India Is Very Much Part of the Global Productivity Slowdown

Despite the success of some Indian industries since the 1990s, we are now seeing a major productivity gap circumscribing the prospects of industrial growth.

A worker separates casting joints of gearboxes inside a small-scale automobile manufacturing unit in Ahmedabad, India, October 12, 2015. Credit: Reuters/Amit Dave/File Photo

A worker separates casting joints of gearboxes inside a small-scale automobile manufacturing unit in Ahmedabad, India, October 12, 2015. Credit: Reuters/Amit Dave/File Photo

In an article published by the Harvard Business Review in 1990, Michael Porter stated, “National prosperity is created, not inherited. It does not grow out of a country’s natural endowments, its labor pool, its interest rates, or its currency value, as classical economics insists”. According to Porter, the answer to consistent innovation by certain companies in certain nations lies in their ability to sustainably strategise, focus upon four broad attributes, constituting what he calls the “diamond of national advantage”. These attributes include factor conditions, demand conditions, related and supporting industries, and firm strategy, structure and rivalry.

Therefore, from conventional economics literature, factors of production (land, labour, capital and entrepreneurship) per se remain marginally important on their own, in explaining the prospects of a firm to enter a given national environment and do sustainably well there over the long run. Simply having a large domestic workforce or low labour costs represents no sustainable means as competitive advantage in today’s internationally competitive environment. And to support this, a given factor of production requires to be highly specialised to an industry’s particular needs and be capable of factor creation through the value created or added (via investment in knowledge-intensive industrial linkages), rather than being “optimally utilised”.

Policymakers in India can perhaps take a closer look at this by drawing some lessons from Porter’s own analytical advice for its own competitive advantage today, if in years to come, it seeks to become a leading manufacturing centre within Asia at least.

Productivity slowdown: A global disease?

Over the last few years, The Economist, through a series of articles, has been highlighting trends of persistently falling global productivity levels across both developed and developing countries. It is bizarre how the geopolitical landscape in parts of both the West and the East seem to be quite isolated in discussing or highlighting the numbers that remain to be seen or gauge the likely socio-economic effects of such trends in the future. The slowdown in global productivity levels seems to physiologically have some kind of a diabetic effect on the global economy body further affecting global employment levels, wages, price levels etc.; and can easily culminate into a deeper economic shock at any point of time. At the same time, there are no direct quick fix solutions to the problem as well.

Measuring productivity is difficult. It tends to be recorded as the residual factor left over when all other growth accounting variables have been taken. In modern growth economics, this is usually done by calculating a metric called the Total Factor Productivity (TFP or portion of output not explained by the inputs used in production), usually used for measuring the allocative efficiency of inputs utilised in production. Assuming inputs are not increasing or have reached full utilisation, an increase in TFP can lead to an increase in output by making extensive resources more productive.

Looking at the figure below, we get a closer idea on the deplorable state of productivity levels (via TFP levels) across all major economies. Before the 2007-08 crisis, the global level in TFP was growing at 0.9% a year and since then it has largely remained stagnant across most regions and countries covered here.

So what can explain these trends? According to Robert Gordon of Northwestern University, “Today’s innovations are far less transformative than the electrical breakthroughs made by Thomas Edison, or the development of the car and the airplane”. Transforming into the age of machine learning, automation, artificial intelligence, robotics; the development of these fields in the developed world is significantly going to affect human performance and labour-intensive machinist tasks across the globe in the future. As machines outperform human performance in a range of work activities, including ones requiring cognitive capabilities, it is critical for major developing economies (like India, China, Brazil) to harness the potential benefits from automation, endogenously, that in a way catalyses productivity across industrial segments without a drastic impact on job opportunities for the new labour entering the market.

One of the other major issues remains our inability to realistically measure productivity even today. Sophisticated growth measurement matrices remain with fundamental arbitrariness of techniques that are employed to distinguish between a production function and shifts in that function. In emerging economies, like India too, a major misspecification is involved in implicitly treating growth as the sum of economic contributions made by distinct exogenous factors alone. In an article written a few months ago, I argued how traditionally used models for productivity measurement tend to inadequately capture the quality changes in new technologies are continually being upgraded to increase efficiency.

While growth accounting explains the difference between the contributions of increasing capital per worker and TFP; yet, there is enough empirical research that points at a widely divergent view on the issue, oscillating between the claims that the process of capital accumulation is fundamental to a country’s economic growth, as against the notion that capital accumulation is largely unimportant in real developmental growth.

The Indian scenario: Cases from automotive and electronics industry segments

In India, TFP growth over the past three decades has remained quite conducive to increasing productivity, with the macroeconomic policy changes brought about, the openness seen in current and capital accounts and the resulting inflow of financial and physical capital. The figure below provides a detailed picture of the Gross Value Added and TFP levels across major industrial segments (26 in total) during 1980-2008. The median growth rate increased sharply for the industries covered below (26 from the original dataset) from 0.13% for 1980-99 to 0.63% for the period 2000-08, albeit there are wide fluctuations in TFP growth rates across industries.

The micro picture in industrial productivity levels seems quite abstruse in the current context. In a recent paper published by the World Bank, we get an in-depth analysis of the automotive industry in South Asia, with India and Pakistan being the two biggest markets in the region. The automotive industry has been one of the most important job creating industrial spaces, not only in South Asia but globally, including in the US.

The study shows how the automotive industry in India alone contributes to approximately around 19 million direct and indirect jobs. Since the early 1990s, with economic liberalisation in India, the automotive industry started booming as a result of the acquired technical and managerial skills from leading original equipment manufacturers (OEMs) of the world who started establishing their regional production centres in India to produce more competitive exportables within the industry for the East and other Asian markets.

However, in spite of the boom and the shining success story of the industry in India since the 1990s, we now observe a major productivity gap circumscribing the prospects of growth within the automotive industry and in its ability to sustainably create more well-paying jobs across the country. The 2016 World Bank study records large-scale productivity gaps that persist with most OEMs together with suppliers in tier 1, 2, 3 all having “subscale, fragmented operations with low capacity utilization, quality levels and investment in skills below international benchmarks”. Another major challenge for the industry in India remains in moving up the global supply chain while competing with other big industrial bases with respect to investment in Research & Development (R&D), more innovation and commercialisation of new products that can create a niche for the industry in the global automotive market space.

Further ahead, looking at the electronics industry in India, the scene looks much worse. The electronics sector, from 1980 to 2000, contributed from 0.2-0.5 percentage points to annual economic growth in nine OECD countries (between 0.3-0.9 percentage points if we only consider the 1990s). The sector, in developing countries too, always had a major potential to grow (with access of more advanced technology from the developed world) and even now remains an important driver of innovation and productivity, a source for the accumulation of technological capabilities and a catalyst for trade and investment.

As per a recent study, electronics companies from the developed first world started relocating to Malaysia, Singapore, Taiwan and Thailand during the 1970s and early 1980s, followed by China, Indonesia and the Philippines, primarily to take advantage of lower labour costs. This shift allowed developing countries to increase their contribution to the global value added in the electronics sector from 11% in 2000 to 30% in 2010.

In India, low labour costs over the last few decades provided an edge to boost electronics firms’ level of competitiveness, both regionally and globally. However, India’s comparative edge in the electronics segment is abysmally lower than East Asian counterparts (China and Vietnam especially). Much of the sector’s prospects in India now remain marred by high trading costs, poor regulatory practices, improper policies and major infrastructural weaknesses. In an article written a few months ago, studying the electronics industry in India, I argued that because of a misdirected policy push towards software in the early 1990s, India lost its comparative advantage in the hardware segment with respect to its trade basket.

Another particular issue in India affecting this sector concerns the lower tariffs imposed on finished goods than on necessary inputs, which discourages local production in selected electronic products. The potential for India to do well in this sector, complimenting other manufacturing spaces, is immense. One simple reason for this is that production in the electronics sector is highly fragmented, where value addition is mostly done in stages across a number of countries before the final goods and services make their way to the consumers.

Therefore, there is a strong need for a robust industrial policy approach by India to push for greater investment in R&D, train workers through human capital development and add value to industrial segments (like the electronics and automotive sectors), and help create more job opportunities within these industries while raising the incomes for those currently absorbed by it. Automation in the future will displace people currently in the labour force in such industrial segments and other areas, and it is important for the state to ensure that alternative employment opportunities are made available, particularly in large emerging economies that are endowed with a big domestic labour base. In the decades to come, opportunities created for smoother mobility for the new and existing labour force in and across industrial segments will be a vital determinant for measuring the economic success of any emerging economy.