The future: productivity and sustainability

The recent Stanford conference on ?Challenges of economic policy reform in Asia? debated issues that concern the region?s future. One that affects India and China in particular, fiscal federalism, was the subject of my last piece. Two other areas that generated discussion were the comparison of productivity in India and China, as well as energy, environment and sustainable growth.

On productivity trends, the main issue was why total factor productivity in China has accelerated far more than in India. The broad conclusions converged on two factors: barriers to technology diffusion and misallocation of resources across firms. Total factor productivity could be doubled if capital and labour could be allocated efficiently within industry and bigger plants allowed to expand. Medium plants could also become more efficient.

What?s the key policy to enable diffusion of technology and improved resource allocation? Flexible labour policies and provisions for quicker entry and exit for firms. This would permit optimal technology use and enable more dispersed grow-th. Other policy priorities are minimising financial distortions, reducing disproportionate taxes (on equity considerations) on efficient firms, and scaling back specific policies limiting the size of firms (like reservations for small industries). All these inhibit technology improvement.

Whatever the route, India must impr-ove total factor productivity or its incremental capital-output ratio (Icor) to realise the somewhat daunting growth targets contemplated for the 11th Plan. Simply raising savings and investment is not enough. The Icor rates in India have barely moved over past years. This is an area where some policy changes will have greater, and faster, impact on growth.

Also on technology, it was noted that while India is moving toward increased focus on research and development, there are still substantial barriers to fomenting and disseminating innovation. The recent legislation protecting intellectual property rights was a positive step, but remains to be fully tested. In the medium term, however, protection of the technology transferred, as well as domestic companies? advan-ces, will contribute to innovation that is inspired by, and uniquely suited to, advancing India?s economic growth.

The framework for reform to en-courage financing of such innovation was a more complicated question. Here, the expertise of some of Silicon Valley?s venture capital community was brought to bear. The primary focus should be on improving the legal basis to support the often complex contracts between investors and start-up companies.

Another interesting issue, with ramifications beyond India-China comparisons, was the model and simulations in a paper titled, ?China, the U.S. and sustainability: Perspectives based on comprehensive wealth,? by Nobel laureate Kenneth Arrow, Partha Dasgupta, Lawrence Goulder, Kevin Mumford and Kirsten Oleson. While the paper was a preliminary draft, its analysis was designed to consider well-being and sustainability through comprehensive wealth accounting. This included valuing natural resources, such as clean air and water, as well as measuring human well-being through health-related statistics like life expectancy and child mortality.

Sustainability was considered in a broader sense, on the capacity to provide for the well-being of future generations. The principal indicator of a comprehensive measure of health was one that included both marketed and non-marketed assets. In the initial conclusions, and contrary to popular perception, in China, investments in reproducible capital (manufactured capital goods) contributed the most to increases in general wealth through increases in human capital. Technology also had a significant role. China?s depletion of natural resources has not yet had as big an impact on wealth as do the contributions from investment in reproducible and human capital.

The same is true of the US, where increases in human capital significantly outweigh the adverse wealth effects from natural resource depletion and higher oil prices. Of course, many of these conclusions, they concede, depend greatly on the assumed shadow prices and the large uncertainties surrounding technological change. Still, the assessment is contrary to the public perception that China?s economic growth is resulting primarily from activities that damage air quality and water purity. Its growth path is not necessarily environmentally unsustainable.

However, population growth, productivity trends and changing technology paradigms can alter these conclusions. Vinod Khosla?s suggestions that technology will significantly alter the cost and availability of alternative fuels, and country energy models like those for India, suggest a basic rethink of the models, as well as great uncertainty.

An area the analysis does not consider is that even while China?s economic growth may be sustainable, its implications for the global economy need closer examination. Pollutants know no boundaries: left in the air, these contaminants travel long distances, causing environmental concerns, and far from any one nation?s jurisdiction. Similarly, changes in groundwater aquifers? chemical composition, and the implications of these for agricultural patterns and drinking water, need to be recognised.

The somewhat provocative conclusions re-emphasise the need for greater research. The rich analysis, however, is well worth replicating for a large demographic entity like India, which will be a major energy guzzler and, by conventional wisdom, a big polluter with similar consequences. While it is not easy to replicate this analysis, leaving out India would render this study incomplete.

Uncertainties aside, however, energy, its security, its sustainable use and the quest for alternative and affordable energy forms to enhance productivity sustainably for the long run is at the heart of current geopolitics. In focusing on these, the Stanford conference made a worthwhile contribution.