9% growth target: How India can sustain GDP momentum

Structural changes in the factor, product and labour markets should be given priority

In the medium to long run, gross domestic product (GDP) growth will depend on the increases in the supply and productivity of capital and labour. While the growth of labour supply depends on the growth of working age population and changes in labour force participation rates, the pace of capital stock growth depends on the rate of growth of investment. Although India does not face a challenge with respect to labour supply, the quality of labour has become a big concern and will remain so in the foreseeable future. This, coupled with current weakness in investment demand, has emerged as a major challenge for sustaining growth momentum in the economy.

Labour productivity in India has fallen significantly in the current decade compared with that in the previous decade. This basically implies that GDP growth has been decelerating more than labour input growth. If India has to achieve a GDP growth of nine per cent, it will have to raise its labour productivity growth by 73.8 per cent over the rate achieved in FY15.

However, labour productivity is only one factor or a partial factor productivity measure and does not provide a full perspective. For example, low labour productivity would mean production inefficiency, but it could be a response to the relative labour capital price mix being faced by the economy. In labour surplus economies, production lines may be deliberately organised to use this abundant and cheap resource, leading to lower levels of labour and high capital productivity. This is why total factor productivity (TFP) has emerged as a better measure for the overall efficiency of a country's production. TFP  is the portion of output not explained by the amount of inputs used in production. As such, its level is determined by how efficiently and intensely the inputs are used in production. In this method, GDP growth is decomposed into sources from factor inputs such as quantity of labour, quality of labour, ICT capital, non-ICT capital and TFP growth. 

A glance at two and half decades of data shows that non-ICT capital, TFP and labour quantity are the key drivers of GDP growth in India. Although the contribution of labour quantity to GDP growth fell to 17 per cent during 2011-2014 from 31.2 per cent during 1991-1995, it is still a significant contributor to GDP growth. However, the same cannot be said about labour quality whose contribution to GDP growth fluctuated in the range of 0.8 per cent and 4.2 per cent during 1990-2014.

Non-ICT capital has been the single largest contributor to GDP growth and continues to be so even now. Also, it is more stable in terms of its contribution to GDP growth. In fact, the contribution of non-ICT capital to GDP growth increased to 51.4 per cent during 2011-2014 from 38.7 per cent in 1991-1995, though not in a linear manner. But the contribution of ICT capital to GDP growth increased in a linear manner to 24.2 per cent during 2011-2014 from a meagre 3.2 per cent during 1991-1995. This indicates rising investments in ICT and its contribution to GDP growth. Unlike technological advancements which are largely confined to manufacturing, the impact of ICT permeates into almost all sectors of the economy and brings about significant gains. This can be seen from the transformation and productivity gains that the wholesale/retail trade or banking sectors have witnessed during the last decade.

In terms of contribution to economic growth, TFP has played an important role in India. The average TFP growth for India during 1991-2014 was 1.6 per cent. China for the same period witnessed TFP growth of 2.7 per cent. Although India's TFP growth does not show any systematic pattern, it rose to 3.8 per cent during 2006-2010 from 1.2 per cent during 1990-1995 but dropped to 0.3 per cent during 2011-2014. As a result, the contribution of TFP to India's GDP growth declined to a meagre 4.6 per cent in 2011-2014 from a staggering 46.2 per cent during 2006-2010. 

Therefore, it can be argued that the dip in economic growth during the first half of the current decade is largely due to the dip in TFP growth. Even in China when GDP growth slowed to 4.5 per cent in the second half of the 1990s from an average 9.7 per cent during the first half, it was due to the slowdown in TFP growth, which dropped to negative 1.3 per cent from 4.6 per cent. 

Although historically capital accumulation has played a more significant role in promoting growth across various countries, the relative contribution shares of various components are not constant across countries and over time. In India, investment to GDP ratio remained range-bound (21.1 per cent to 27.3 per cent) during 1991-2004, but TFP growth fluctuated in a wide range of negative 3.4 per cent to 3.3 per cent during this period. However, the period 2005-2010 saw a synchronised movement in investment to GDP ratio and TFP growth. While investment to GDP fluctuated in the range of 34.9 per cent to 39 per cent, TFP growth fluctuated in the range of 2.3 per cent to 4.6 per cent. This synchronous movement, however, broke down during 2011 to 2014, as investment to GDP remained high in the range of 35.9 per cent to 39.4 per cent, but TFP growth dropped in the range of negative 0.7 per cent to 2.1 per cent. This shows that capital accumulation alone does not guarantee TFP growth. More crucial is the capability of a country to assimilate and leverage the capital accumulation as reflected in both ICT and non-ICT capital and combine it with labour input to reap benefits. Given the policy paralysis and stalled projects India failed to do this during 2011-2014 and thus, while investment to GDP remained high, TFP declined, pulling down GDP growth.

It is therefore imperative that structural changes in the factor, product and labour markets are given priority to allow economic agents to combine inputs efficiently and intensely to generate higher TFP. This is critical for accelerating and sustaining GDP growth over the medium to long term. Sooner the policy issues relating to land acquisition, goods and services tax and labour market reform are settled and/or implemented, the better it is for the Indian economy.

Sunil Kumar Sinha is principal economist and Devendra Kumar Pant is chief economist at India Ratings and Research. Views are personal