Perspectives on China and India: India's Future Growth - Hurdles and Opportunities

November 12, 2012

India's GDP now stands at close to $4.69 trillion (as of November 2012), larger than Japan and Germany and larger than the U.K and France combined. There are hurdles and opportunities for maintaining further growth, and Ravikumar discusses both. Hurdles include labor regulations and infrastructure. On the other hand, opportunities include a labor force that is well-equipped with skills in science and engineering, total factor productivity and a large consumer market.

Presentation (PDF)


B. Ravikumar: So I want to talk about kind of future growth in kind of two broad categories. What are the obstacles on the way and what are the potential opportunities in Indian growth? So only two big obstacles—of course, there are lots and lots—but there are two big obstacles I want to talk about. One is labor regulations. So the picture that I showed you earlier where the growth of the Indian economy was predominantly due to services, while manufacturing was remaining roughly stable around about 15 percent share of GDP, and it is related to the labor regulations. So there's lots of obstacles to going to large-scale manufacturing. There are restrictions on, above a particular number of employees you cannot fire them, or how much expenses you need to incur in terms of benefits. All these are very heavily regulated.

And the challenge or what these regulations are doing in terms of the picture that I showed you earlier is that it's preventing large-scale movement of people from agriculture into manufacturing. Typically if you want to absorb a lot of agricultural workers, you need large-scale manufacturing operations. So in India, while the agricultural path looks normal in a sense that it's been declining from 30 percent to about 20 percent of GDP, the share of labor that's sitting in agriculture is like half of the labor force. More than 50 percent of the labor force is still sitting in agriculture. So if you remove these labor regulations, that opens up large-scale manufacturing, and that's a way to absorb a whole bunch of unskilled labor into productive work force in other aspects of the economy. That's one.

The second is infrastructure. So anybody who has made a trip to India, this would become apparent. I don't think I need to put up any numbers on this. The railroads and highways are growing too slowly. In fact, this is such a common problem, the last time I went to India I saw this example illustrated on a t-shirt and I couldn't have put up the numbers to back this up. So this is how congested the Indian railways are. You have to travel in one of them to see how bad the infrastructure problem is. So clearly this requires a lot more investment from the Indian side.

The second thing that I want to bring up is sort of the opportunities. The part that's commonly known is the fact that Indians are kind of well-equipped when it comes to science and engineering. So anybody who has been to a university, you know, sort of the Indian students over there, what their typical backgrounds are in terms of the technical skills. The two things that are probably not known is what I'll describe as total factor productivity and the size of the consumer market. The total factor productivity is an economist's jargon, so let me explain what this is typically trying to pick up. When you think of increasing the output or GDP of an economy, so typically you put in more input you get more output. So for the average person to see an increase in his income, this can only go so far. You can increase the number of factories, increase the number of workers, increase the number of roads. Ultimately you're going to hit diminishing returns, and this is something that YiLi talked about, too. So there's a limit to how much you can keep increasing GDP as a result of putting more or more inputs.

The way you want to provide for the long-run engine of growth is somehow you have to have more output produced with fewer resources. And this is typically what economists call total factor productivity. So in order to sustain the long-run growth, you sort of need to see improvements in total factor productivity. So to give you a previous example of an economy that was growing very fast, so this was Japan post World War II. So the way I've drawn this particular picture is I have drawn Japan's real GDP per capita relative to U.S. GDP per capita. So Japan started out less than 30 percent, around 25 percent of U.S. GDP. So if that line is sloping up, that means Japan is growing faster than U.S. So per capita income in Japan is growing faster than the U.S. If the line is flat, then the growth rate in Japan is exactly the same as that of the U.S.

So initially you see that Japan was growing very, very fast. And this you can achieve as a result of putting more inputs in and grow very fast. But ultimately diminishing returns are going to hit. So for the economy to continue to take off, it's going to be coming from total factor productivity. So the increase in the long run is a result of getting more out of the inputs than what you got before. So an example would be, so all of us are walking around with cell phones. Imagine for a minute you were living in the U.S., let's say in the 50s. So there were lots of things we were doing with various kinds of equipment. We had calculators, we had telephones with landlines on them, we had letters, we had envelopes, and we had pens to communicate in terms of whatever messages we wanted to send. We also had cameras. Now, imagine what's in your cell phone. We can do all of that in a very small piece of equipment. It actually takes less resources than all of that we were putting into building a camera, building the telephone and building the papers and pencils and pens. It's all in the cell phone right now. So in some sense, we got a lot more in terms of measurable output out of far fewer resources than went into producing a particular cell phone.

Now, on this margin, we can think about decomposing the GDP growth into components. How much of it is due to inputs and how much of it is due to total factor productivity? So if you do that particular calculation for India, that looks positive. It's good news in terms of opportunities. Now, pre-reforms which is sort of the 50s to 90s, if I asked how much of whatever was happening in India in terms of growth was coming as a result of putting more and more inputs in. Only 20 percent was coming from improvements in the sense of getting more out of fewer resources. So by the time you go to post-reforms, this number has shot up to 55 percent.

So the total factor productivity growth is sort of good news when it comes to future potential. Of course, in the initial stages you can get total factor productivity growth, not necessarily as a result of technological change but just by reducing the inefficiencies and reducing the distortions and getting more out of the resources instead of wasting them due to the inefficiency. So eventually it will kind of catch up and you have to think about technological change. So but the part that it's being achieved through improvements to getting more out of the resources is sort of good news.

The second part of the good news is sort of the population structure of India. This is sort of the age distribution roughly about eight years ago in the data that we have. So those of you who have seen the pictures of U.S. population would see something starkly different about this age distribution right away. So if you've seen the age distribution in the U.S., you would see a lot more height on the last two bars. In India you see a lot more height on the first two bars. So to give you some magnitude, there are more than 500 million people in India below age 25. So how big is that? Well, if you added up the population of U.S., Mexico and Canada, you still wouldn't come to 500 million. That's how many people are below age 25 in India. It's not even the total population, just the people below age 25. So it's a big market. And this, of course, is working age population, so they're going to be moving through the years both earning and spending for the next few decades. So these are potentially good opportunities for not only Indian growth but for the U.S. as a consumer market base.

Now, I'm just going to give you one example of the sort of consumer market base that the U.S. can take advantage of because it's a capital goods oriented and service oriented society. So I want to run this movie in a minute. So I want you to watch the blue circle and the yellow circle. The yellow circle is United States, the blue circle is India. So there is a slightly large pink circle right behind India. That's China. So I haven't marked it over here. This graph or this tape is going to run the number of cell phones per 100 people in each country. Now, as the years move along from 1980 to '81 to '82, so cell phones are coming into play. Of course, both economies are growing, so the incomes of the economies are growing. And you will see that as they'll move more and more to the right. But also, the populations in all of these economies are growing. So the size of the circle is also going to grow as a result of the population.

We started off in '80, so there were hardly any cell phones anywhere. Then all of a sudden the cell phone technology kind of kicks in around the mid-80s, and U.S., of course, starts taking off. And then India and China start taking off in terms of the number of cell phones being used. So by the time the 2000s are rolling around, the number of cell phones per 100 people is increasing. So 2010 rolls around. There are 60 cell phones per 100 people. Now, there are lots of ways to interpret this particular picture. My way of interpreting is the glass is kind of half full. So the half full is that means there are 40 people without cell phones in India per 100. So just to add up the numbers, that's like 400 million cell phones. That's a huge market. That's if every man, woman and child in the U.S. had a cell phone, you still wouldn't come to 400 million. That's a lot of cell phones to be thought about in terms of marketing in India.

With that, I'll conclude with the basic message that the reforms are gradual and it's gradually paying off. It is the world's largest democracy, so none of the reforms are going to be immediate like China. You cannot bulldoze from point A to point B in order to build a highway, so you have to go through lots of court and legal procedures if you want to go do anything in India because it's a democracy. It's well-integrated into the global economy, so you saw data on trade. And the fact that the total factor productivity is improving is a statement about they are competing in the world market in a way that's good for them. That's nice. And the last part is, while there are hurdles to future growth like regulations and infrastructure, there are also potentially very large opportunities for future growth in terms of just the size of the economy and the consumer market.

With that, I'll stop and let Cletus take over the Q&A. Thank you.

This popular lecture series addresses key issues and provides the opportunity to ask questions of Fed experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

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