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Analyzing India’s growth story

Author : Dr. Taniya Ghosh, and Prashant Parab, Indira Gandhi Institute of Development Research


An analysis of the macroeconomic variables that sustained India's growth.

Keywords : Productivity, GDP Growth, Foreign Direct Investment, Human Capital, Gross Enrollment Ratio

Date : 29/03/2024

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Productivity of a country - defined as the average quantity of goods & services produced per unit of labor input  - determines the standard of living of its residents. A highly productive workforce raises real GDP, earnings, and living standards. India was leading in the race of fastest-growing economy for over two decades before the Covid-19 pandemic hit. What factors influenced India’s productivity and hence its growth?  A reflection on the policies which worked well for India and which did not can answer how India will be able to maintain the high growth momentum it has achieved in recent years. 

Figure 1 – Total Factor Productivity  and GDP per capita for India

Source: World Bank, Authors’ Estimates

A higher productivity of the average worker is synonymous with more physical capital, human capital and technological knowledge. Human capital is the knowledge and skills that employees gain through education, training, and experience, whereas physical capital refers to the stock of equipment and structures used to produce goods and services, among other things. Technological knowledge refers to society’s understanding of how to produce goods & services. It includes new ways of organising work, new methods for ensuring higher output quality in factories, and innovative institutions that aid in the process of converting inputs into output. India’s total factor productivity and GDP per capita have increased consistently. However, with a per capita GDP of around US$ 1900 in 2020, India still lies in the lower & middle-income category.

Modern growth theories assert research and development (R&D) or technological progress as the most important factor in achieving long-term economic growth, along with human capital. Paul Romer was awarded the Nobel Prize in Economics in 2018 for this contribution. According to the theory, technological change drives growth by allowing firms to produce new intermediate goods and consumer products at lower costs, making them more efficient and profitable. The nature of ideas, in particular, is such that  anyone can use them at any time. 

India, as a developing country, should not only develop new technologies through its own R&D but also adopt existing technologies from the developed world. Since it is already in place in the host country, it is easier, faster, less expensive, as well as more effective to do so. Along with  importing technology-intensive goods, foreign direct investment (FDI) is one of the most popular ways to implement new international technologies. It is defined as an investment in physical capital (e.g., a factory) owned and controlled by a foreign entity to boost overall investment and thus productivity. India, for example, has the most efficient and affordable internet and telecommunications infrastructure, the majority of which are the result of FDI and technology imports rather than indigenous innovation. Multinational corporations are motivated to invest in the host country  to maximize profits by earning relatively higher potential returns on capital (because of the low levels of capital/labor ratio in the host countries). Global firms outperform domestic firms due to their expertise, experience, superior technological know-how, and improved management and operational processes. To survive in the face of increased competition, domestic companies must learn from international firms’ best  practices. Through increased competitiveness, FDI promotes more efficient use of resources in the domestic economy in addition to generating local jobs. 

Prior to 1991, due to the Government of India’s closed door, self-reliant policies, only two brands, Hindustan Motors (Ambassador) and Premier Automobile (Fiat), produced and supplied passenger cars in India. The cars were large, expensive, and had poor gas mileage, making them mostly unaffordable to the general public. As a result, there was very little demand for such cars in India, discouraging other entrepreneurs from entering the market and causing the Indian automobile industry to stagnate. Recognizing this, the Indian government established Maruti Udyog Limited as a public-sector company in 1982, with Suzuki Motors as a foreign partner. Suzuki Motors promised to provide low-cost, fuel-efficient car engines made in India, as well as local equity participation. Suzuki Motors invested extensively and heavily in Indian component manufacturers, improving the quality, lowering the cost of the components, and training Indian employees about Suzuki Motors’ production methods, quality assurance, and other Japanese management methods. If Suzuki Motor was not allowed to enter India, the current landscape of India’s automotive industry, in which many international car companies operate and an average Indian can think of owning a car, would have been completely different. The aviation industry is another more recent example. It is clear that  merely importingmajority of the products and services from foreign-based Boeing and Airbus will not change India’s civil aviation industry’s technology and know-how. Airbus is seeking to increase India’s contribution to its international product portfolio by manufacturing various aircraft parts and materials locally and promoting domestic technology and innovation services through its investment in India under the Government’s ‘Make in India’ initiative along with intensive training and mentoring of its workforce here and fostering research collaborations with Indian start-ups and entrepreneurs. It is also working with Indian companies Tata and Mahindra and is partnering with the Indian Defence Research and Development Organization to develop new defence aircrafts, helicopters and other technological upgrades.  

India’s rapid growth was fuelled in large part by economic reforms implemented in the 1990s. Outward-oriented policies (e.g., the removal of trade or foreign investment barriers) were a major part of the reforms, which aimed to encourage India’s integration with the global economy. Foreign direct investment into India has steadily increased since 1980, rising from $79 million in 1980 to around $64 billion in 2020. India has also been quite successful in increasing its human capital base. Gross enrollment ratio of secondary students, a crude measure of human capital, has increased over the past two decades from around 10% to 27% according to the All India Survey of Higher Secondary Education (AISHE). India has increased its R&D expenditure in absolute terms (7.6 billion Indian rupees in 1980 to 1447.2 billion Indian rupees in 2020) but R&D expenditure as a percentage of GDP has remained stagnant over time (0.23 percent in 1980 to around 0.65 percent in 2020). 

Figure 2 – Human Capital and R&D Expenditure

Source: Penn World Series Database, World Bank

Figure 3 – Net FDI Inflows (Absolute and as a % of GDP)

Source: World Bank

Human capital and foreign direct investment (FDI) are two possible reasons for India’s meteoric rise in recent decades. Our study (Ghosh and Parab, 2021) supports these findings. Furthermore, our findings show that the relationship is nonlinear, implying that while increased FDI and/or human capital leads to increased total factor productivity in India, policies that reduce them harm the country more by lowering total factor productivity more than proportionately. Therefore, a sustained increase in targeted foreign investments and promoting education through more public schools and colleges, education loan subsidies could contribute to the productivity enhancement. The implications of the findings are crucial at a time when the Indian Government has embarked on a ‘Make in India’ campaign to spur growth, as well as the very recent announcement of a “self-reliance” strategy to be adopted for India’s post-Covid recovery. The importance of the role of FDI in India’s economic growth can get completely undermined if the agenda and purpose of ‘Make in India’ and the policies of ‘self-reliance’ etc., is not thought about and understood well.

 

References:

Ghosh, T. and Parab, P., 2021. “Assessing India’s productivity trends and endogenous growth: New evidence from technology, human capital and foreign direct investment, Economic Modelling, Volume 97, April 2021, Pages 182-195, https://doi.org/10.1016/j.econmod.2021.02.003

 

Image Credits: Pixabay

 

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