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What will drive India's growth?

By Suman Bery
July 31, 2015 14:01 IST
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People who are engaged in manufacturing also need educated workersLong-term sustained growth ultimately rests on a set of mechanisms and institutions, notes Suman Bery

In remarks reported earlier this week, Arvind Subramanian, the government’s chief economic advisor, expressed optimism that India’s economic growth rate could return to rates above eight per cent provided certain conditions were met.

Among these, he considered vigorous growth of manufactured exports to be of particular importance.

While it is the duty of the CEA to bring cheer to the markets, on this particular issue Dr Subramanian has form.

He is a noted scholar on the Chinese economy and has contributed to the international debate on economic 'convergence': whether poorer countries have been catching up on their much richer peers, and if this is likely to continue.

That said, his remarks come at a time of considerable pessimism on the prospects for a return to robust growth in the advanced countries, and associated scepticism about the medium-term prospects for the major economies in the developing world.

Is his optimism justified, even if conditional? Or is India condemned to make its way in a much more sombre global setting for the foreseeable future?

My understanding of these issues has been greatly advanced by reading a recent paper by Professor Charles Jones of Stanford University’s Graduate School of Business1.

This is a tour d horizon of the current state of economic theory and empirical knowledge on economic growth over the long run.

The fundamental message of the Jones paper is that, at the end of the day, long-term growth is all about growth in productivity which is hard to measure and even harder to predict.

I summarise the argument briefly below, before exploring the implications for Indian policy and prospects.

It is helpful to distinguish between three groups of countries: the United States; other rich countries (usually referred to as the OECD, although OECD members now include countries such as Chile and Mexico which are usually considered emerging markets); and low- to middle-income developing countries.

In addition, regrettably academic and media discussions do not always distinguish clearly between labour productivity (real output per hour worked) and a more sophisticated (but more powerful) concept known as 'total factor productivity'.

Unless otherwise indicated, the discussion here will primarily focus on TFP and real income will be in purchasing power parity terms.

The reason for considering the United States in a class on its own is that for over a century it has been the most affluent major economy in the world.

For me, one of the most striking findings reported in the paper is that for nearly 150 years 'GDP per person in the US economy has grown at a remarkably steady average rate of around two cent per year'.

Starting at around $3000 (in 2009 real dollars) in 1870, per capita GDP rose to more than $50,000 by 2014, a nearly 17-fold increase.

In this sustained exponential rise, the Great Depression of the 1930s is clearly visible; but its effects are temporary.

Even in the case of the Depression, where per capita output slumped by 20 per cent in four years (shades of Greece today), by 1939 the US economy had returned to its previous peak and to its earlier growth trajectory.

Analysis elsewhere in the paper confirms that the dominant contribution in this exponential rise has come from growth in TFP, even though the rate of growth of TFP has itself varied considerably from decade to decade.

In the post-war period, for example, 80 per cent of growth in output per hour was attributable to growth in TFP.

Put crudely, TFP is what remains of economic growth after accounting for growth in other inputs: labour, physical capital and human capital.

Unlike labour productivity it cannot be directly calculated from published data, but requires specification of an explicit model as well as estimates of labour and capital inputs which are themselves most readily available in countries with sophisticated data systems.

Even once calculated it is no more than a residual in an equation, but a residual which captures much of the organisational dynamism in the economy.

This brings us to the present -- to the outlook facing the US and, indirectly, the prospects for India.

Despite the long history of steady US growth, there is at present considerable unease and soul-searching in US policy circles on whether this run will continue into the future.

The debate takes many forms: secular stagnation; rising inequality; technological unemployment and dysfunctional politics.

All point to a deep-seated concern that the US no longer possesses the institutional resilience that sustained it over the twentieth century; also that the kind of innovation that is taking place currently is much less powerful than the waves of innovation that characterised the last century.

Were such a slowdown in US productivity growth in fact to occur, it could have repercussions beyond just the US.

To a surprising degree, real per capita income levels in other advanced countries has tended to be capped by the US, as befits its status as the “frontier economy”.

And while India has an enormous distance to travel to catch up with the likes of Thailand let alone the US, a slow-growing world economy would obviously make its passage that much harder, including via the export route stressed by the CEA.

There are additional implications for India that flow from these findings. First, it is worth mentioning that US real GDP in 1870 was roughly equivalent to India’s in 2005 (or China in 1993).

So the period described by Jones is not irrelevant to India’s situation today.

Second, it is striking that, at the end of the day, slow and steady can also win the race.

The US has reached where it is through the awesome power of compound interest rather than through dramatic sprints.

This is not to deny that growth opportunities for (relatively) poor countries today are wider than of those who have gone before, largely because of those predecessors.

Nor is it to suggest that we should not be ambitious in our growth aspirations given the desperate living conditions of large numbers of Indians.

It is rather to note that long-term sustained growth ultimately rests on a set of mechanisms and institutions capable of autonomous response and adjustment, and it is these that will matter in the long run.

Photograph: Reuters

1. Charles I Jones, ‘The facts of economic growth’ April 2015 (preliminary; mimeo) Suman Bery is chief economist, Royal Dutch Shell. The views are personal.

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