Let me now shift gears considerably. So far I have talked about the reform efforts, repeatedly alluding to the impact of reforms on efficiency, productivity and improved resource allocation.
But what about the perspective for the growth of inputs? Ever since Krugman’s 1994 article[18] in Foreign Affairs, about the extent to which East Asian growth was ‘merely’ caused by a high flow of inputs in terms of labour and capital, all of us have had a heightened consciousness about both (a) the power of additional inputs in delivering high growth rates, and (b) the importance of asking whether there is productivity growth over and above this.
Let me start with labour. It is conventional to focus on citizens between age 15 and 64 as ‘the working population’. The fascinating thing about India is that we will be one of the last large countries in the world to experience our demographic transition. Current projections show that from 2010 or so, the fraction of Chinese and of Koreans in the age group of 15–64 will start dropping. In the case of Japan, this fraction has been dropping from 1995 onwards.
In the case of India, we will experience ‘demographic dividend’ as the ratio of working population to the total population will grow all the way till 2050. In particular, a sharp drop in the dependency ratio from 59 per cent to 50 per cent is projected between 2005 and 2020. The dependency ratio is projected to drop to 47 per cent in 2040. It is only from 2040 onwards that India’s dependency ratio is projected to go up. This will give robust fuel to the process of economic growth. This forecast for India reflects the existing young population structure, coupled with a deceleration of fertility, so that a large number of children are not expected to be added.
A second change that is taking place on the labour force is equally significant for economic growth. This concerns the quality of the labour force. Every year, the human capital of the stock of labour goes up, through gains in education and gains in experience. Hence, we are likely to obtain improvements in the labour inputs to economic growth from three, distinct directions: (a) Incremental workers, (b) Incremental education and (c) Incremental experience of the existing stock of workers. All this is potent fuel for economic growth. The experience of Asia shows that the ‘growth miracles’ in Japan or in ‘Tiger’ economies of South East Asia or in China occurred at the similar stage of demographic transition when the share of working population in total population grew sharply.
What about capital? One element flows directly from demographics. Children and old people tend to save less; saving is the highest in the working years. Using NCAER survey data,[19] we find that in 1994–95, while the overall savings rate was 20.3 per cent, this dropped to 16.9 per cent when the head of household was below 30. The highest savings rate, of 23 per cent, was found when the head of the household was in the fifties. In the case of urban households, these effects were more pronounced, with a savings rate of just 7.8 per cent when the head of household was below 30.
So the demographic projections which clearly point out that India will have a bigger fraction of the population in the age group from 15 to 64 simultaneously predict a higher savings rate in the future. Further, holding household characteristics identical, a larger number of children would induce higher consumption, so declining fertility is likely to induce higher saving.
A second factor that is at work is the sheer GDP growth. NCAER data shows that there are extremely low savings rates for low income households. Remarkably enough, as of 1994–95, only 1.9 per cent of all saving was done by households with income below the then-prevalent median income. In 1994–95, the poorest 80 per cent of the population accounted for half the income, and this group accounted for 23.9 per cent of total savings. As a rough approximation, we may say that significant savings behaviour only took place in the top quartile of the income distribution of 1994–95. Households in the top decile had a much higher savings rate, of 35.8 per cent, as compared with the general population.
Economic growth steadily pushes households above the absolute income threshold required to be in the top quartile by the income distribution as of 1994–95. Thus, every year, a large number of households graduate into the income group where saving will commence. The bottom 30 per cent of the 1994–95 income distribution has near-zero or negative saving. GDP growth shrinks this set of zero-savings households. The top quartile of the 1994–95 income distribution had high savings rates. GDP growth pushes more households into this set of high-savings households. Through this process, holding other aspects of the stochastic environment of the household constant, the high GDP growth rates that India has been experiencing are likely to generate a steady escalation of the savings rate.
The two arguments suggested above — about the impact of income growth, and about the changing dependency ratio — have been at work for some time. If these arguments are on track, then it should have been the case that the savings rate in India should have been going up in recent years. The empirical evidence is consistent with this prediction, for household savings grew from 18 per cent to 23 per cent over the period after 1990. Looking forward, our arguments suggest that household savings will grow further in the coming 15 years. In addition, growing openness of capital account would mean greater inflow of foreign capital as the country becomes a ‘willing globaliser’ i.e., more open to trade and investment. This means that in the coming decade, the supply of both domestic and foreign savings are going to sharply increase leading to a much higher rate of capital accumulation compared to the last two decades.
Paul Krugman noticed that East Asian growth had weak foundations in terms of productivity increases; that the high growth rates were primarily a combination of demographics (an increase in the working population) and capital being brought to bear on production. This is disappointing. The essence of development is improved technology; it is all about new ways of organising production, of injecting new scientific knowledge and new institutions into the economy. We expect that when economic development takes place, productivity should be transformed.
It is important to point out that many studies have taken place on productivity in India, and the consensus suggests that there has been significant TFP growth in India. The definitive measurement is by Bosworth and Collins in 2003,[20] who find that in the period after 1980, 2 per cent of the growth (out of a total of 5.73 per cent) was accounted for by productivity changes. This suggests that India’s reforms process has been able to obtain results in terms of better incentives and competition, coupled with better public goods, inducing improvements in productivity.
The outlook for the acceleration in the TFP growth in the coming decade or two is very promising. This is for several reasons. The first is the impact of information technology. In the coming decade, the rate of diffusion of IT is going to be greater due to increased availability of hardware, telecom infrastructure and human capital. In the US and other countries, the diffusion of IT has had a well documented positive impact on productivity growth. The second reason is the beneficial impact of mesoeconomic reforms and privatisation of the infrastructure sector on productivity. The international experience has been that such meso-economic economic reforms have led to an all-round increase in productivity. The third element is the engines of increasing returns which will be accruing from network industries due to network externalities.[21] The new highway network and telecom networks are two prime examples of new network industries. In the US, both these network industries have had profound impact in accelerating growth in total factor productivity.
When we look back at the experience with growth across various countries over the last 200 years, each experience with rapid growth has been caused by accumulation of capital, coupled with a catching-up of scientific knowledge. Over the years, the technologies of information processing and dissemination have steadily improved. This suggests that the diffusion of knowledge takes place faster and faster. This is consistent with the fact that the more-recent growth episodes, like those of China, Korea and Taiwan, have experienced higher growth rates when compared with the older growth episodes, like those of Russia, Japan and the US. Looking forward, India will benefit strongly from the great technological improvements in the diffusion of knowledge which have taken place in the last 25 years. When Korea was integrating into the world economy, and catching up with global scientific knowledge, the process of knowledge acquisition was slower than that found today in India, given the greater extent of information access through the Internet, voice calls, international travel, etc. This suggests that the speed of productivity change in India, in the next 20 years, could be higher than that seen in any experience with rapid economic growth in the last 200 years.
These arguments suggest that in the coming decade, it is not difficult to envisage a sharp increase of more than 50 per cent in the annual TFP growth a doubling of the TFP growth from the present trend of 2 per cent per annum. Such an increase would be in line with the international experience of dynamic economies.