Why productivity is almost everything

RK Pattnaik | Updated on October 18, 2020 Published on October 18, 2020

More than anything else, corporates will get their edge from a highly skilled workforce that can perform in the longer term

RBI Governor Shaktikanta Das recently spoke of a focus on human capital and productivity growth as a way to push economic growth in the medium term. Speaking to business leaders at the National Executive Committee of FICCI, he 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, 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.”

Power of productivity

A recent World Bank report on productivity recognises 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 enhance the standard of living in the economy, there should be emphasis 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 booster shots, even though these have not worked in the current scenario. In contrast, the issue of productivity is unglamorous, and often not taken note of in public debate.

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 concluded that 80 per cent of the US output per labour hour during 1909-1949 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 an emphasis on human capital. According to data available with the RBI, the Indian economy experienced an overall productivity growth of 0.9 per cent per annum, on an average, from 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 an 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, has suffered in terms of income earnings. By the data analysis above, the GFC pulled down the productivity growth to 0.3 per cent from 0.6 per cent. Based on the analogy of the GFC, we can conclude that the Covid-19 pandemic could have pulled down the productivity growth into negative territory, given that people stayed at home due to the lockdown and there has been a reduction of supply of labour to firms.

Furthermore, the RBI Annual Report 2019-20 estimated a worst-case scenario under which the output gap widens to about (-)12 per cent of potential output. The RBI has envisaged two scenarios — one, that is, lockdown-I, impacts the supply side of the economy by decreasing the labour supply and its productivity. And, two, that is lockdown-II, additionally considers an increase in input cost, which will also impact productivity.

Human-capital shortfall

Having discussed the fragile productivity growth scenario due to Covid-19, let us now turn to human capital, that is, education and health. According to the World Bank report on Human Capital Index 2020, substantial human-capital shortfalls and equity gaps existed even before the crisis. Furthermore, worldwide, a child born just before the advent of Covid-19 could expect to achieve on average just 56 per cent of her potential productivity as a future worker. India represents a weaker position at 49 per cent against the world average of 56 per cent. Thus, due to a substantial gap in human capital, our clamour on 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 the 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.

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

The writer is a former central banker and a faculty member at SPJIMR. Through The Billion Press

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Published on October 18, 2020
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