Sunil Jain: More bouquets, less brickbats

When Goldman Sachs first came out with its Dreaming with BRICs report which said India would overtake the world's second largest economy, the Japanese one, by 2032 (in real US $s, not PPP $s), most were stunned by the outcome. So much so that India's top-retailer, the Future Group (formerly Pantaloon) reacted by appointing one of the report's co-authors, Roopa Purushothaman, as the head of its strategy function.

And while the growth assumptions used weren't so fantastic (a 5.7 per cent per annum GDP growth till 2020), it got former chief economic advisor Shankar Acharya exercised enough to point out that when the BRICs authors tested their projections by running their model backwards for the period 1960-2000, the predictions were on the ball for most, except for India where the model predicted a growth of 7.5 per cent against the actual outcome of 4.5 per cent! Acharya's reaction, now that Goldman Sachs has upped the sustainable growth number to 8 per cent, promises to be an interesting one. Based on the new, improved, growth projections, India's economy will be even bigger than that of the US before 2050 (in the first one, India's 2050 GDP would have been 80 per cent that of the US). The new report does not report the per capita income number (this would be influenced by inflation resulting from a higher GDP growth) but in the first report, in 2050, India would still have a per capita income which is only a fifth that of the US. 

Productivity will drive this (Average percentage point contribution to growth)
	TFP	K	L	E
1971-79	-2.5	1.2	1.4	2.6
1980-89	1.4	1.4	1.3	1.7
1990-99	1.3	1.8	1.2	1.5
2003-05	3.5	1.8	1.2	1.5
2006-10E	3.1*	2.4	1.4	1.4
2011-20E	3.4	2.7	1.1	1.3
2021-50E	2.3	2.6	0.4	0.9
TFP=productivity; K=Capital; L=labour; E=education Data is for fiscal years; *37.3% of the growth will occur due to productivity (TFP) hikes  Source: Goldman Sachs, Global Economics, Paper No. 152, Jan 2007

Goldman Sachs, though, is not the only one to feel there has been a structural change in India's growth dynamics since 2003. Surjit Bhalla who heads Oxus Investments argues a similar structural break and says there is enough momentum in the economy to even sustain a 10 per cent growth. The new BRICs report then, to use NCAER's director general Suman Bery's phrase, lies in between the Raging Bear of Shankar Acharya and the Raging Bull of Surjit Bhalla.

The crux of the projections is the productivity surge that India will get due to the "demographic dividend" and the "urbanisation bonus" "" essentially a higher educated younger population, increasingly living in urban areas, would be far more productive than the less educated and largely rural population of the past. Various instances are cited to bring home this change. The country's international trade has boomed (the trade-to-GDP ratio rose from 13 per cent in 1990 to around 31 per cent in 2005) while tariffs fell from 48 per cent to around 10; access to finance has increased dramatically and domestic credit-to-GDP rose from 27 per cent in 1991 to around 43 per cent of GDP in 2005; IT expenditure is up to around 6 per cent of GDP from 3.5 per cent in 2001; India had 23 cities with a population of over a million in 1991 and this rose to 35 a decade later (by 2020, another 140 million rural dwellers will move to urban areas, according to Goldman Sachs projections); the list goes on.

All of this, the argument goes, is getting reflected in the huge surge in India's total factor productivity (TFP) "" the movement of surplus labour from low-productivity agriculture to high-productivity industry and services is projected to contribute about one percentage point extra GDP growth each year given how industry/services have a four-times higher productivity than agriculture. Interestingly, the entire analysis pre-supposes no change in India's investment ratios, they remain at the 29 per cent of GDP they were some years ago "" various simulations are made, of higher investment and productivity levels that are needed to attain a 10 per cent growth. The report assumes the reforms momentum will not slow down (land will be available for new cities to come up), but assumes fairly modest increases in the levels of education, and does not assume any increase in the proportion of population in the labour force.

According to the new BRICs calculations, the tremendous productivity surge India witnessed since 2003 (TFP rose from 1.3 per cent per annum in the 1990s to 3.5 per cent in 2003-05, see graphic) is what is driving India's growth. So, while productivity improvement was responsible for around a fourth of the GDP growth in the '80s and the '90s, it accounted for over 40 per cent of the 2003-05 growth, and will continue to account for around 38 per cent of extra growth till 2020.

This is where the report runs into trouble with even those who believe India's on a sustainable growth path which is significantly higher than the 5.7 per cent used in the original BRIC paper. Arvind Virmani, the Planning Commission's principal advisor for development policy, international economics and socio-economic research, estimates that the peak total factor productivity growth potential from the Indian economy is around 2.7 per cent per annum, a far cry from Goldman Sachs' 3.5 per cent estimate for 2003-05. If such surges in productivity don't take place in just a matter of two years as Virmani says, then the contribution of the productivity hike to GDP growth (43.5 per cent in the 2003-05 period according to Goldman Sachs) would also look suspect.

A similar thought is echoed by Bhalla. In a mid-year review of the economy some months ago, while saying India was now on a 10 per cent growth path, Bhalla argued that a one percentage point hike in growth would result from a combination of a greater proportion of those entering the work force and higher productivity.

Shorn of the mumbo-jumbo, total factor productivity is a notoriously difficult variable to capture/measure and is usually a residual factor explaining the growth that the model has not been able to attribute to factors like more investments, more labour, more rainfall and so on. But even if Goldman Sachs has exaggerated the impact of productivity hikes, help is at hand. According to Bhalla's calculations, investment levels in the economy are already up to around 38 per cent of GDP "" so, if it isn't factor productivity that gets Goldman Sachs its targetted GDP growth, it is the sharp surge in investment levels in the country. This makes the growth a lot less self-sustaining than Goldman Sachs would believe (interest rate hikes affect investment spending but not productivity surges, for instance), but that's another story.