Why productivity is almost everything

RBI governor Shaktikanta Das recently spoke of a focus on human capital and productivity growth as ways of pushing economic growth in the medium term. Speaking to business leaders at the National Executive Committee of FICCI, the governor said: “By any reckoning, COVID-19 will leave long lasting scars on productivity levels of countries around the world. During earlier episodes of epidemics in the past -- SARS, MERS, Ebola and Zika – productivity is estimated to have declined by about 4 per cent over three years. The COVID impact on productivity could be expected to be much larger.”

On productivity, the Nobel laureate Paul Krugman remarked, “Productivity isn’t everything but in the long run it is almost everything.”  The criticality of productivity is also highlighted by another renowned economist Maurice Obstfeld. To quote him “If sustained, low productivity growth would have profound adverse implications for progress in global living standards.”  The recent World Bank report on productivity has recognised that human capital comprising knowledge, skill and health that people accumulate over their lives is a central driver of sustainable growth and poverty alleviation. Thus, to sustain higher economic growth and enhancing standard of living in the economy, the emphasis should be on human capital and productivity growth.

But how does this work in times like the pandemic, when growth has collapsed and the outlook is gloomy? There is a clamour for interest rate reductions as a booster even though this has not worked in the current scenario. In contrast, the issue of productivity is unglamorous, and often not taken note of in public debate.

The recent World Bank report on productivity has recognised that human capital comprising knowledge, skill and health that people accumulate over their lives is a central driver of sustainable growth and poverty alleviation.

To understand the power of productivity, which is the ratio of output (as measured by GDP) to labour input, it is important to see how this rather than mere capital accumulation (higher savings and investment rates) drives growth. The 1950s growth model by Robert Solow concludes that 80 per cent of US output per labour hour during the period 1909 and 1949 was due to technological progress. Illustratively, Solow’s finding was that during the above period, the average annual growth was 2.9 per cent per year, of which 0.32 per cent was attributed to capital accumulation,1.09 per cent was due to increase in the input of labour and the remaining 1.49 per cent was due to technological progress.

Solow’s conclusion is useful even today and also in the Indian context, which is a labour surplus economy because labour and technology are critically related. Thus, in case of productivity growth, two critical inputs are a skilled labour force to draw the benefits of technological progress and a healthy labour force to work at potential -- which is nothing but seeking an emphasis on human capital. According to available data with the RBI, the Indian economy experienced an overall productivity growth of 0.9 per cent per annum, on an average, over the period 1980-81 to 2017-18. In the immediate post- Global  Financial  Crisis (GFC) period – from 2008-09 to 2012-13 – there was a decline in productivity by 0.3 per cent annually, while the period thereafter up to 2017-18 recorded annual productivity growth of 2.4 per cent. The contribution of productivity growth to the overall GDP growth of the Indian economy over the period 1980-81 to 2017-18 was about 15 per cent. During 2013-14 to 2017-18, its contribution increased significantly to about 34 per cent.

The pandemic has caused loss of life. Livelihoods have been crippled and a substantial part of the labour force, notably migrant labourers, have suffered in terms income earnings. As per the above data analysis, the GFC pulled down the productivity growth to 0.3 per cent from 0.6 per cent. Based on the analogy of GFC, we can conclude that Covid-19 pandemic could have pulled down the productivity growth to negative territory, given that people stay at home due to the lockdown and there has been a reduction of supply of labour to firms.

In case of productivity growth, two critical inputs are a skilled labour force to draw the benefits of technological progress and a healthy labour force to work at potential -- which is nothing but seeking an emphasis on human capital.

Furthermore, the RBI Annual report 2019-20 has estimated a worst-case scenario under which the output gap widens to about minus 12 per cent of potential output. The RBI has envisaged two scenarios viz; the first scenario, i.e., lockdown I, impacts the supply side of the economy by decreasing the labor supply and its productivity. The second scenario, i.e., lockdown II, additionally considers an increase in input costs input cost that will also impact productivity.

Having discussed the fragile productivity growth scenario due to Covid-19 let us now turn to human capital, i.e. education and health.   According to the World Bank report on Human Capital Index 2020, substantial human-capital shortfalls and equity gaps have existed before the crisis.  Furthermore, worldwide, a child born just before the advent of COVID-19 could expect to achieve on average just 56 percent of her potential productivity as a future worker. India represents a weaker position at 49 per cent as against the world average of 56 per cent. Thus, due to a substantial gap in human capital our clamour regarding demographic dividend is self-defeating. As a World Bank report observed, “This underscores the urgent need to protect and rebuild human capital to foster recovery in the short and longer terms.”

Yet, we can see that India has failed to meet the test in precisely these two areas. Productivity presupposes good labour relations and a healthy work force. The former is not helped by suspension of labour laws and the hardships faced by migrant labour as they fled to the safety of their villages. The health of the workforce is impacted by our weak response to the pandemic and lack of adequate and appropriate health infrastructure. It is the government that must play a catalyst role and set out appropriate policies. At the same time,the government faces a hard budget constraint, apart from absence of fiscal space. So, intentions and priorities apart, it can’t spend its way through this crisis.

Industry captains have an important role to play in boosting productivity and in building human capital.

As per IMF estimates, the fiscal deficit of the Central and State governments relative to GDP will be around 12 per cent and debt to GDP ratio will be around 85 per cent as against the stipulation of 6 (3 per cent for the Center and 3 per cent for the States) and 60 per cent (40 per cent for the Center and 20 per cent for the States).

In this scenario, industry captains have an important role to play in boosting productivity and in building human capital. They will have to appreciate the fact that lower interest regime, subsidies, lower tax regime, tax holidays have limitations as demand management policies. Their edge will come in recruiting, training and retaining a highly skilled workforce that is supported in areas of health and education. Only those companies that can perform and outshine in the medium and longer term will be the ones to drive growth in a new era.

(Pattnaik is a former Central banker and a faculty member at SPJIMR)