Sunday, June 16, 2024

India’s post-pandemic potential growth could be pushed higher

Three years have now passed since the pandemic brought the world to a standstill. Economic activity collapsed. India was no exception. The economic recovery around the world has been uneven. India has managed to avoid the inflationary surge that many rich countries are battling as well as the balance-of-payments crises that have brought many of our neighbours to their knees.

However, economic output is still below where it would have been in case there had been no pandemic—a gap of around $350 billion. Think of this as a permanent output loss. Millions who left the labour force have not yet rejoined it. The labour force participation ratio is still below its level before the pandemic. Despite such lingering pain, India managed to negotiate the storm better than most countries.

How does the road ahead look? It is sometimes useful to peer into the rear-view mirror before focusing on what can be seen through the windshield. Indian economic growth began to accelerate in 1980. The average speed of economic progress in the three decades since then has been 6.3%. This anchor number needs to be kept in mind by those who expect the Indian economy to accelerate during this decade as well as those who write about a deceleration.

The pandemic shock had created four worries for the medium term. First, a persistence of weak private-sector investment activity that began around 10 years ago. Second, a drop in the labour force participation rate. Third, a decline in the quality of human capital because of learning losses when schools were shut. Fourth, lower labour productivity because of the movement of people back to agriculture. Some of these have started to correct themselves, but they can still weigh down on potential growth—or the rate at which the Indian economy can sustainably grow without either intolerably high inflation or an unsustainable balance of payments.

The World Bank has this week released a large database with estimates of potential growth over the years for various countries. There are different ways that economists estimate potential growth. The World Bank economists have used six statistical techniques. This column uses the estimates derived from production functions, which consider the growth in capital stock, the labour force and productivity in a country to figure out levels of sustainable growth. (The other common set of techniques come from the use of time series filters, which may underestimate potential growth, given that India went through a sequential slowdown before the sharp decline in output during the first stage of the pandemic.)

There are three significant takeaways from the data for an Indian audience. First, the World Bank estimates Indian potential growth at 7% a year. This is close to the 30-year average mentioned earlier in this column, as well as in the same range as many private-sector estimates, which tend to be between 6-6.5%. In its Report on Currency and Finance released earlier this year, the Reserve Bank of India settled on a range of between 6.5% and 8.5%. The International Monetary Fund puts its estimate at 6%, with a 0.5 percentage-point reduction in potential growth because of the effects of the pandemic.

Second, Indian potential growth is higher than that of most emerging economies it is usually compared to: Brazil, Mexico, Indonesia, Malaysia, the Philippines, Thailand, Vietnam and China. Bangladesh is a rare example of a country that the World Bank estimates can grow sustainably at the same rate as India in the coming years. This broadly backs the widespread belief that India is one of the few bright spots in a slowing global economy.

Third, the sources of Indian growth are worrisome. Of the 7% growth rate, four percentage points are accounted for by productivity growth, two percentage points come from investment activity, and only one percentage point from growth of the labour force. This is in tune with other similar exercises in ‘growth accounting’. The contribution of labour to economic growth should be higher, given India’s bulge in the working-age population, aka the demographic dividend.

The tea leaves suggest that India will outperform most other large economies over the rest of the decade. However, any hubris should be tempered with an uncomfortable fact. India currently has a per capita income of around $2,500. Last May, this column had examined how fast other countries in the region had doubled their per capita income from an initial level of $2,000. Countries such as China, South Korea and Taiwan took four, five and six years respectively. The Philippines needed 16 years. Indonesia and Malaysia took 12 years. India is currently looking more like Indonesia than China in this context, albeit against the backdrop of a very different global situation.

How to raise potential growth by at least another percentage point should thus be a matter of serious debate. The job cannot be done by fiscal or monetary stimulus. Deeper structural changes are needed to drive more investments, greater labour force participation by women and also higher productivity across the economy. These are the structural challenges for policymakers to address over the rest of this decade and beyond.

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