The Indian Economy Blog

December 19, 2006

The Indian Productivity Miracle

Back in the late 1990s, economists were trying to figure out what it was that led to the secular acceleration of economic growth in the United States: the longest and largest peace-time economic expansion in the 20th century (see footnotes). How was it that a country could grow so much and for so long without causing inflation and overcapacity? Was the business cycle dead?

Clearly not: the financial crash that followed was swift and brutal – making investment bankers’ Christmases depressing for all of two years. Indeed, the accompanying recession was the shortest and shallowest in US history (click to see on the chart below).

us gdp.bmp

During the boom, the US economy benefited from an unprecedented acceleration in productivity growth. This was driven primarily by the efficiencies created by technological and financial deepening – particularly in the retail, wholesale, electronics, semiconductors, and financial services industries. While the dot-com’s and Stanford techies in pastel suits got the glory, the economy itself was being powered by

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the Wal-Marts, Intels, and GEs – who were innovating rapidly – and implementing that innovation in long-term strategies to enhance their bottom line.

Now before I get to how this compares to India today, a brief economics refresher. According to neoclassical theory, at the most basic level, a country’s output is powered by structural and cyclical forces. Structural or long term growth is driven by three factors inherent to the economy: the number of workers, their productivity, and how much long-term capital is available to them. Cyclical growth is powered by the various short-term influences on the economy: wealth effects from the asset markets, monetary and fiscal policies, etc. In theory, an economy should grow at its structural (or ‘trend’) growth rate plus or minus the cyclical component. To simplify, a country trend level of annual real GDP growth should equal:

Y% = (% change in labor force) + (% change in productivity)

This is the rate at which an economy can (and should) grow without causing excess inflation. The current capacity debate (discussed here, here, and here), in essence, is about what this number is today. Ajay Shah, the Economist, and various investment banks (including Morgan Stanley and HSBC) have repeatedly said that India is overheated – evidenced most clearly by the run-up in inflation, and also by ‘bubble-like’ real estate and equity prices. Skittishness about the policy direction of the current governing coalition supports the prevaling belief that a crash (or, for the less brave, a “cooling down”) is imminent. According to them, economic growth and/or asset prices are both set to decrease in the near-medium term.

They may well be right. Nevertheless, it is worth taking a look at the numbers and seeing exactly what has been powering economic growth in India over the last couple of decades. If we want to figure out where the Indian economy is headed over the next 4-5 years (as opposed to say, the next 4-5 quarters), surely this is better than looking only at the short-term indicators.

Our potential workforce (defined as people aged 15-64) has been increasing at about 2% a year – and is projected to continue at that rate at least till 2020. However, labor force participation rates vary substantially from state to state, between the sexes, and between rural and urban areas – as do unemployment and underemployment. Given that labor force growth (potential workforce x overall participation rate) has been averaging about 2% over the past 10 years, in the absence of better statistics, it is a safe assumption that overall employment is growing in the range of 1-2%

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and gradually accelerating.

The rest of real GDP growth has to come from growth in the productivity of those workers. In this framework, there is one fixed determinant of productivity growth: the capital-to-labor ratio. When capital is substituted for labor, then up to a point, this increases the productivity of labor. The rest of productivity growth is lumped up into a residual which economists call total factor productivity growth, or TFPG. While there is considerable debate on this, there is strong evidence at the national and industry level that TFPG is correlated strongly with measures of competition, deregulation, technology and innovation (much more on this in a later post). For the purposes of this analysis, we can simply say that TFPG is the component of growth which captures the extent of the structural change in an economy.

By running the calculations over the 1980-2005 period using real GDP, capital stock, and the labor force as the variables, we can see a relatively clear trend in India. Labor force growth has been fairly steady around 2%, and capital deepening has been a fairly small contributor to growth (on average 1.5%). Predictably, the acceleration in GDP growth since 1991 (and through much of the 1980s) has been almost entirely because of an increased pace of TFPG.

india tfpg.ppt (Updated chart)

The 5-year averages in the chart hide an even bigger change: if you look at the breakdown from 2004-2006, TFPG has been almost 5%. This acceleration has been partially due to changes in government policy, but my guess is that a larger portion of it is driven by the impact of the natural forces of globalization. The internet and the opening up of global financial markets has allowed a boom in IT enabled and financial services, and the loosening of trade barriers has boosted industry. Furthermore, there have been massive changes in the way Indian companies do business: ranging from increased transparency in order to tap the capital markets, aggressive cost-cutting and outsourcing of non-core functions, and an increased pace of technology transfers – both from abroad, and within industries. All of this impacts the productivity of labor (and TFPG) at all levels of the economy – and in another sense, is the very definition of ‘structural change’.

While there is an eventual limit to how much all these factors can influence productivity, it is my contention that we are a long way away from that point. When our leaders remind us that the reform process is “irreversible”, it is not just a diplomatic online pharmacy

nicety to appease investors; it is in fact the truth. The forces of competition unleashed over the last 15 years cannot proverbially be brought back into the box – they will continue until they run their course; until all those who want to and can take advantage of the benefits of

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a more-open economy, have done so. Further policy changes have the ability to increase or decrease the magnitude and the speed of this change – but can cialis and viagra be taken together they cannot alter its direction.

If this were the extent of the change, it might alone be enough to help India out of chronic underdevelopment. Fortunately, the extent is even bigger. Along with the acceleration of TFPG, we will most likely soon see

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an acceleration in capital deepening as well, and soon thereafter in the growth of the labor force. The investment to GDP ratio has risen by about 5% from 1991 to now. Most economists are expecting a further increase once the numbers for the current fiscal are released – the prevailing estimates are that it will be

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about 29-30% of GDP. Surjit Bhalla of Oxus is even more optimistic, saying that it will increase to over 35%. As long as this investment boom lasts – and there are some reasons to believe that a lot of this is long-term capital, not just short-term ‘hot money’ – the capital deepening portion will continue to accelerate. And, as I mentioned earlier, sometime between 2009 and 2015, labor force growth will peak around 3.5% – 4%. This alone would constitute a 2% acceleration from the current trend level of GDP growth.

Now the real heart of the capacity debate

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centers around this question: what is India’s trend rate of growth now and what will it be for the next few years? (This is the red italicized number in the previous chart) If you add up the numbers, it seems to me that at a minimum, trend growth is at 8% with the capacity to reach 10% in the coming years. The 6.5% baseline level of pharmacy growth that the Economist and others use to form their assessments of the Indian economy is fundamentally flawed. Any

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judicious propecia cost accounting of the productivity trend over the last 25 years, when combined with stable and high labor force growth, should reveal that, over the long-term, the ‘supply-side’ of the economy is advancing at an accelerating rate.

Now, all this is not to say that ‘India-bears’ don’t have legitimate concerns: accelerating inflation, rapidly increasing asset prices, and a lack of sufficient policy direction are all worrying signs. But one must clearly distinguish between short-term fluctuations, and the long-term trend. On the fiscal front, the government is clearly too profligate: spending by the centre as a percent of GDP has increased by 2% over the past three years. The RBI (on account of persistent goading from North Block) has not increased short-term interest rates enough, with real rates continuing to decline. And, as our recent discussion about the real estate “bubble” highlighted, asset values are quite clearly borrowed against future growth.

However, all this does not

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necessarily add up to unmitigated disaster. High productivity growth is the closest thing to a panacea that central bankers can find these days – it tends to keep long-term inflation expectations down. The recent run-up in prices can be explained by short-term capacity constraints (particularly in agriculture), and an increase in oil prices in the first half of the year. Similarly, on the fiscal front, we are extremely unlikely to see a fiscal stimulus of the type introduced over the last three years (in particular the employment guarantee scheme). Moreover, high growth and structural change have allowed the tax base (% of workers that pay taxes and tax/GDP) to expand rapidly. This has allowed for a gradual change in the nature of government spending, with direct subsidies growing slower and direct investment growing faster. (Having said all that, I will admit that state finances are a complete bloody mess).

As for the asset markets – even after the run-up of the SENSEX, India’s market-cap to GDP ratio is still around 95%, which is lower than countries like South Korea (100%) and South Africa (240%), as well as developed capital markets (which range from 120% – 400%). Similarly, to summarize our earlier discussion, real estate has exhibited some disturbing trends in some regions, but on the whole, the jury’s still out on whether this means that it’s a nationwide price bubble.

To conclude, India faces some real risks in the short-term. If I had to give my top three, they would be:

  1. Supply bottlenecks (particularly in agriculture and industry)
  2. External environment (particularly turns in the global growth and liquidity cycles)
  3. Frothy asset values (particularly those which are borrowed against unreasonable future growth)

Nevertheless, any sober analysis will reveal levitra original rezeptfrei that in the midst of unprecedented structural change, it will take a lot more to knock India off its long-term growth trajectory. Of course, we should expect to see fluctuations – sometimes big ones. However even the most pessimistic levitra dosage observer must see that the fluctuations are happening around a steadily increasing mean. Amidst this rapid transformation, India’s progress and prospects cannot be best judged month-to-month or quarter-to-quarter – but rather year-to-year, and in some instances, even decade-to-decade.

In India, we must see this as a golden opportunity to get our house in order: start cleaning up governance and the budget; build infrastructure; and balance growth between the regions. All these things will be much harder to achieve when (and if) the going gets tough.

In other words: don’t worry too much, but don’t get complacent either.

(If you want to check out my numbers and projections in detail, keep checking back at I will be posting a link to my spreadsheet in the next few days, once I clean it up a bit)

[1] 107 consecutive months
[2] added $1.7 trillion in inflation-adjusted dollars to GDP between 1995 and 2000


  1. [...] At the Indian Economy blog, Nanubhai, in a detailed post argues that while short term hiccups can be expected, the Indian economy will continue to grow in the medium to long term. The post is a bit technical but a very good read especially if you have followed the recent discussions on whether the economy is over heated. [...]

    Pingback by DesiPundit » Archives » The Indian Productivity Miracle — December 19, 2006 @ 3:12 pm

  2. Nanubhai,

    By several measures, this is a landmark post on IEB.

    But I see a dilemma here. The fact that India is on a trend growth rate of about 8% will not only make our policymakers more complacent about microeconomic reforms, but also more inclined towards the politics of reservations.

    Comment by Nitin — December 19, 2006 @ 6:55 pm

  3. Nitin,

    What you are saying is a distinct possibility. However, I would like to believe that a growing middle class will somehow manage to alter the politics of expediency. I think that once growth starts impacting the majority of people, it will become harder and harder for our leaders to practice the politics of reservations. Also, as I stated in the post, I think growth in increasingly independent of policy changes – so, in my view, only the most drastic reform reversals have the potential to alter India\’s trajectory.


    Edward was trying to post this response to your question but it wasn\\\’t appearing on the website:

    \”The fact that India is on a trend growth rate of about 8% will not only make our policymakers more complacent about microeconomic reforms…\”

    This is an interesting point, Nitin, and indeed Aninda, if and when he shows up, has been arguing this view to some extent. The thing is rather than a dilemma, it is a downside. It isn\\\’t really a dilemma, since what is going to make this growth happen has already been done (the demography and the initial opening to globalisation) and this either can\\\’t or shouldn\\\’t be undone now.

    And really the whole thing is rather caught in a growth double-bind, since the very people you might want to ask to slow growth to force more reforms (eg the RBI, as the ECB is trying to do in Europe right now)) are not exactly independent institutions yet. Also there is a balance between growth and people suffering severe hardship, so you can hardly wish for less growth to punish the politicians you don\\\’t like, and then easily sit back and watch children die.

    The thing about backing the move to a market economy is that you can\\\’t then argue for rigging the market when those very market processes you have unleashed bring benefits to incumbents which they may well not deserve. Markets bring growth, and this is what we now have, like it and lump it, I\\\’m afraid.

    On the other hand all of this should produce a much more favourable climate for discussing the advantages of the reforms and the need for more, so there is upside, and if the number of \\\’haves\\\’ starts to rise in proportion to the \\\’have nots\\\’, then the politicians will have to pay attention to this. We need more stakeholders in India\\\’s future, and less in India\\\’s past, and growth will to some extent bring this change in the balance of interests.

    Comment by Nanubhai — December 19, 2006 @ 11:50 pm

  4. I have one question, not really an economist, so these equations are new to me. It seems like you are saying that:

    %GDP= cyclical growth + trend growth = %labor + %productivity

    This makes sense to me. The only thing is it seems like you ignore the cyclical portion of growth in the later parts of the post and go on to say:

    %GDP= trend growth = %labor + % components of productivity

    Can’t you say that loose fiscal policy and low interest rates have created an unsustainable increase in the %labor. An example would be the rural employment scheme that you referred to, which creates artificial employement on borrowed money. Another would be subsidies that make it possible for farmers who would normally be unemployed to keep farming. Low interest rates make it possible to for inefficient companies to exist at least in the short term.

    Comment by Patel — December 20, 2006 @ 4:17 am

  5. Nanubhai,

    When you talk about productiity, are talking about:

    1. The amount of goods and services a worker can produce per hour worked?


    2. The amount of goods and services a worker can produce a year?

    During American growth periods, many workers simply work more hours. They aren’t necessarily working more efficiently. There is a limit to the amount of hours a worker can work, so there is a cap on the amount of productivity gains that can come from workers working longer hours.

    You also leave out the demand side of growth. People will work harder and longer when there are things they can buy with their extra money that justify such sacrifice. Again, there is a limit to this. Many Americans now find themselves trapped into working longer hours simply to pay for their bigger houses and expensive cars…that they’d gladly give up if it meant they could work less.

    Once people lift themselves out of poverty, they tend to scale back on the “working hard to get ahead” mentality and begin to “purchase” more leisure time so they can enjoy the fruits of their past labor…

    Have hours per year worked by the average Indian worker been climbing?

    Are Indian workers willing to sacrifice further economic gains for more leisure time once they reach a comfortable level of income…like many Europeans, or do they tend to be insatiable in their desire for more and more wealth?

    Comment by alphie — December 20, 2006 @ 5:10 am

  6. nanubhai,
    great post..would like to point one factor you excluded though..the lack of basic economic understanding even among the educated middle class, which leads voters to beleive in protectionism and other growth impring economic policies. and as you have seen what happened to the thai stock market, the inadequacies of government fiscal policy, though we have respected economists working in the govt now.

    Comment by krishna cherukuri — December 20, 2006 @ 11:14 am

  7. Nanubhai,

    Two points:

    1) I am not sure where you got the 15% jump in TPGF in the current five years – from my understanding productivity factor is a plug in GDP growth ex-post. There seems to be a circular argument here. May be I am just not reading it correctly.

    2) TPGF doesn’t happen in a vacuum and especially the increase in growth rates. It’s all about getting the policy right. Business can only go so far to improve productivity in a bad policy environment – granted Indian companies, at least in pockets of industries, are excellent. And you pretty much summarize policy issues. So I guess I don’t see a case for higher trend in productivity factor in the next four years going forward. There is surely a case for labour and capital components.

    Obviously, I am not as optimistic as you when you say, “don’t worry too much.” Economic reforms are everything – no reforms, year after year, are bound to catch up. It’s just that someone else has to take the rap for slower growth and pain of economic reforms.

    Comment by Chandra — December 20, 2006 @ 11:49 am

  8. Krisha,

    “the lack of basic economic understanding even among the educated middle class”

    Well this would be a world-wide phenomenon (although lack of understanding can take many weird and wonderful forms), not just an Indian one.

    But your bigger point is will there be a back-reaction? Will India get some version of reform fatigue? Hard to say, but I tend to agree with Nanubhai that many things here are irreversible.

    “and as you have seen what happened to the thai stock market”

    Now here you raise a very interesting point, and it is pretty central to the whole Indian debate. What just happened in Thailand? Well the government tried to use administrative measures (capital controls of a sort) to try and stop money (foreign exchange) coming in. Now what is so striking about the situation is that this is the exact opposite of the situation which lead to the crisis in Thailand in 1998, when all the foreign money wanted to leave.

    So something very important has changed, as these days money is struggling hard to try to enter emerging markets, not to leave them.

    This is the result of many things, but one central point is what Ben Bernanke calls the global savings glut which is in part caused by ageing populations in the developed countries trying hard to save for their retirement and in part by petro dollars in those countries which suddenly have gotten rich on the back of high oil and commodity prices. Either way what we have is a phenomenon of massive global liquidity and low yields, and this doesn’t look like it is going to go away anytime soon.

    This whole situation is central to the debate about growth in India in the coming years (and we have already talked about some of the consequences of the situation in the comments on the housing bubble post).

    Basically we are likely to see a continuing large inflow of funds into India, and this will produce local distortions in house prices, and probably later-on this will include excesses in investments etc etc. It is this liquidity background which makes the large increase in infrastructural investment in India a realistic possibility.

    On the other hand, this inward liquidity gradient will also make it very hard, for example, for the RBI to control long term interest rates, or to stop the rupee from rising. It will also make it hard from them to control inflation, although letting the rupee rise might be one way to do this, the thing is just how far and how fast, since India will also need to export to be able to import the machinery and equipment needed for development with the latest technology, so exports are vital if you don’t want the trade deficit to continue and deteriorate.

    These are all factors which you need to think about in the present context, but they are all going to make it difficult to -as it were – ride the tiger, since government won’t have the level of control it would like to have (in the good sense, there does have to be a good sense, doesn’t there, since if there isn’t how, otherwise, can you direct complaints about ‘sizzling growth’ to politicians). Basically, as we have just seen in Thailand (since the government rapidly had to back off) you can’t take globalisation in parts, and to a certain extent you inevitably lose local control. (In passing I would note that this issue is far from resolved in China, and it is, of course, leading to huge distortions).

    Comment by Edward — December 20, 2006 @ 12:28 pm

  9. Another comment just disappeared on me. Lets try again:


    I think you say something which makes one of the problems in the debate explicit, so forgive me if I use it as an anvil:

    “It’s all about getting the policy right.”

    No! It isn’t ALL about getting the policy right. Policy isn’t everything, I think this is the whole point. If this was the case then that would reduce economics to politics, which it isn’t. This is the danger in some of the way some people are seeing things at the moment.

    Economic systems are to a great extent self-organizing ones.

    Apart from policy, there is evidently an inbuilt demographic component in the Indian situation, and this is going to have an impact whatever the policy. It is this component that most of the ‘pessimists’ on India seem to ignore. Or I could correct that, since in the case of Germany and Japan it is the ‘optimists’ who tend to ignore demography: the point is that those who don’t think that demography is important, don’t think it can either help India or hinder Germany and Japaan: On this account all that matter are structural reforms. But, as I say, this is a kind of policy reductionism, and it IS to reduce economics to politics.

    Now I am not simply arguing the reverse side of this. I am not saying it is only demography, but I am saying that demography is PART of the picture, and we need to try and measure the importance of this component.

    Looked at another way, where did India and China’s huge populations come from? Children don’t just grow on trees, and fertility forms part of a whole complex of social and economic processes, so one day someone will need to scratch around and look into all this a bit more thoroughly, then perhaps we will understand a bit better the massive imbalances we are currently trying to grapple with at the level of the global economy.

    Sorry if I took a phrase which I am sure you might like ot modify, and used it to my purpose, but I do think that even if it was a slip, it was an interesting one.

    Comment by Edward — December 20, 2006 @ 12:48 pm

  10. edward,
    in complete agreement with your post. the worst part about the thai situation is that it is the byproduct of the de facto dollar peg of china which causes global imbalances and the hot money has to find a home. and in november many countries started trying to reduce their holding of U.S dollar which was why there were spikes in the thai bhat which made the government there try to enforce capital controls. what i am scared about is that since india already faces such high inflation the rbi has lesser control on the credit spreads, and excess liquidity can cause asset bubbles.
    and regarding economic aptitude i studied till the 12th grade in india and im a freshman in the US now and what i learned in the few classes of economics in high school in india was conceptually basesless compared to the approach taken by the classes here. if the subject is just thought in the right way in high school it would make a huge difference.
    there is this great blog by brad sester at rge global economics

    Comment by krishna cherukuri — December 20, 2006 @ 2:00 pm

  11. I don’t know why the server doesn’t like me all of a sudden, but I have to keep multiple posting comments:

    “what i am scared about is that since india already faces such high inflation the rbi has lesser control on the credit spreads, and excess liquidity can cause asset bubbles.”

    “it is the byproduct of the de facto dollar peg of china which causes global imbalances ”

    I think the dollar peg is one factor but it is more complicated than this. The dollar peg only exacerbates a situation which would still exist in any event. China may be big, but she is still comparatively poor, and cannot shoulder alone this huge imbalances which have been building up. Trying to put all the weight on China will simply crash China and then we will have an even bigger mess.

    Needless to say, I think demographic asymmetries form an important *part* of the picture here, especially when you apply the Modigliani life cycle model to populations.

    “there is this great blog by brad sester”

    Yes, I agree, although Brad and I differ somewhat, we have a pretty amical debate about all this, in true blogging spirit. Incidentally can I also recommend Claus Vistesen’s blog, since he has a slightly different take from Brad. Just leaf back through the posts and you will find plenty on all this.

    Comment by Edward — December 20, 2006 @ 3:36 pm

  12. Thank you for your comments.

    Patel: The model I was using was
    Actual Real GDP Growth = Trend Growth +/- Cyclical Growth
    Trend GDP Growth = Productivity Growth + Real GDP Growth
    You’re right in saying that I ignored the cyclical component. But the purpose of the post was different: it was to say that no matter what the cyclical component is, it will not change the fact that our average growth rate over the next 5 years will likely be 8% (or 10% in the optimistic scenario). So suppose the cyclical component was -1% for 2007, and GDP growth comes in around 7% – that implies that GDP growth in one of the next three years will be 9%. I know this is crude, but I’m just trying to highlight the relative importance of trend growth vs. cyclical growth.

    Loose fiscal and monetary policy has certainly given an unsustainable stimulus to the economy, but ideally, as that stimulus is withdrawn and cyclical growth falls, rising productivity and labor force growth fills the gap – this is the central bankers’ “sweet spot” and it is what I am arguing is likely to happen in India over next few years.

    Alphie: Ideally speaking, productivity should be measured in output per hour (as it is in the US thanks to a tireless Bureau of Labor Statistics). However, as economists, we have to live and operate with the data that is available, and unfortunately, in India labor statistics are terrible (most of the series last reading was in 2002, and they don’t even attempt to measure hours worked). My guess is that this is mostly because large pockets of the economy are ‘informal’ (ie. Not reported) and thus tough to measure on a meager budget. In my analysis the measure for productivity is Real GDP per worker. If I can find better numbers, I will certainly adjust the analysis.

    “There is a limit to the amount of hours a worker can work, so there is a cap on the amount of productivity gains that can come from workers working longer hours,”

    Theoretically, the number of hours worked should be captured in the labor component and not the productivity component. Also, you should take note, that hours worked is an issue only when analyzing productivity growth in developed/mature economies – since their labor force participation rates are high, and there is a visible limit to how much output you can add simply be adding more labor (or hours). In developing economies, where participation rates are comparatively low and under-employment is comparatively high, there is a much longer ‘catch-up’ phase for hours worked.

    “Many Americans now find themselves trapped into working longer hours simply to pay for their bigger houses and expensive cars…that they’d gladly give up if it meant they could work less.”

    That last statement is a big leap of faith, my friend. But I understand your larger point that as people’s incomes grow, they have less of an incentive to increase their productivity or their labor input (That’s why 4% productivity growth in India is considered ‘normal’ whereas in the US it would be considered a ‘miracle’ – hence the title of the post). Remember, real GDP per worker in India is still less than 2% (even at purchasing power parity, it is still less than 9%) of what it is in EU/Japan/US, so the average Indian worker’s productivity has a long way to go before one can apply the same logic as one would to workers in the developed world.
    “Are Indian workers willing to sacrifice further economic gains for more leisure time once they reach a comfortable level of income…like many Europeans, or do they tend to be insatiable in their desire for more and more wealth?”

    I guess we’ll find out once Indians reach that comfortable level of income

    Krishna: Thanks. As Edward noted, a lack of economic understanding can sometimes manifest in the most marvelous ways. I still think that Indians’ desire to improve their material condition trumps their desire to condemn outsiders. (Am I am too hopeful?)

    Chandra: not sure where you got the 15% jump in TFPG… I have TFPG at 4.1% from 2001-2005 and 4.7% from 2006-2010. As for your other question whether the logic of TFPG is circular, if you think about GDP growth and productivity conceptually, TFPG is essentially that part of GDP growth which can’t be accounted for by more workers, or more capital. It is ‘everything else’ that powers the economy. Now in mature economies, this ‘everything else’ is fairly small since the increase in capital and the demographic component tend to capture most of growth. However, in economies where there is a lot of structural change happening, it tends to be high (in fact, the US growth from 1995-2000 was largely powered by TFPG). There have been some studies of TFPG at the national level, and also those comparing the TFPG of different industries, and all point to the same thing… that structural changes (whether it’s the introduction of a new powerful semiconductor, or the implementation of policy reform) impact productivity directly via TFPG. So yes, there are some intellectual problems in trying to figure out what ‘everything else’ will be in the future – but it’s not impossible.

    As for your second point, I concur with Edward that, insofar as growth and productivity is concerned, it is NOT all about policy. It is largely about globalization. Yes, the initial opening by the government was important for Indian businesses. But from then on, it was the competitive pressures of globalization which led them to greater efficiency (and profitability). Nevertheless, policy does serve an important function: it provides us with the framework under which workers can increase their productivity.

    Comment by Nanubhai — December 21, 2006 @ 12:16 am

  13. Nanubhai and Alfie

    Alfie raises an interesting point here:

    “There is a limit to the amount of hours a worker can work, so there is a cap on the amount of productivity gains that can come from workers working longer hours,”

    Really the point I want to make relates to the question of what we are actually talking about when we talk about productivity. You see if you read the above sentence carefully you will notice something strange: I mean on the simple, basic and intuitive level, how can productivity be to do with working longer? Isn’t it all to do with producing more in the same time (or, hopefully in less time)?

    Well, yes and no.

    The problem comes from the fact that when we talk loosely about productivity, we are often talking about a number of different things, and in particular both:

    1) The productivity of a society
    2) The productivity of an individual

    And these two are not necessarily the same thing at all.

    In fact Alfie’s point about people working longer hours has little to do with individual productivity changes (indeed individual productivity may well drop a little beyond a certain point as things like fatigue set in, and especially if you don’t measure output simply over a weekly basis, but look at – say – the lifetime productivity of the individual).But it does have everything to do with productivity at the societal level, because it indirectly boosts participation rates.

    I mean there are two ways to increase labour market participation: either you have more people (a higher percentage) working, or you have the same percentage working more (the indirect path). Both of these increase societal productivity because of the issue of dependancy ratios and tranfer payments, since effectively some people working more hours does raise the average per capita income of an entire society on an annual basis.

    This type of productivity increase is often termed having a ‘more efficient labour market’.

    But it is not entirely clear that people really have always thought about what they mean by efficient here. Obviously most developed societies have raised per capita incomes in part by raising female participation rates, and this, from a gender equality point of view, is fine and excellent, but it is also the case that increasing such participation rates beyond certain levels may be detrimental to fertility (and of course almost all these societies now have below replacement fertility) so it may well be that if you squeeze the lemon beyond a certain point, the overall impact is negative. We need yet one more time to think about the time scale over which we measure the ‘efficient’ component.

    Also, according to one well known biological theory of ageing – the rate of living theory – burning the candle now may result in less candle to burn later. This theory is almost certainly too simple in terms of details, but it still does offer a fairly good approximation to how life expectancy works, and, of course, as the theory would predict, life expectancy in the US (where people work rather longer hours) is significantly lower than in most Northern and Western European countries (where people work rather less). So again it depends exactly what you want to mean by ‘efficient’. Of course, individuals in the US may well be exercising what appears to them to be a perfectly rational choice of having more money now in return for fewer years later. It all depends on the relative value you put on money and time, and as Milton Friedman would have reminded us where he still alive (and going by the age he lived to he didn’t burn the candle that intensively himself) accounting for these kinds of preference decisions is beyond the remit of the economist: ie ask a sociologist or an anthropologist.

    So this is the working longer part of the story, but then there is the individual, labour productivity, angle. Now really this, viewed over the longer term, would appear to be much more interesting, but again, we need to be careful to be clear what we are talking about.

    A person can be more productive for a variety of reasons:

    a) because quite simply they run faster, ie they work with more vigour, more intensively. We all know how this works in our own individual cases. Equally we know such intensity cannot be sustained permanently. One way productivity can be raised at the company or organisation level then is to have a labour market which runs on a lot of temporary or short-term contracts, and try and employ each individual just for the period of time you can keep them motivated to work on their most intense level, then move on to the next one. From what I can see soccer teams at the top level increasingly work like this. Ronaldinho is reputedly the best player in the world, but the idea of giving him a lifetime playing contract is a hugely controversial one.

    b) because they run at the same speed but with more modern capital equipment (this is what Nandan calls capital deepening), and it appears to show a higher level of labour productivity, although the improvement may have little to do with the labour input, however certain kinds of work may increasingly require a better prepared worker (the skill-bias argument).

    c) because the same worker with the same machine operates in a more favourable institutional environment (better transport systems, more efficient financial markets and lower interest rates, IT driven logistics and planning, eg WalMart, restructured and outsourced company etc). This is possibly the least evident of the reasons for improved productivity, but at the end of the day may well be among the most interesting, and it is of course why the reform process in India is so vital.

    d) because the same worker at the same machine is healthier and better educated. This is not that dis-similar from (c), but is perhaps worth treating under a separate header, since it does raise a slighly different set of issues and has another focus of debate.

    OK, that’ll do for now. All this has been rather long-winded perhaps, but I hope it will make some of the issues involved in the term ‘productivity’ a bit clearer for the non-economist.

    Since most of the issues are not really that hard to understand in principle (as opposed to treating it theoretically, since productivity is probably one of the most difficult topics in economics), getting a clearer picture of what ‘productivity’ is all about may help people participate in a more mature political debate about exactly what kind of society they actually want in India, and not remain simply blinded by science from the ‘expert’.

    Comment by Edward — December 21, 2006 @ 1:55 pm

  14. Edward,

    I guess I am one of those guys who don’t think much about the impact of demography – Japan and Germany just won’t fade away, economically speaking.

    “Economic systems are to a great extent self-organizing ones.”

    This true. But we are talking about growth. Sure socialists countries like India, at least until recently, had an economic system but it didn’t do much for the vast majority of people because of usual problems associated with command and control economy.


    any number of examples show that it is crucial to get policy right: cell phone industry growth, for example – growth didn’t come around until the policy was cleaned up – and that took 10 years to get it right. While current globalization provides for current growth, without reforms in the economy, future growth is not a given (India’s economy is still very restrictive). That’s why I was not sure where the bump in productivity would come from. I understand productivity gains due to tech transfer. And I realize India is 40% productive than most western countries (I think it is less than China too) – so there are huge gains to be had.

    Using your #s 4.7/4.1 = 15% jump from ’00-04 to 05-10.

    Comment by Chandra — December 22, 2006 @ 12:42 pm

  15. Chandra,

    My TFPG forecast for 2006-2010 (which I have revised down slightly – see updated chart) is still lower than what TFPG has been from 2003-2005. It is higher than the 2001-2005 average mainly because we had two years (2001-2002) of extremely low growth/tfpg.

    Comment by Nanubhai — December 22, 2006 @ 9:05 pm

  16. The Great Indian Sell Off

    The Indian Economy has seen several ups and downs; more recently ups in the much heralded Post-Liberalization Era. The booming stockmarkets, overflowing Forex Reserves, multiplying billionaires, IT and India’s very own entrants in the elite Fortune 500 Club point to a success story in progress. Major contributors? In my opinion, not the foreign MNCs trying to get a foothold in India, but our homegrown MNCs. These companies have given tough competition to the mega-giants and have prevented them from hijacking and puppeteering our growth.

    But an old phenomenon is making a comeback, threatening this success story – Divide and Rule. The eyes of the world are on India. Phrases like fastest growing, largest potential markets, and largest youth to population ratio prefixed with India are turning greedy eyes towards India. Vodafone sniffing for Hutch being one of the latest examples. And it is Indians who are most vulnerable to this latest invasion. Their short-sighted approach is leading them to believe that selling off their companies to foreign giants for a quick billion would restrict the growth of their competitors on the home-front. Little do they realize that they are facilitating the entry of a much more predatory competitor from abroad.

    Take the case of Vodafone trying hard to acquire Hutch. The world’s largest telecom operator valued at over $150 billion is desperate for the deal to make its disgruntled shareholders back in UK happy. With its seemingly unlimited cash reserves, it may arm-twist its way into India. The scene will get much uglier with Vodafone resorting to monopolistic practices, something it is well-known for.

    This immediately puts Indian players at a disadvantage. I would prefer that capital stays in India, and this is only possible if Indian MNCs are preferred over foreign behemoths during takeovers. I see it as the best way of keeping the Indian initiative intact and potent.

    Context: Just wondering how would something like this affect the growth of the telecom sector of India.

    Comment by Parikshit Gupta — December 23, 2006 @ 6:13 pm

  17. Chandra,

    “I guess I am one of those guys who don’t think much about the impact of demography – Japan and Germany just won’t fade away, economically speaking.”

    Well, OK. No problem. But remember this: the situation may be symmetrical. That is there may be an ageing demographic penalty which is akin to the demographic dividend, as the median age of the workforce rises over a certain age, and as the elderly dependency ratio rises. So underestimating it on the one side probably implies underestimating it on the other. That is to say just as the upside risk on India is considerably reduced, the downside risk on some of the elderly economies begins to grow.

    No Japan and Germany (and Italy, and those about to join them like Scandinavia) will not simply fade away, they will very much make their presence felt, and this is part of the whole issue, since they will be increasingly export driven (and increasingly run trade surpluses), and all that saving makes money very, very cheap, which of course makes it very difficult to slow growth in India (if you think it is overheating), etc etc.

    This I think would be the point.

    Comment by Edward — December 23, 2006 @ 7:56 pm

  18. This post, which is excellent, by the way, tackles a broad macroeconomic topic without giving cultural issues their due, and may be its stated objective was well met without stepping out of bounds, as it were. However, any time one ventures into very broad economic projections, one must address the essential drivers of broad economic trends and they are never purely economic. They are sociocultural. If broad economic outcomes could be accurately predicted through models, then, well, economics would be a science. But it is not, and that is the genius as well as sheer fun of economics as an intellectual pursuit.

    A case in point regarding the economy’s sociocultural dependency is Japan. Its economy’s unusually prolonged downward trend may have been somewhat cyclical and somewhat demographic and somewhat due to tactical errors – as in, paying for a lot of past sins – and hence accountable by pure economic theory, but the main reason for its reversal was the unusual sociocultural traits of the Japanese society. And the main reason for its recent upward trend is again the sociocultural globalization of the previously insular Japanese society.

    As another example, America’s success, despite the fact that its polyglot mess should make it the most unlikely candidate for success, is largely attributable to the state of mind that is America – again a sociocultural driver of the economy. After living here for over 33 years, I continue to be amazed by this society’s nimbleness at adapting and changing. No traditional society could do that without a massive social upheaval which, dear economists, will kill the golden goose that we call the economy.

    My question then is: what are the core sociocultural values of India that might help or hinder the economic scenarios suggest by this post? As an Indian, I have my educated guesses. But I would like to defer to Nanubhai’s opinion on the subject.

    Comment by Floridian — December 25, 2006 @ 4:52 am

  19. Floridian,

    Firstly, thanks for your comment.

    In my view, productivity and demographics are themselves indicative of a nation\’s socio-cultural values. Like all other social \’sciences\’ the purpose of economics is relatively simple: to observe realities via unnecessarily complex models; and then to extrapolate – either simply for the sake of knowledge, or to make lofty prognostications, or to tell others what they should do (or in most cases, all of the above).

    Productivity, in essence, tells us what an average worker is willing to (and can) do with a fixed amount of time. For better or worse, the majority of the country fits into the role of \”worker\” and what they do directly affects the \”non-workers\”. Workers drive the level of material change in any capitalist society and they are driven by all kinds of things: family, education, religion, language, level of opportunity, and values. Furthermore, what they do, in turn also influence all these things.

    Now, I realize I haven\’t answered your question. I was simply trying to highlight that what economists do is integrally related to what any other social science does. Now, I’m not a sociologist (nor, for that matter am I technically an ‘economist’ – no PhD!). Since I took my shot at productivity, I’ll take a crack at your question.

    Socio-cultural values (and factors) which can \’help\’ the economy

    A nationwide belief in individual freedom
    A strong national identity
    A vigorous argumentative spirit
    A strong sense of tradition, heritage, and family
    A desire for progressive change
    Selfishness (within the bounds of the law)
    A strong work ethic
    A genuine appreciation for education, knowledge, and creativity

    …and many more

    Values which can hinder the economy:

    A sense of entitlement – “Babudom
    Communalism and sectarianism
    Deference to authority and power
    Fear of change
    Aristocratic or oligarchic socio-stratification
    Selfish outside the bounds of the law – corruption
    A fear of science and knowledge which challenges one’s preconceived notions

    Comment by Nanubhai — December 25, 2006 @ 1:34 pm

  20. May I add a few of my own?
    -The Indian view of the family unit as a cohesive economic enterprise much like a corporation, a trait that might have a significant positive impact.
    -On the negative list, the centuries old habit of forming and adhering to multiple hierarchies, which modern business has eschewed in favor of the flattening of hierarchies.

    There are many positives and negatives, but I do understand the limits one must put on the scope of economics if it is to remain relevant. After all, no discipline can be so wholistic.

    Comment by Sarat — December 25, 2006 @ 7:15 pm

  21. […] As for the asset markets – even after the run-up of the SENSEX, India’s market-cap to GDP ratio is still around 95%, which is lower than countries like South Korea (100%) and South Africa (240%), as well as developed capital markets (which range from 120% – 400%).[…]

    whoever said the above statement, it is a wrong metric to look at when understanding the valuation of any equity market. ex: If sensex reaches 200% market-cap to GDP ratio this year..that means the average PE of indian equities would be around 45-50, which is a dangerous level. (MarketCap = total earnings of all listed companies * avg. PE of the market) is not at all corelated to GDP. The PE ratio is a much better multiple that hints you if a market is over-valued. Indian equities has to consistently deliver earnings growth north of 15-20% for the next 2-3 yrs to even justify the current PE multiple. Our PE multiple is higher than china and south-korea, which means there’s lot of froth in our valuations.

    There are certain set of companies delivering higher earnings growth (in the order of 30%) which deserve a higher PE. but, earnings for 70% of indian equities are tied to GDP growth which means these companies were just riding on the wave of good companies and would take a hard-hit once realities set in.

    The GDP range of a country doesn’t tell you how many companies conducting business in that country selling goods/services to those consumers, how many of them were listed on bourses, what’s the total market-cap of these listed companies> Gross Domestic Product /market Cap is a superflous ratio and could not be statistically used to determine the relative under/over-valuation of equities in an economy in relation to other economies.

    Comment by Krishna Moturi — January 19, 2007 @ 10:40 am

  22. Nice piece.
    Its hard to find well researched economic pieces on the Indian economy. Much of it is just self-congratulatory fluff.
    Will keep coming back to this blog.
    Well written and enlightening to read!

    Comment by Aditya — January 29, 2007 @ 4:03 am

  23. [...] In its lead article, the Economist challenges two big notions that have been raised on IEB: one is the idea of the demographic dividend, and the other is the idea that Indian productivity has seen a step-function increase in the early part of this decade. “Many Indian economic commentators say that further structural reforms, though desirable, are not essential to keep the economy growing at 8% or more because of the “demographic dividend”.” Even our own Edward Hugh, perhaps the biggest proponent of India’s demographic dividend that I have come across, probably would not sign on to this. As I have repeatedly stressed here, the Economist is making a political judgment: ‘reforms are essential; and the government (and the, ahem, optimistic economic commentators) don’t realize this.’ “Yes, the economic reforms of the early 1990s spurred competition, forced firms to become more productive and boosted India’s trend—or sustainable—rate of growth. But the problem is that this new speed limit is almost certainly lower than the government’s one. Historic data would suggest a figure not much above 7%—well below China’s 9-10%.” [...]

    Pingback by The Indian Economy Blog » An Overheated Debate About India Overheating — February 2, 2007 @ 9:41 am

  24. [...] INDIA: Productivity Miracle: [...]

    Pingback by Agenda & Objectives: « Siva Moturi’s Economic Policy Critique Blog — August 1, 2007 @ 2:42 am

  25. Thanks for the interesting article on an important research topic. Here is a point I like to make. There is a limit in every sector to the increase in physical productivity of labour. And some sectors show a greater limitation in the possibility of raising labour productivity. At the same time the cost of labour is guided by the increasing wages in the productive sectors. This is called as the cost disease plaguing many social sectors where the very nature of operations is such that the productivity cannot be raised(doctors, teachers etc).In such a milieu only an inter-sectoral analysis of labour productivity seems to be useful.

    Comment by shyamsundar — August 13, 2008 @ 3:23 pm

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