Opinion: India’s Productivity Crisis & How It Can Be Solved

Opinion: India’s Productivity Crisis & How It Can Be Solved

In conversations about economic growth, usually only two components of growth are talked about. Those are capital and labour. Capital is the investment in land, machinery and tools that labour then uses to produce output. The greater the output, the higher the GDP and hence, richer the country.

There's a third variable here that's arguably more important but completely ignored in the discourse — Total Factor Productivity (TFP). For instance, agricultural output depends on how much land is available (capital) and how many workers can be hired (labour). But farming techniques play an important role in output. Drip irrigation allowed the same yields without a commensurate increase in water costs. TFP refers to all such improvements in output that are achieved without increase in either capital or labour.

As late as 1880, 50% of the US workforce was employed in agriculture. In 2025, that figure is less 2%. Yet, the US is able to grow much more food today than in the 19th century. All of these are possible due to improvements in productivity.

The same story repeats in India. Prior to the Green Revolution, food shortages were common. As is well known, India famously imported wheat in the 1960s from the US's “PL 480" aid programme. High Yielding Variety (HYV) seeds were later adopted by farmers starting in 1966-67. The outcome was a tripling in yields of cereals, with only a 30% increase in land area cultivated. Wheat and rice also saw their yields increase. In general, modern farming techniques use less land and labour while producing more food than humanity has ever produced.

This is the very definition of abundance and wealth. Everyone has access to as much food as they wish to consume. So much so that we have GLP-1 pills to help the obese lose weight by reducing their hunger levels.

This occurs across the world. Due to the Industrial Revolution, Britain was able to produce huge quantities of textiles. In fact, it was so dominant, that by 1850 it was producing more than half the world's cotton. Only those countries that put up heavy protective tariffs against British cotton imports were able to have cotton spinning industries survive. With such an advantage across many industries, Britain was able to rapidly industrialise and provide an abundance of material wealth to its citizens. I'm not denying that colonization had an impact. But that wouldn't have been possible without the superior productivity provided by the Industrial Revolution.

TFP in Colombia has stagnated over the past three decades. Consequently, this puts a cap on the amount of economic growth possible. There is mounting evidence to show that the “middle-income trap" is often due to a stagnation in productivity growth.

India's TFP growth. 1955-2019. 2017 is indexed at 1.0. Source: St. Louis Fed.

The above graph shows the growth in India's TFP over the decades, from 1955 to 2019. 2017 is indexed at 1.0. Relative to that, productivity in 2019 was at 1.017. That implies a TFP growth rate of approximately 0.8% per year.

USA's TFP growth. 1955-2019. 2017 is indexed at 1.0. Source: St. Louis Fed.

This graph now shows the US's TFP growth from 1955-2019. 2017 is again indexed at 1. The index of productivity in 2019 is 1.016. That implies a yearly TFP growth rate only a tad lower than India's.

This should be ringing alarm bells. There are three concerns here:

Starting approximately in 2012, India had a boost in TFP growth. For a variety of reasons, that has petered out and now TFP is growing more slowly.

For a rough comparison, India's GDP is roughly at the size where the US was in the late 1980s to early 1990s. As can be seen from the graph, the growth in TFP was much stronger for the US in that timespan.

Growth in productivity gets much harder when you're at the technological frontier. Every improvement gets harder to eke out. Countries that have yet to reach the frontiers of tech, can get this productivity boost for “free" by just copying what has worked for countries higher up the tech ladder. Keeping this in mind, it is worrying that India's TFP growth is similar to the US. This would lead to divergent outcomes and the gap in nominal dollar terms would remain huge.

To understand the stagnation in productivity, let's understand the factors that are causing stagnation.

A useful question to ask is why does the US have such higher productivity? An economy is more productive because firms within its borders efficiently and maximally use its capital and labour. Firms are incentivised to produce goods cheaper than their competitors. As a result, there will be some firms that are more productive with their inputs than others.

If additional capital and labour could be directed towards such firms in proportion to their productivity, we would call it an appropriate allocation of resources. Within the Indian economy, more productive firms often fail to get more resources. That's what is called resource misallocation.

India's political class has an unhealthy obsession with MSMEs. Smaller firms are provided with credit support, regulation holidays and other perks. Naturally some of them will be successful and start to grow big. That's when the benefits cliff kicks in. Growing beyond a point invites regulatory costs far bigger than the marginal value of the product. Given this calculation, these productive firms choose to stay small.

Let's look at some examples of policies that are unfriendly towards large businesses:

The Code on Wages requires a company to seek government permission for layoffs if it employs more than 300 workers. And this is an improvement over prior laws that put the limit at only 100 workers.

India's Priority Sector Lending (PSL) policy enforced by the RBI requires banks to lend a percentage of their portfolio to sectors like agriculture or MSMEs. This is double whammy. First, PSL forces banks to artificially limit loans to the most productive firms. Second, it redirects them to small scale businesses. When these businesses grow big, they'll lose these benefits. Because PSL sectors are inherently more risky and underperforming, banks compensate by charging higher rates from other debtors.

Many electricity utilities in India are under financial distress. The root cause is usually highly subsidised electricity for agriculture. Free resources incentivize indiscriminate use. The costs for the electricity have to be recovered from somewhere. Charging consumers more is a political non-starter. So commercial and industry users bear the brunt of the charges. That causes more wastage of capital that could be more productively used elsewhere.

It would be good to have a comparative measure to know the extent of what the economy is losing out on. Hsieh and Klenow set out to measure it for the manufacturing sector. Using plant-level data from India's Annual Survey of Industries (ASI) and the US Census of Manufacturing, they try to compute the TFP growth that India could have if resource allocation were as efficient as the US. They estimate that India's TFP could increase by 30-50% if resources were allocated as efficiently as the US.

To drive home the impact of this, consider a contrived example. If making 10 cars cost Rs 1,00,000, this increase in productivity would make 13-15 cars in Rs 1,00,000. That means the retail price drops too. The purchase power of the Indian consumer increases significantly. And that's what wealth ultimately is — the ability to purchase more stuff!

It is important to note that it isn't India that uniquely faces these issues. Mexico has been struggling with negative TFP growth for some time. The IMF estimates that correcting its resource misallocation could more than double its productivity!

India's red lines on agriculture came to the forefront during the scuttled India-US trade deal talks. Reportedly, India was reluctant to open up its agricultural sector to the market. There are various political and economic reasons why. I want to focus on the productivity aspect of this.

Agricultural value added per worker. Source: Our World In Data.

Agricultural value added for developed countries like Canada and Australia are $120,000 per worker. That number is $1,500 for India. Practically, that means fewer workers are needed to grow food. The implication is that food is cheaper because it is grown so efficiently.

Barriers to agricultural productivity in India are many. Electricity subsidies allow farmers to pump out groundwater cheaply. Judicious use is disincentivized. Massive fertilizer subsidies deter farmers from looking for efficient ways of using crops.

Another big problem is unclear land titles. 66% of pending civil cases in courts across India involve land issues. While clogged courts affect productivity in their own way, the proximate impact is that farmers are reluctant to invest in improvements for the long term.

Rice yields compared to some developed countries and China. Source: Our World In Data.

Crop yields are a good way to show the disparity in productivity. I've chosen to show only rice yields here, but the story repeats itself in many crops. India produces 4t/ha of rice, the US produces about 8t/ha and China produces about 7t/ha. So both of these countries need approximately half as much land to produce the same amount of rice as India.

It would be wrong to pigeonhole this as an agricultural issue only. In a densely populated country as India, land is a precious resource. More land for agriculture implies less land for industry and housing. Consequently, because demand stays the same, prices have to rise, contributing to the rising inputs in those sectors. In turn, that has second order effects on productivity.

Cities carry immense benefits. They're agglomeration engines. Multiple firms and workers are close to each other. Knowledge spillovers lead to exchange of ideas increasing innovation. Innovation is the only way to increase productivity.

Cities also offer large and diverse labour pools. Specialised skills are easily available. That's one reason why, despite increasing costs, firms still find it hard to leave the San Francisco Bay Area. For employees, there's minimal frictional unemployment and switching costs. Involuntary unemployment being low, workers can continue being productive longer.

As a result of higher density, cities have better infrastructure. Infrastructure provides more returns on investment as the density of a city increases. Supply chains are also easier to setup locally which reduces logistics costs for many companies.

And this is just a partial list of benefits. In light of this, it seems odd that local governments across the country seem intent on enforcing low density norms.

New York City allows a Floor Area Ratio (FAR) of up to 15 in some areas. London doesn't have a maximum FAR. Instead it bases its permission on access to public transport. Tokyo allows an FAR of up to 5 for residential areas while commercial areas can go up to 16.

Other than Hyderabad, no other Indian city has FARs that come even close to these levels. Sparse cities force residents into ever longer commutes affecting productivity. They force industries to pay higher prices for land. And they force residents and firms to disperse which nullifies the biggest benefit of cities.

For firms, the most productive ones should be able to accrue more factors of production to produce more output. That's a fancy way of saying that the most efficient firms should be able to get more land if they want to. A study from the World Bank covering the period 1989-2010 concluded that the most productive firms weren't able to do so. It estimated that improving this constraint could increase worker output by 25%.

There's a common fear that high productivity will kill jobs and lead to unemployment. France put a cap of 35 hours/week of work because of this misguided belief. This is just the lump of labour fallacy.

Productive firms and workers create goods and services cheaply. Cheaper products cause higher demand. So that productivity growth itself created new opportunities. Also, if output itself is high enough, that less hours are needed to produce necessities, new sectors are often created. The entertainment industry is a good example where more leisure contributes to increasing entertainment output. In turn, the entertainment industry is generating demand for workers.

Historically, industrialisation increases productivity and also makes some jobs redundant. But it does so gradually while creating new industries. Automation in factories would have probably contributed to jobs in design. Firms could afford to hire designers to ensure that their products would stand out in the marketplace.

The core proposition is that high productivity increases the size of the economic pie. Effectively, there's more of everything to go around.

I often find it useful to use agriculture as an intuition pump. When a given piece of land could grow only enough food for one family, it would be hard for the family to be generous and give away food. Someone would have to go to bed on a hungry stomach. But higher productivity could allow them to grow more food than their immediate need. Which would allow them to give away food to mendicants.

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Across the economy, higher productivity works similarly. A rising tide lifts all boats.

Rohit Shinde is a US-based software engineer interested in economics and India's policy challenges. He writes at The Indic Prism on Substack and posts on X as @rohitshinde121. Views expressed in the above piece are personal and solely that of the author. They do not necessarily reflect News18's views.

Source: News18
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