Improving Total Factor Productivity: Challenges and Way Forward – Explained, pointwise

Introduction

India’s Total Factor Productivity (TFP) growth has seen a moderate decline compared to the global experience, though it remains above that of emerging markets and developing economies. The back-to-back setbacks of the pandemic and the Russia-Ukraine war led to supply chain disruptions which has increased costs of production. It is also anticipated that there will be increase of capital outflow from India as the US Federal Reserve is expected to increase the interest rates. In such a situation, there is a need to focus on improving the TFP to reduce the costs, as well as to attract greater investment. 

What is the trend of Total Factor Productivity (TFP) growth in India and the World?

A recent Reserve Bank of India (RBI) report points to a moderate decline in TFP growth compared to the global experience. TFP growth rate for India during the 2010-2019 period was approximately 2.2%, as against -0.3% for emerging markets and developing economies. However, as indicated by the graph underneath, the TFP growth has been erratic, having fallen below 0% on multiple occasions.

During the pandemic, the TFP for India declined by 2.9% in 2020 and marginally improved by 0.1% in 2021. In 2022, TFP growth rate is projected to increase to 2%. 

Source: Live Mint

Global productivity growth has witnessed a prolonged slowdown since 2010, with the deceleration sharper in emerging and developing economies. This is ascribed to a weakening investment climate, and lower employment growth levels in developed economies, among others. TFP growth for the world economy was 0.7% in 2021 and may shrink by 0.5% in 2022.

What are the Structural Determinants of TFP Growth in India?

According to an RBI Report, Total Factor Productivity (TFP) growth can be explained through the sensitivity of the economy to four factors: 

Capital deepening: It is represented by growth in the stock of fixed capital. Fixed capital are assets used in the productive process. These include Property, Plants, and Equipment. Increase in fixed capital enhances productive capacity of the economy. Greater the investments in fixed capital, greater the increase in stock, and consequently higher the increase in productivity.

Capital composition: It is represented by the average rental price of capital across 3 major types viz. construction, machinery and transport equipment. Capital composition has a negative relationship with TFP growth. An increase in cost of capital, such as machinery, without any significant improvement in its productive capabilities may restrict firms from expanding its scale of operations and technological upgradation, limiting its TFP growth. (Firms may not be ready to invest if the cost of capital is high. Lack of investments keep the scale low, and scale economies may not be realized.)

Labour quality: It is represented by an index of the composition of the labour force under five broad education categories (below primary, primary, middle, secondary & higher secondary and above higher secondary) weighted by their average annual earnings. It is expected the higher the education levels, higher the skills of labor. A high proportion of educated, skilled labour will enhance the TFP.

Input use intensity: It is measured by the input growth. It also shows a positive association with TFP growth.

What is the need to enhance the TFP?

Optimum Utilization of Resources: Improvements in TFP shows a country is able to extract the best out of its factor inputs that results in maximization of output with minimum input i.e., less resources are used to get more output. This also enhances sustainability and reduces pressure on resource base.

Attracts Investment: TFP growth reduces the cost of production. It allows a country to attract domestic as well as foreign private investment towards it.  

Improves Standard of Living: Improved TFP minimizes per-unit cost facilitating the horizontal expansion of consumption demand, thereby improving the standard of living.

Contribution to GDP: It plays a pivotal role in determining economic growth of a nation. Growth can happen by increasing resource inputs or by enhancing productivity. According to RBI estimates, TFP growth contributed to 30% of India’s GDP growth during 2010-2018. 

What steps have been taken to improve productivity in India?

Skilling initiatives: The Government has launched many initiatives to upskill the population which include the National Apprenticeship Training scheme, PM Kaushal Vikas Yojana etc. 

New Education Policy, 2020: NEP, 2020 lays emphasis on reforms in education at all levels from pre primary to higher education. It aims to bring transformation in the education system of India in line with contemporary needs. 

Labour Codes: In 2019, the Ministry of Labour introduced four labour bills to consolidate the existing 29 labour laws. These bills relate to (1) industrial relations; (2) minimum wages; (3) social security; and (4) occupational safety, health and working conditions. The labor code will address the structural impediments in India’s labor market and improve labor productivity.

Infrastructure: Union Budget 2022-23 has an increased outlay for creating public infrastructure. PM Gati Shakti has been launched to streamline the process of infrastructure creation. This will remove infrastructure bottlenecks and improve productivity of the economy.

PLI Schemes: The Government has also launched PLI Schemes have the potential to create an additional production of Rs. 30 lakh crore. Incentives under PLI are expected to bring in foreign investment and technology which will boost productivity. Union Budget 2022-23 plans to create 60 lakh new jobs under the PLI schemes in 14 sectors.

What are the challenges in improving TFP in India?

Insufficient Allocation: Various experts, committees and reports have recommended that India should allocate 6% and 2.5% of GDP to education and health respectively. However, actual allocation has been much lower.

Underutilization of Land: Agriculture has a disproportionately high share in land available for use in economic activity, despite being the least productive. Further, the 2013 Land Acquisition Act has been questioned by several stakeholders, stating that it may stall land acquisition by making the cost of land prohibitive for industry and the procedures more cumbersome.

Red Tapism and Corruption: Excessive paperwork and corruption creates delays and push up the total cost of projects thereby reducing productivity. According to the Ministry of Statistics and Programme Implementation data, the number of stalled projects has increased sharply since 2018 for projects above INR 150 crore of investment. The average cost overrun per project shows an increasing trend, touching a high of 31% of the original cost in 2020 .

Labour Issues: India has one of the lowest Labour Force Participation Rate (LFPR) among the major economies, partly due to very low female LFPR (22%) (WDI, World Bank), especially among poorer states. Further, there is a prevalence of high informal employment under which workers work on meagre wages with little or no social security. Similarly, 28% of the population is illiterate and another 26% have received only primary school education (PLFS, 2019-20). Only 9% of the population possesses a graduate/post graduate degree in India.

What steps should be taken going forward?

First, there is a need to focus on boosting innovation and research. Though India’s ranking in the Global Innovation Index, 2021 has improved to 46, investment in R&D has remained low (<0.7% of GDP). This must be enhanced.

Second, employers are acknowledging the fact that manpower is an essential component in profit earnings and have shifted their focus on retaining talent. This positive transformation seen after the pandemic needs to be extended further.

Third, to combat the issue of underutilization of land, the states should formulate their respective laws to ease the acquisition process. Gujarat, Rajasthan, Maharashtra, Jharkhand, and Telangana have already enacted new laws. Further, for parity and distributional justice, there is a need to explore avenues for land pooling.

Fourth, focus should be on raising the quality of labour through large scale expansion of public expenditure on education, health and the skilling.

Conclusion

In a nutshell, it can be said that quality education, better healthcare, nurturing of innovation, introduction of efficient technology and processes in domestic companies and reduction in misallocation of resources can help improve TFP levels in India.

Source: Mint, RBI