment rate. It shows a Bosworth
massive in and Collins (2008) show that between 1978 and 19

India's
crease in savings and investment as a fraction of gdp from per capita output growth was 3.30% and the growth r
around
8%-9?/o in 1950-51 to a peak of 35% of gdp in 2008-09.of
These savwas similar, at 3.25%. By comparison, in the east As
capital
average,
ings and investment rates compare favourably with the peak the capital growth rate was 5.5%, which was mu
savings
rates achieved by Japan, south-east Asia and China, in each of their
faster than the average output growth rate of 3.7%.
respective economic rniracles. The acceleration in investment and
Figure 2: Investment and Savings (Per cent of GDP at current market prices)
40 the 1990s,
savings is fairly smooth except for a lull in the reform era of
when rates remained relatively constant. Corresponding to the rise in
growth rates there is also a clear jump in all series since 2000.
The large rise in investment rates has featured in explanations
of India's growth acceleration. According to Basu (2008), for ex
ample, the rise in the savings and investment rates was the most
significant macroeconomic change that occurred in India
through the 1970s. He attributes the subsequent growth in the
1980s to the earlier acceleration in investment rates. A persuasive
link between early reforms and rising savings rates is given by
Athukorala and Sen (2002) and Virmani (2004), who attribute
the rise in savings rates in the 1970s to the nationalisation of
1950-51 1960-61 1970-71 1980-81 1990-91 2000-01
banks in 1969, and the spread of branches to rural areas. Bardhan
Source: Reserve Bank of India (2010).
(2006) and Mohan (2008) also note the complementary effects of
public investment over this period. During the 1980s the invest
Therefore, capital accumulation has played a much less pr
ment rate continued to rise and Sen (2007) attributes thisrole
nent to ain India's growth relative to east Asia over this pe
falling relative price of equipment due to the relaxation Bosworth
of import et al (2007) argue that a poor investment clim
controls and increased access to imported machinery. responsible for low investment incentives. In particular they su
In addition to the acceleration in the investment that
rate, Sen of public infrastructure is reducing private investme
a lack
There
(2007) argues that the investment in machinery and equipment is a broad consensus over the woeful state of In
has been associated with embodied technological progress. In infrastructure
public his and many studies concur with the
to to
paper, "Why Did the Elephant Start to Trot?", he points improve
cor the investment climate (Kochhar et al 2
Nevertheless
relations between total factor productivity (tfp) growth and there is room for dissent as to whether India's o
equipment investment in the Indian data, suggesting that invest growth rate really reflects such a dismal effort. Sp
investment
ment is a cause rather than an effect of productivity growth.
cally This
Bosworth and Collins' (2008) data show that the gr
builds upon a significant body of literature, includingrates
De Long
of capital and output are approximately the same. Th
and Summers (1991) and Greenwood et al (1997) that precisely
stress the
what one would expect along a steady state growth p
role of investment spending in generating growthIt through
suggests that the rate of capital accumulation was about rig
Economic & Political weekly BESS October 2, 2010 vol xlv no 40 121

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 SPECIAL ARTICLE - -_= -
increase
In contrast, east Asia's faster rate in labour inputs,
of capital growth (l+g) denote
means the annual
that increase in
productivity,
the ratio of output to the capital stock, measured
y/k, is in effective labour
falling. Thisunits, and 8 denote the
falling
depreciation rate
capital productivity reflects Krugman's on capital.
(1996) The steady that
remark state condition
"Leefor the
Kuan Yew's Singapore is an economic twin
Solow-Swan Growth of
model Stalin's
is sy/k Soviet
= (i+n)(i+g)-(i-<5), where s is
Russia". Thus, though many east Asianrate.6
the investment economies had
Using this, the steady statehigh
equilibrium out
savings and investment rates, it put-capital
is highly ratio is,
debatable that the 40%
rates of Singapore were necessary, or even desirable. Taiwan and
/7 (i+n)(i+g)-(i-5) r.
South Korea achieved equivalent growth rates with only a frac y/k
5
=- -UJ
tion of the investment. As shown by Robertson (2000), the
growth rates in Singapore would have been
A constant only
value of y/k willmarginally less
indicate a balanced or steady state,
even if it had halved its investment
onlyrates.
if all of these variables, s, n, g, 8, are constant. In this case a
So an equally valid interpretation
doubling
ofof the
the investment
data presented
rate would halve by
the equilibrium
Bosworth et al (2007) might be that India's
value of y/k. rate
As we have seen,of capital
this was accu
not the case. In India there
mulation was about right, and that of the
was a fourfold east
increase Asian
in 5 economies
since 1950, but y/k did not fall to one
and China are too high. quarter of its initial level. Rather it increased!
Alternatively,
This is not quite right however. The argument consider a growing
that economy,
India like India, where n
is, even
and 8 are
approximately, on a steady state growth approximately
path is wrongconstant but both
since a the investment rate, s,
strongly
and the productivity
rising investment rate is inconsistent with a growth rate,state.
steady g, are rising. What happens to
Rising
investment rates, other things beingcapital productivity
equal, is a balancing
will imply act between
higher increases in g and
growth
increases
rates of capital over a transition and in 5.
a falling capital productivity,
The principal
y/k. The standard neoclassical growth modelreason why the
implies fourfold
that increase of the invest
a doubling
mentarate
of the investment rates should cause has not ledof
halving to ay/k.
rapidly Bosworth
falling value of y/k
andis that there
was also a rapid
Collins' (2008) data, by contrast, imply acceleration in y/k,
a constant the rate of productivity
since both growth, g.
Based
the growth rates of capital and gdp peron worker
data from Bosworth and Collins (2008), the average
were approximately
value of
equal. To resolve this paradox we need toproductivity growth from
trace India's 1951-79 was
growth ?=1.4%, but from
path
1980-2008
more carefully. Extending Sen's (2007) the average iswe
metaphor, g - 4.4%.7
needAtosimple calculation using
follow
(1) shows
the elephant's trail, looking at how y/k that this 3 over
behaved percentage point increase in g is sufficient to
time.
raise the average product of capital by approximately 50%.8
3 The Elephant Trail Thus India has not been on a steady state, but on a slow transi
tional's
I begin by looking at Bosworth et with (2007)
rising s and g and an approximately
output and capital constant average
stock data.4 Figure 3 compares theproduct
y/k of capital, based
series y/k. Thison
is what lies behind
official Bosworth and
data
Collins'the
reported in Sivasubramonian (2004), (2008)data
resultsused
showing
bythatBosworth
capital growth rates have
been similar
et al (2007), as well as the latest series taken to gdp growth
from rates.
the Because productivity growth
rbi.5
It can be seen first that, in the
was 1978-2004 period,
also trending upwards, there
the capital wasratio y/k has
productivity
tendedratio,
considerable fluctuation in the y/k to be fairly
butconstant and the
little netgrowth rates of capital and
change
gdp have
since 1978. The data show very clearly been approximately
that the average the same. This means
product of that capital
has contributed
capital y/k, has not been falling and, less, relatively,
if anything, hastobeen
India's growth than it did to the
rising.
What causes yA to rise, or remaineast Asian economies. But
constant, in this
theis due to the
face ofacceleration
the in pro
strong investment growth? The ductivity growth. It growth
neoclassical does not meanmodel
that the investment
sug rate in
gests three factors: labour force creases
growth;have notthe
been important or substantial.
depreciation rate;
There islet
and productivity growth. Specifically, one caveat,
(l+n) which is to do
denote withannual
the depreciation rates.
Though productivity growth rates have been rising, so too has
Figure 3: Average Product of Capital (y/k)
0.44-? the implicit depreciation rate. The net investment rate, calcu
lated as (fct+1 - kt)/yt, has been much more constant over time
than the official gross or net investment rates shown in Figure 2.9
Sivasubramonian (2004)
Thus the relationship in the data between the gross investment
rate and changes in the capital stock has not been constant.
Whether one attaches much importance to this depends on
whether one believes that the accounting practices in national ac
counts reflect real economic depreciation or not. But it does help
explain the different pictures painted by the investment optimists
(who refer to gross investment data) and Bosworth et al (2007,
0.34
2008) (who base their conclusions on the growth rates of capital).10
The central insight then is that the increases in investment rates
1950-51 1960-61 1970-71 1980-81 1990-91 2000-01 have been large and consequentiy there has been a high rate of cap
All the data series are identical prior to 1993-94.
Source: Reserve Bank of India (2010). ital accumulation. With a constant rate of productivity growth, at

122 October 2, 20io vol xlv no 40 DECS Economic & Political weekly

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________________________ __ __ _ SPECIAL ARTIC

any level, the Even this

increases in estimat
the inv
the average overstate
product of the
capitalcont
to
productivity the investment
growth was also bo
ac
capital reasonably
remained fairly view
close to t
pattern of growth
growth as
ensures an upp
that
contribution" Moving
will be beyond
close to b
the
y/k remains to quantify
fairly the
constant. ef
B
that the growth
investment rates
process prec
has b
Robertson (2000
4 The Long Investment
lated using Boo
existi
We have seen in
that investment
the rat
"capital-co
ing results calibrated
depends on model,
both the
productivity 9% of
growth.gdp,
It yields
does n
potentially the absence
interesting of
policyan
v
affects the rise
growth in investmen
rate. This, how
way of 0.76
approaching percentage
the issuepoo
increases in the investment
per worker, orrat
28
theory. As This
above, thereduced
most fig
usefu
textbook very
Solow-Swanimportant.
or Ramsey B
In the mentgrowth
Solow-Swan rate rises
modar
in investment growth
from s rates
to s' on
over
income is given by
5 Investment in
y'/y = (Sys)^-a), ...(2)
where a is the The preceding
income share arg
of c
steady state been
level of an
per importan
capita inc
of a = 1/3, we When
have one
a/(i-a) looks
= t
o.5.11
rule" - rate
example rises
for
to must
double gdpn
the investmentcause
rate. the recent
India's i
inve
mately a
quadrupledlevel where
since 1950, it is
from
per capita over Specifically,
this period in
hasth
in
years, the from
doubling of 25%
gdp to
due35%
to t
rate translates short
into an time. Howeve
average ann
relative to the the growth
average rates
growth ratd
Thus, by this solute
measure,change.
the Thu
quadru
counts for the investment
approximately 44% rat
of I
This, however, increase
is an in per capi
overestimate
are gradual and half-life
the peak of 14has
rate year
o
A slightiy betterincrease in income
back-of-the-enve
dividing the 0.6% per rate
investment yearrise
fromi
ment rate doubled:
it 1950-80
will only and 19
account
can assume thatfuture
the transition
growth is
rate
led to a 40% Thus
increase in the
per neoclass
capita g
Since increases age
in point
the rise in
investment
ital effect
accumulation, it on
takes the
timeinc
fo
Hence, for the tion.15
second Hence,
period the
1980
of the actual a smaller
transition impact
has been r
would be tude. Likewise,
approximately 3/4than
of
gdp. This is based on
play an
an assumed
increasing
implies a costly
transitional in terms
half-life ofof
1
means that 3/4th of the transition
period 1980-2008.
6 Conclusions
Simple arithme
to be 1.85. Thus
Despite thethis back-of-th
stratospheric investment rates of recent years, the
that the fourfold
picture that emerges
increase
for India is that rising productivity
in has been
the
85% increase inthe key
peringredient of economic
capita growth. Specifically,gdp
the lack of ov
lates to about 1 change
percentage
in the capital-output ratio, or its inverse y/k, point
is not due to p
the actual a lack of average
annual capital deepening, but due to an acceleration
growth in the o

Economic & Political weekly QGESS October 2, 2010 vol xlv no 40 123

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SPECIAL ARTICLE

productivity growth rate. Thus, without disputing any of the But the importance and existence of the sources of productivity
facts, this gives us cause to reconsider Bosworth et al's (2007) growth are contentious and not well understood. Like growth
gloomy assessment of India's record on capital accumulation. accounting methods, the preceding analysis is appropriately,
But one may also take issue with the upbeat assessment of silent on the sources of productivity growth. Rather, it aims to
investment. Can further increases in investment really keep the build upon standard growth accounting methods to provide a
elephant trotting? Perhaps inauspiciously, recent research shows deeper understanding of the relationship between investment
that Asian elephants cannot actually run in a technical sense. and growth. Within the context of that model, we have shown
They are simply too big and heavy.16 The metaphor is apt since that the fourfold increase in the investment rate has produced
the neoclassical model also suggests that adding capital without some significant growth over the post-independence era.
productivity growth will cause India to stumble under the weight Nevertheless, productivity growth clearly dominates. Moreover,
of a large and inefficient capital stock. with an investment rate now above 30%, a similar percentage
Of course, the neoclassical model is not the only theory of growth. increase in the investment rate is highly unlikely. Even if it does
Much of the productivity growth that has occurred may depend upon occur, the square root rule means that it is unlikely to generate any
productivity improvements that are embodied in new capital goods, significant growth benefits. Hence productivity growth, and not
or on economies of scale. For example, this is the view of Sen (2007). investment, will dominate India's growth over the coming decades.

NOTES we have n=o.o2 and g=0.0285, a=1/3 and in Asian Elephants", Journal of Experimental
5 = 0.025. This gives a convergence rate approxi Biology, 213: 694-706.
1 Similar criticisms have also being levelled at China
mately 0.05, or 5% per year. The half-life is then
Greenwood, J, Z Hercowitz and P Krusell (1997):
(Bardhan 2006, Prasad 2009, Tyers and Lu 2009).
ln(2)/o.05=i4 years (see Barro and Sala-i-Martin "Long-run Implications of Investment-specific
2 Interestingly, with respect to India, the share of 2004, for further discussion). The total combined
machinery and equipment in investment spend
Technological Change", American Economic
increase in per capita GDP is then 1.31 x 1.41 =1.85. Review, 87(3): 342-62.
ing has fallen from 0.59% of investment in 1995 The 1.85 fold increase translates to an annual
96 to 0.47% in 2007-08. This was precisely when Hall, R E and C I Jones (1999): "Why Do Some Coun
growth rate of i.8s1/58-i=o.oi, or a growth rate of tries Produce So Much More Output Per Worker
India's economic growth was accelerating.
1% compared to an average annual growth rate of Than Others?", Quarterly Journal of Economics,
3 On a steady state both the growth rate of output per 0.028% per year or 1/2.8=38% of the growth.
114 (1): 83-116.
worker and capital per worker are equal to the la
14 The results are sensitive to the assumed capital Kochhar, Kalpana, Utsav Kumar, Raghuram Rajan,
bour productivity growth rate l+g. Hence, the "capi
share however. A capital share of 0.4 would sig Arvind Subramanian and Ioannis, Tokatlidis (2006):
tal contribution" from standard growth accounting
nificantly increase the growth rate due to invest "India's Pattern of Development: What Happened,
techniques will equal a x g and the relative contribu ment from 0.76% per year to 0.9% per year, What Follows", NBER, Working Paper 12023.
tion is simply a. If the growth rate of capital exceeds
though this is still much less than half of India's
the growth rate of GDP then y/k must be falling and Krugman, P (1996): Pop Internationalism (Cambridge:
2.7% annual economic growth rate. MIT Press).
the relative capital contribution will exceed a. Con
15 Of course, these conclusions are based on the as
versely, if the growth rate of capital is less than the Levine, R and D Renelt (1992): "A Sensitivity Analysis
sumptions of an aggregate production function
growth rate of GDP theny/fc must be rising and the of Cross-country Growth Regressions", American
which is also sometimes questioned. A less re Economic Review, 82(4): 942-63.
capital contribution will be less than a. See Robert
son (2002) for a detailed discussion.
spectful alternative subtitle for this paper might
be "Fact or Neoclassical Parable". Mohan, Rakesh (2008): "A Story of Sustained Savings
4 Again, I am very grateful to Barry Bosworth who and Investment", Economic & Political Weekly,
16 Rather, they just walk fast without the necessary 33(19): 61-72.
kindly provided me with his data.
vertical oscillation to really get up speed. For a fur
5 In this figure, output is measured as a fraction of Panagariya, A (2004): "Growth and Reforms during
ther discussion of Asian elephant biomechanics,
GDP at factor cost, measured in constant prices, 1980s and 1990s", Economic & Political Weekly,
see Genin et al (2010).
and k is the net capital stock at constant prices. 39(25): 2581-94.
6 I have used the discrete time formula here, to as Prasad, S Eswar (2009): "Is the Chinese Growth Miracle
sist with mapping the formula to annual data. Built to Last?", China Economic Review, 20(1): 103-23.
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is Barry, Susan M Collins and Arvind Virmani Tyers, Rod and Feng Lu (2009): "Competition Policy,
still, however, little net change over the whole period. (2007): "Sources of Growth in the Indian Economy", Corporate Saving and China's Current Account
11 An identical result holds in the Ramsey growth NBER, Working Paper 12901. Surplus", Working Papers in Economics and
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12 The average growth rate is calculated as 2V58-i=0.012. Journal of Economics, 106, (2): 455-502. Virmani, A (2004): "India's Economic Growth: From
13 The rate of convergence in the linearised Solow Genin, J J, P A Willems, G A Cavagna, R Lair and Socialist Rate of Growth to Bharatiya Rate of
Swan model is (i-a)(n+g+5). From Indian data N C Heglund (2010): "Biomechanics of Locomotion Growth", Working Paper No 122, ICRIER, New Delhi.

124 October 2, 2010 vol xlv no 40 Q3S3 Economic & Political weekly

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