ExplainSpeaking: Why Indian manufacturing’s productivity growth is plummeting and what can be done

The reason: Conventional economic wisdom is that manufacturing (as against the services sector) is more capable of soaking up excess labour that is involved in agriculture. To be sure, every economy can basically be divided into these three sectors — agriculture, manufacturing and services.

In India’s case, this need to soak up excess labour is quite high. Agriculture contributes only about 20% of India’s Gross Value Added (GVA, which, like GDP, is another way to measure national income) but still employs close to 55% of India’s workforce. The fact that agriculture is not as remunerative as manufacturing or services is made worse by the fact in India there are just too many people dependent on agriculture.

Raising farm incomes is not easy — and this may explain why no one ever hears of the government’s promise of doubling farmers’ income.

The better solution is to pull people out of farms and get them employed in other sectors. Here manufacturing is more conducive because it requires fewer “soft” skills. Just compare the skill set needed to sell a car in the showroom as against the skills needed to efficiently weld two pieces of metal in the factory.

Having more people in manufacturing was a great strategy not just for making India the preferred factory of the world but also to pull millions out of poverty.

But this required a rapidly growing manufacturing sector and it was the kind of “structural transformation” that an economy like India needed.

As things turned out, this did not happen in India. The share of manufacturing both in India’s GDP or overall employment has largely stayed stagnant. Most of India’s GDP now comes from the services sector while millions continue to languish in the agriculture sector.

Last week’s ExplainSpeaking showed how the incumbent government’s strategy to incentivise the private sector to invest in the economy had failed to get the desired result despite a whole host of incentives.

This edition will focus more on the productivity of Indian manufacturing.

According to a new study by Achyuta Adhvaryu (University of California San Diego) and others, the productivity growth of India’s manufacturing sector has worsened in the past decade.

Key takeaways about productivity of Indian manufacturing

Last week, Adhvaryu presented an academic paper titled “Workers, managers, and productivity: How investments in workers can fuel India’s productivity growth” during the annual India Policy Forum organised by the National Council for Applied Economic Research (NCAER) in New Delhi. As the title suggests, the focus of the paper was on the likely solution but what stood out more than anything else was the nature and extent of the problem.

Here are four stylised facts that the paper noted about manufacturing productivity in India:

#1: Productivity growth in Indian manufacturing is slowing

The authors have used the data from India’s Annual Survey of Industries (ASI) and looked at revenue (sales) per worker to measure productivity.

Figure 1 below shows the trend in the three-year moving average of aggregate (pan-India) annual productivity growth in manufacturing from 1990 to 2020.

“The figure reveals a general downward trend in productivity growth since the 1990s, accelerating in the mid-2010s and in the years leading up to the Covid-19 pandemic. The growth rate of productivity fluctuated between 10 to 15 percent in the 1990s and 2000s; productivity growth began to stagnate after 2015, and this negative trend accelerated into the several years preceding the pandemic,” states the paper.

#2: Indian manufacturing productivity is several times lower than that of the United States

In 2020, the level of manufacturing productivity per worker in India was $94,249 — that’s close to a fifth of manufacturing productivity in the United States ($484,862).

Even if one makes adjustments for purchasing power (because Rs 80 buys more of the same commodity in India than what a dollar buys in the US), Indian productivity rises to $296,000 per worker — still only three-fifths of the figure in the US.

#3: There are wide differences in manufacturing productivity across Indian states

One might say, this is not new: everything in India has differences across states. But that is where this finding was surprising.

Look at the India map (Figure 2); the darker the region the higher the manufacturing productivity.

The data shows that the manufacturing productivity in Madhya Pradesh (a state few would associate with manufacturing success) is much higher than that of Tamil Nadu (a state that is the preferred destination of most companies).

“Western and Central Indian states tend to have the highest average productivity in manufacturing, while the Southern and Eastern states have the lowest. This is in contrast to the GDP per capita ranking of states, in which Southern states tend to have higher incomes than their Western and Central counterparts,” state the authors.

#4: Productivity is strongly correlated with firms’ investments in their workers

Simply put, data shows that investing in workers pays rich dividends for firms. This investment could either be through higher salary and/or better benefits (e.g. medical facilities, recreation, festival bonuses etc.)

As Figure 3 shows, there is a tight positive association between the investments in workers and productivity across states.

Of course, correlation is not causation but the remaining part of the paper is essentially about establishing causation — and there’s a lot of India-specific evidence to that effect.

Upshot?

The findings throw up many questions — some that may have fairly straight forward answers and others that require more research.

For instance, why has the growth of manufacturing productivity in India declined over the past decade?

This may be explained by Figure 4, which uses official data to show that the manufacturing sector’s growth rate itself has been nosediving since 2015.

Or by Figure 5, which shows that investments-to-GDP ratio has been faltering in the economy and has become particularly weak since 2015.

Another question could be: If evidence is so clear that paying better salaries and providing more benefits raises productivity, why don’t firms invest in their workers more?

One simple yet reasonable answer could be: Because most owners don’t know that this works.

But there are also counter arguments.

For instance, as Maitreesh Ghatak of the London School of Economics pointed out: Why would firms invest when the labour market is slack? In other words, if there is mass unemployment, there is no incentive to retain workers.

Look at Figure 6, which uses government data to show that formal employment in manufacturing has been largely stagnant while informal employment (which was the bigger contributor) has declined.

Even more striking is the Figure 7, which maps the total number of people employed in India’s manufacturing sector since 2016.

This data from CMIE shows that employment in India’s manufacturing sector has fallen from over 51 million in 2016 to less 36 million in 2023 — a fall of over 30% even as the country’s working-age population continued to grow by millions every year.

What should India do to boost the manufacturing sector? Share your views and queries at udit.misra@expressindia.com

Until next time,

Udit