With employment levels lower than what they were 40 years ago, faster growth alone won’t do

India has emerged as one of the fastest growing major economies in the world. But being the fastest growing economy with low per capita income, low and stagnant youth workforce participation level and low growth in productivity is, at best, a cause for celebration at an election rally.

We still have around eighty crore people dependent on free ration. The household savings rates have declined and so have their financial savings rate. Real earnings have not been growing even for white-collar employees. We need credit to drive consumption growth. Yet, some leading economists continue to search for solutions in liquidity and lower interest rates without recognising the fundamental problem that we face.

The fundamental problem is that the reforms have not helped raise the quality of growth and the current incentive plans for production are not consistent with our economic and social reality. Our expectation that the reforms will bring all-round prosperity by unleashing animal spirits has not been met.

The solution lies in improving our capital productivity (value-added per unit of capital stock), which has been declining during the post-reforms period. In addition, we must increase the share of higher value-adding economic activity without destroying our ability to improve productivity for low value-adding activities.

This article reviews our economic performance and outlines the economic strategy that can help accelerate growth and improve the quality of our growth. The analysis is based on the KLEMS database maintained by the Reserve Bank of India.

Decline in capital productivity offsets gains from growth in labour productivity, making our growth problem even more intractable

Post the mid-nineties reforms, we did experience an acceleration in economic growth, though it was adversely impacted by catastrophic events – first the Global Financial Crisis and then COVID-19. However, the acceleration in value-addition did not come with consistently high growth in employment (Chart 1 below). Our growth in employment peaked during 2005 – till a sharp reversal in 2019 – more on this sharp reversal in the next section.

On the positive side, the labour productivity, defined as value-added per employed person, grew faster than the pre-reform period, though there was a decline in capital productivity – defined as value-added per unit of capital stock (Chart 2 below), i.e., gains in labour productivity were offset by decline in capital productivity.

Since 1999, the average annual growth in labour productivity has been 4.5% and that for capital productivity a negative of -1.0%, with fourteen out of 24 years experiencing a negative growth in capital productivity.

India had experienced a positive annual capital productivity growth of 0.8% from 1982 to 1998, though labour productivity growth was lower at 3.5%.

During the post-reform period, the average annual growth in total factor productivity (TFP) fell to a low of 0.3%, from 0.90% between 1982 to 1998. Growth in TFP was negative for nine out of 24 years, as against five out of 17 years during the pre-reform period.

In short, we have not seen a significant improvement in quality of our growth during the post-reform period.

Employment levels too continue to be lower than what they were 40 years ago

Our employment to population ratio had steadily fallen from 39.9% in 1983-84 to 34.4% in 2017-18. While there has been a surprise sharp jump in employment during the COVID years, the employment level at 39.0% of population during 2021-22 is still lower than what it was in 1980-81. It also implies that a slowdown in population growth has not helped improve the workforce participation levels – a disappointing fact. In most years, the growth in employment level has been slower than growth in population, as seen in Chart 3 below.

A review of quarterly data (Chart 4 below) suggests that the youth labour force participation (LFPR) continues to be low and stagnant, except for women workers during the recent years.

The surprise jump in employment during COVID and the post-COVID period does not add up

As mentioned earlier, there was a surge in employment level when economic activity was far from being normal. As seen in Table 1 below, the employment levels in construction and trade were increasing at historically high rates without a corresponding increase in GVA (Gross Value-Added) for these sectors or a reduction in employment in other sectors.

An increase in agricultural labour during the COVID period is understandable, because of COVID driven reverse migration to rural areas. But the increase in agriculture labour, at the same time as an increase in construction and trade sectors, without a decline in other major sectors is intriguing.

Employment in trade has never increased at such a pace anytime since 1981. Employment in construction did increase at rates faster than the current rates, but those were go-go years from 2001-2012 when the construction sector GVA too was growing faster than the current level of GVA growth.

In addition, the 2019-20 fiscal was a low growth year even before the COVID-related mandatory shutdown by the government in the last week of March 2020. It is, therefore, surprising that the businesses were employing significantly more people when the growth in value-addition was slowing down at a fast pace (Chart 5 below).

It is, therefore, highly likely that these numbers will be revised in the coming years, but the current performance data does not reflect the economic reality of the reporting period.

If we assume the employment numbers to be correct, the quality of growth during the last few years was poor. However, if we believe them to be overstated, the employment conditions are not as good as the numbers suggest them to be.

Potentially, we need to explain a 40-50 million gap in employment level during the COVID and subsequent recovery years, as our best employment performance had added a maximum of 44.8 million jobs during 2002-2005 with growth in labour productivity, whereas we have added 81.7 million jobs between 2019-2022 period with a decline in labour productivity. We have never added more than ten million jobs in a year anytime other than the above-mentioned years since 1981.

In a similar incident during the fiscal year 2020-21, the initial report had suggested that the inventory levels (changes in stock) went up during the lock down period – an impossibility. At the time of the initial release on August 31, 2020, we had reported this anomaly (see article below).

During the May 2022 release, we saw a reversal from an increase of INR 154,276 crores to a decline of INR 11,573 crore, though the number turned positive once more during the later years but only by Rs. 25,616 crores.

Let us keep this anomaly aside for the time being and assess our performance to identify an approach for accelerating growth in earnings-led consumption (not credit-led consumption), which can, in turn, accelerate growth in capital formation.

Drivers of employment: Services not manufacturing, and that too the low value-adding services

As mentioned earlier, the most important problem that India must solve is to employ its youth in a productive and meaningful economic activity. Globally, manufacturing has served this purpose for most large countries.

In our context, the services sector has absorbed labour at rates faster than the growth in our population (Table 2 below). However, the growth was driven by low value-adding services – the sub-sectors where the labour productivity has been lower than the sector average. High value-adding manufacturing and services sectors have added people at rates faster than the growth in population, but with a much smaller base.

As for low value-adding manufacturing, which absorbs larger number of people, the employment has grown (green shaded area), at rates faster than our population, just during one period (i.e., 1999-04), ignoring the period since 2019 (for the reasons mentioned in the previous section)

Table 3 below lists down the sectors by their level of labour productivity.

Labour productivity: Low value-added manufacturing does better than services 

Table 4 below suggests that manufacturing, particularly low value-adding manufacturing (green shaded areas), has been a greater driver of productivity and not services. Unfortunately, the high value-adding sectors have been the productivity laggards.

Even in absolute terms, the value-added per person in the low value-adding manufacturing sectors is Rs. 2.537 lakhs, compared with Rs. 2.157 lakhs in the services sectors. High value-adding manufacturing too creates 26.6% greater value than its counterparts in the services sector.

The solution, therefore, is enhancing labour productivity in high value-adding manufacturing and services sectors in a mission mode, along with an increased effort to continue improving it in low value-adding services sectors.

Declining capital productivity across sectors is the biggest challenge

As mentioned earlier, we define capital productivity as the ratio between value-addition and the capital stock.

Our capital productivity performance is not as good as our labour productivity performance, as the growth in capital productivity has been negative across all periods, except 1989-99 and 2014-19.

Once again, we see manufacturing, particularly low value-adding manufacturing, doing better than services – highlighted through green shaded cells.

The pink cells represent the sectors where there has been a negative growth in value-added per rupee of capital stock (Table 5 below).

As for the absolute level, manufacturing at 0.32 did better than services at 0.29 during 2018-19 (Table 6 below). During the same year, the level of capital productivity in the low value-adding manufacturing sectors at 0.31 was about the same as the high value-adding manufacturing sectors at 0.33.

Capital intensity: A capital-starved country needs a wiser approach to capital allocation

Given our stage of development, India is a capital starved country. We have also experienced a steady decline in household savings rates during the recent years. A decline in net financial household-savings rate makes it worse.

Given that we run a large trade deficit, it is important that our growth strategy too focuses on capital allocation to sectors with higher capital and labour productivity and we keep our dependence on foreign capital as low as possible. In other words, we must actively manage the capital intensity of our economic activity. We define capital intensity as capital stock per labour employed.

Table 7 below informs us that the capital intensity of manufacturing and services is nearly the same – INR 13.999 lakhs for manufacturing and INR 13.079 lakhs for services, with low value-adding services being far less capital intensive compared to low value-adding manufacturing.

Our economic performance and its implications for business and economic strategy

In summary, our economic problem stems for low growth in employment levels, low growth in capital and total factor productivity. While our labour productivity growth has been higher than growth in capital productivity, we are still relying on low value-adding manufacturing and services activities to drive growth and earnings.

Given these challenges, we cannot leave anything to chance and work with a belief that market-based policy choices will somehow help us accelerate growth or enhance the quality of our growth.

Our businesses need strategies that can accelerate both capital and labour productivity at the same time and our economic policy choices must provide an environment for these strategies to work for every entrepreneur and not a chosen few.

Currently, we are helping China sell low as well as high value-adding products for Indian consumption and capital formation activity, as is visible in an ever-increasing trade deficit with them. We need this to change.

Enhancing the level of domestic higher value-added consumption

India’s labour productivity is naturally low, as we are a low-income country and therefore our consumption too is that of low value-adding products. A country like China has raised the standard of living for its people by producing and selling higher value-adding products to higher income countries in the West. We have missed that opportunity.

It is, therefore, essential that we help an average Indian earn better and raise the quality of our domestic consumption, which, in turn, accelerates the production of higher value-adding products – thus creating a virtuous earnings-consumption-production cycle. In addition, we must raise the level of our labour as well as capital productivity.

One possible approach for raising earnings is through improved share of labour in income, which has indeed been the case since 2008, though it is still far below the levels observed during the pre-reforms period (Chart 6 below). However,the fair share is determined by the contribution that labour makes to growth in productivity. In our case, labour productivity has indeed been growing faster than capital productivity.

We observe a very low correlation, ranging between 0.05 to 0.10 between productivity and share of income in manufacturing, though the correlation for services sector is higher and ranges between 0.20 to 0.30. We must, therefore, assess if labour is getting its fair share.

From production linked incentive schemes to productivity and employment linked schemes

Our production-linked incentive (PLI) schemes need an immediate overhaul, as they, at best, encourage lazy manufacturing. In the worst-case situations, they provide large capital subsidies to a couple of players for creating a few thousand jobs. Consequently, we neither manage productivity nor employment.

Some of these large capital-intensive projects, with low employment generation, can help us demonstrate that we have arrived as a country – a country that can afford to provide large subsidies or invest in vanity projects that benefit only a small section of the Indian society. However, these projects do not solve the country’s most important problem of providing meaningful work for 100+ million of our young people. We had highlighted this problem in an earlier article too shared below.

A reduction in corporation tax rates during 2019 too has not helped, as the private capital expenditure still continues to be on a low-growth trajectory. Our fiscal incentive schemes must, therefore, focus on large-scale employment generation with a focus on labour as well as capital productivity.

Risk-sharing arrangement between labour and capital

A big business-focused policy poses yet another challenge, as it allows the big business to transfer risk to low and middle-income families. We can romanticise gig-work by calling them entrepreneurs or partners, but they are never going to be able to help India become a developed country. Big business, including aggregator platforms, pass on the financial and economic risk to their workers and suppliers who do not have and are not likely to have the required risk-capital ever for dealing with these risks.

If we continue to encourage this transfer of risk to low- or middle-income urban families, it will be a repeat of what we have done to our farmers – forcing them into a vicious cycle of economic slavery through low productivity work. We had discussed this problem and possible solution in our earlier articles: How real is our farmers’ angst? and Why farming is more important than IT to India’s economy and why MSP reforms shouldn’t wait.

In summary, we need policies that help households as well as businesses together and not one at the cost of other. We must incentivise employment generation and productivity growth, ensure that labour and capital get a fair share of income and create fair risk-sharing arrangements. We must stem decline in capital productivity and accelerate growth in labour productivity, particularly in high value-adding sectors.