Productivity in India and China

As someone from India who has lived in the West much of his life, it is gratifying to see the country receive so much attention in the Western media for its economic success, and not just its exoticness or internal turmoil. India?s growth performance has improved enough for it to receive regular coverage, including comparisons with the 800-pound gorilla of economic growth, China. Hewing to this new fashion, The Economist?s January 27 issue highlights recent studies of total factor productivity (TFP) growth in India. One study, by Barry Bosworth and Susan Collins of the Brookings Institution, together with India?s own Arvind Virmani, performs detailed TFP calculations for India. Another, by just Bosworth and Collins, compares India with China.

Several key points apparently emerge from these studies. First, China continues to outdo India in TFP growth. Second, its lead on this count is most pronounced in agriculture, followed by industry. Third, India?s service sector growth might be overstated, so that India?s seeming good performance in this sector relative to China might be a mirage. Fourth, the consequence of the last point is that India?s overall growth might be overstated by the official figures. The conclusion from The Economist is unobjectionable: boost industrial productivity through bolder reforms. Nevertheless, policy formulation is best done with a deep understanding of the ground realities, and the processes of change. What is really happening to productivity in India?

Before answering this question, keep in mind the pitfalls of aggregate TFP calculations. Fifteen years ago, Alwyn Young caused a stir by claiming that East Asian growth was all input driven, with TFP growth not out of the ordinary, and that Singapore was the worst performer in these terms, likely to suffer from diminishing returns to excessive physical investment. It turned out that Singapore continued growing quite rapidly. So did East Asia in general, barring the 1997 financial crisis. Investment was certainly significant for growth, but so was the structural transformation that TFP imperfectly tries to capture. In the US, Robert Gordon continually expressed scepticism that information technology was having any impact on the US economy, just before the data indeed began to show accelerated TFP growth. Data problems, measurement differences, and the fact that aggregate TFP is calculated as a residual mean that it gives a limited picture of the underlying economic processes.

In the latest India-China comparison, several points can be made. First, the focus seems to be on India?s data issues, and those are brought out because there is an insider on the research team. Data and measurement problems for China get ignored. For example, The Economist quotes a figure of 33% for the share of services in China?s GDP. Yet a year ago, this figure was revised at a stroke to above 40%, as China redid its calculations. Second, data biases can go the other way: many personal services in India are under-reported, to avoid income-tax. Third, the case against service sector growth in India is partly based on unusually strong growth in ?traditional? services such as transport and retailing, rather than high-fliers such as finance and telecoms. But there is a conceptual case to be made that traditional services have improved in efficiency as certain kinds of transaction costs have been reduced. An input-output analysis of India?s growth seems to bear this out (see my December 2006 FE column). Putting aside these issues, seeing what is going on with productivity in India requires digging deeper, using microeconomic studies. One firm-level study finds evidence that both India and China could increase productivity dramatically if all firms were as efficient as the best practitioners in their industries, but this is not surprising, and the data for India is old, going back to 1994-95. Other microeconomic case studies suggest that at least some pockets of industry have adapted and become more efficient in response to increased competition. Information technology adoption is also yielding measurable gains. Yet other studies suggest that management practices and financing constraints often continue to hinder adaptation. Some of the greatest problems seem to come from poor government regulation?poor both in design and in quality of implementation. Doing business in India is still too costly, especially for smaller firms. All sectors could benefit from policies that reduce these costs, without using reservations, quotas or excessive subsidies.

Hence, while there is a place for the headline-grabbing macroeconomic calculations and comparisons, the real issues have to be tackled at the micro level. Understanding the process of transformation in India?s business firms is critical, and more empirical work is clearly needed. More enterprise-friendly policies will require coordination at the national, state and even local levels. SEZs, as currently conceived, are probably an inefficient and needlessly costly way to achieve the needed improvements in business climate, but perhaps are better than no policy initiative at all. They create small enclaves when India needs to broaden its entrepreneurial success stories throughout its hinterland.

Here, then, is my prediction. If India?s policymakers get things even one-quarter right with respect to the business environment (including fixing the education system and overall governance), the next comparison of India and China?s productivity will show that India is indeed catching up with the other global giant.

?Nirvikar Singh is professor of Economics at the University of California, Santa Cruz