Kerala’s growth prospects, a long-term view

Sthanu R Nair/Sreenath K Namboodhiry | Updated on October 18, 2021

Promoting MSMEs are an ideal option, given Kerala’s land constraints   -  KK Mustafah

The State must combine a strategy of promoting MSMEs, value-added services such as IT and high-value fruits and crops

The recent decision of Kerala’s home-grown garment manufacturer Kitex Garments Ltd to shift investment from Kerala to Telangana gave raise to two divergent views on the economic development strategy suitable for the States. Since Kerala is endowed with rich environmental capital, the first view is that a heavy industrialisation strategy is not ideal for it. The second view is that Kerala needs to catch up with other industrialised States.

What does the long-term economic development trajectory of Kerala reveal about the approach it could follow towards economic development? To answer this question, we examined Kerala’s long-term economic growth performance compared to comparable States — Andhra Pradesh (+Telangana), Gujarat, Karnataka, Maharashtra, Rajasthan, and Tamil Nadu — under three growth phases.

The first phase was from 1980-81 to 1986-87 when Kerala's economy was going through a phase of economic stagnation (Phase 1). The second phase starting from 1987-88 to 2001-02, is when the State economy grew moderately (Phase 2). This was followed by the third phase, when the State witnessed accelerated economic growth from 2002-03 onwards (Phase 3).

Growth performance

The growth rate of Kerala's Gross State Domestic Product (GSDP) increased consistently from 1.85 per cent in Phase 1 to 5.84 per cent in Phase 2 to 6.97 per cent in Phase 3. Though this development record is encouraging, a comparison of Kerala’s economic growth performance with other States reveals two areas of concern. First, in all three phases, Kerala’s economic growth rate was the lowest or second-lowest among all the comparable States. Second, in Phase 3, Kerala experienced the lowest percentage points (pp) increase (1.13) in the growth rate compared to Phase 2 (3.99 pp), implying that a significant acceleration in economic growth has occurred in Kerala during Phase 2. Hence, Kerala needs to find new growth sources to overcome growth saturation and accelerate economic growth.

The agriculture sector seems to be one potential target area. Except farm sector, all the other sectors have contributed to the improved economic growth of Kerala over time. Barring Phase 2, the growth of the agriculture sector was negative in Kerala. Notably, the agriculture sector growth in Phase 3 was significantly lower than comparable States and the national average of 4.53 per cent.

Currently, Kerala’s agriculture sector faces several challenges. They mainly include the predominance of smallholders, the declining area under cultivation, falling productivity, and low capital formation.

Kerala has tremendous potential in high-value-added crops such as fruits, plantation crops, organic products, and medicinal plants. To fully explore this potential, the State needs to adopt modern farming practices such as contract farming, electronic trading, and farmer producer companies need to be promoted. The State’s current agricultural development strategy relies heavily on government support. The State’s potential can be explored better if the private sector is provided adequate opportunity to develop the agriculture sector.

The services sector has been a major source of growth for Kerala. Kerala's economy has undergone a significant structural transformation over time, with the growing dominance of the services sector. Between Phase 1 and 3, a substantial portion of the decline in the agriculture share in Kerala’s GSDP has been made up by an increase in the share of the services sector.

During the same period, the State has witnessed the second-largest increase in the share of the services sector in GSDP among the comparable States. In phase 3, Kerala had the highest services sector share (51.72 per cent) in GSDP, which is significantly higher than the all-State average (40.95 per cent) and comparable States.

However, one major area of concern is that the services sector growth in Kerala is fuelled by low value-adding and non-exportable services such as real estate, public administration, transport and communication. Importantly, despite being a leader in educational and health attainment, Kerala is yet to become an IT software powerhouse like her neighbours.

Therefore, the State needs to create an eco-system conducive to the growth of high-value-adding services such as IT software, financial services, and luxury tourism. Kerala’s tourism potential remains underutilised. Within IT software, Kerala should strive to move up the value chain and become a leader in high-value-added services such as engineering and research and development and software products. With its high human development index and quality of life, Kerala is well placed to attract the best brains to pursue this ambitious goal.

Push investment

Contrary to popular perception, the industrial and manufacturing sectors have witnessed consistently higher growth of over 6 per cent in Kerala during Phase 2 and 3 compared to less than 1 per cent recorded during Phase 1. However, compared to other States and all-States average (ranging from 6-8 per cent), the growth of these sectors has been lower. This suggests that Kerala lags behind other States in industrial development but, on its own, performed reasonably well.

Though Kerala’s industrial backwardness has been attributed to structural factors such as heavy labour unionisation, investment unfriendly image and hostile attitude of civil society towards private investment, the fact remains that promoting industrialisation through a large factory set up is not feasible in Kerala due to non-availability of a vast tract of land and concerns regarding environmental degradation. Therefore, the promotion of Micro, Small, and Medium Enterprises seems to be the best option for Kerala to industrialise.

Finally, for higher economic growth, Kerala needs a massive push in investment spending. Gross fixed capital formation (GFCF), an indicator of the level of investments in the economy, declined consistently from 2.06 per cent of state GSDP in Phase 1 to 1.52 per cent in Phase 2 to 1.09 per cent in Phase 3. Among the comparable States, investment in Kerala has been the lowest in all the phases of growth.

An analysis of CMIE data on investment projects reveals that during the 10 years from 2011 to 2021, Kerala received only 0.63 per cent of private investment projects completed in India, which is much lower than the top performing States — Gujarat (13.39 per cent) and Maharashtra (11.99 per cent).

The fact that all the comparable States have recorded higher economic growth rates than Kerala over time underlines the importance of investment in fuelling economic growth.

Nair is Professor of Economics, and Namboodhiry is former Academic Associate, at Indian Institute of Management Kozhikode

Published on October 18, 2021

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