Nobel laureate Paul Krugman in his 1990 book The Age of Diminished Expectations offers insights into the problems faced by the US in the late 1980s and asserted that the economy had not delivered much in the preceding years.
A key issue that Krugman identifies, which pushed the economy into an era of diminished expectations, is slow growth of productivity. Given the prevailing uncertain global economic environment, it is important that India recognises the need to enhance productivity in the economy.
Unleashing Prosperity, a 2008 report by the World Bank, shows how improved productivity led to economic growth in developing countries during 1999-2005.
Since then, the global financial crisis and the pandemic have caused deep economic disruptions, leading to uncertain conditions. As economic activity plunged during the pandemic, some firms took bold steps to transform their business by accelerating the pace of digitisation and deploying other technologies.
Digitisation drive
But such initiatives have been taken mainly by large firms. Increased investments in new technologies have the potential to raise productivity by substituting employees or raising output per worker. This has to be scaled up to raise the economy-wide pace of productivity growth for which human and physical capital accumulation need to be sustained. Prevailing global conditions do not offer conclusive evidence on enhanced capital accumulation.
Regarding human capital, there has been an accelerated adoption of fully digitised approaches to learning but the temporary closure of educational institutions due to lockdowns has impacted skill formation negatively. There has also been a negative impact on short-term accumulation of physical capital.
For example, in the US, total investments, which grew by 5 per cent between 2015 and 2019, remained flat between the third quarters of 2019 and 2020 and Europe experienced a much steeper drop in overall investments. While capital accumulation is picking up, albeit at a slower pace, it is important to focus on productivity growth, to reap the full potential of increased investments.
India faces two problems while attempting to enhance productivity growth. First, by global standards the productivity level is low. Second, there is a trade-off between employment growth and productivity growth. Regarding the former, research done for the Reserve Bank of India shows that India has achieved a more than five-fold increase in labour productivity during 1980-2017, with an annual average growth rate of 4.5 per cent. The RBI data also indicate that India has one of the lowest labour productivity although it has one of the highest average annual growth rates. The Global Productivity Report 2020 confirms that the fast growth in productivity narrowed the productivity gap with the advanced economies, but the level of productivity remains very low in India.
Despite the multi-fold increase, India’s labour productivity is only three-fourth of that of China, around half that of Brazil and Thailand, a mere 20 per cent of that in Japan and 13 per cent of that in US.
The study aptly summarises the challenge: “If India wishes to emulate China and achieve the same economic might, then it also must narrow down the relative gap in labour productivity by adopting suitable policies to increase its labour productivity at a faster pace...”
To assess the trade-off between productivity and employment growth we need to examine trends in productivity of all the factors involved in the production process. Here again, evidence from the RBI (RBI Bulletin, January 2023) shows there is large heterogeneity among sectors.
For agriculture, there is positive productivity growth in 2010-19 over the period 2001-10. Within the low and medium-technology manufacturing, productivity growth is highest in textile and textile products, rubber and plastic products, coke & refined petroleum and other non-metallic mineral products. These sectors, which saw an increase in productivity growth, however witnessed a decline in employment growth during 2011-19 as compared to 2001-10.
That is, the sectors with higher productivity are also witnessing labour displacement. Within services, business services registered increase in productivity growth, but this is not commensurate with growth in employment. Evidence shows that in India the acceleration of productivity is not broad-based among firms and sectors. It is higher in sectors that were already ahead of their peers. Some large sectors within services, as well as some sub-sectors of manufacturing, have seen less progress in enhancing productivity.
At the firm level, productivity acceleration appears to be concentrated among the big ‘superstar’ firms, across many sectors. This is because of these firms lost less revenues during crises, including the pandemic, while their smaller counterparts experienced a decline in revenues during crises.
As decline in revenues impact productivity-enhancing investments, divergence in productivity growth is observed. Investment in technology has lifted productivity for some sectors and firms, but its benefits have not been fully captured or broadly shared.
Relying too much on digital technologies might not provide the answers, as a recent survey by McKinsey in the US reveals that digital transformations fail five times more often than they succeed. The key here is to assess the benefits of current technologies and ensure that their dividends are spread economy-wide.
Productivity growth is low globally now. But industrialised nations already have higher levels, so lower growth rate does not affect them.
The writer is Professor of Economics at IIT Madras and currently Advisor to Prime Minister’s Economic Advisory Council. Views expressed are personal