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Students Corner - A Decade of Economic
Reforms in India - A Review

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Productivity plays a major role in sustaining the industrial growth since it is the principal determinant of cost, price and trade competitiveness of firms and industries. Notwithstanding the differences of views on measurement issues, there is a near unanimity in the empirical literature on productivity growth in the Indian manufacturing sector. It is recognised that there was a decline in total factor productivity growth (TFPG) till 1980, with a turnaround taking place in mid-1980s following the reoriented trade and industrial policies and improved infrastructure performance (Brahmananda, 1982; Ahluwalia, 1985, 1991).14 In fact, the significant shortfall in the target for industrial output till about the Sixth Plan can be attributed to the negligible TFPG in manufacturing. The later studies covering the period up to mid-1990s have found evidence of a positive TFPG (Balakrishnan and Pushpangadan, 1994; Majumdar, 1996; Rao, 1996; Pradhan and Barik,1999). Thus, there seems to be turnaround in the productivity growth in the mid-1980s.

The role of the reform process in terms of its impact on manufacturing productivity continues to be debatable. While a positive rate of growth in productivity is noticed in the post-1985 period, the level of labour productivity is found to be abysmally low and its convergence to the international standards seems to be a difficult proposition in the near future (Trivedi et al, 2000). The low labour productivity appears to have offset the comparative advantage in terms of low labour cost (CII-World Bank, 2002). NCAER (2001) has observed a decline in productivity growth in 1990s (up to 1997-98) in relation to the 1980s. Besides, the mean technical efficiency of all firms taken together seems to have declined in 1990s as compared to the pre-reform period. Unni et al (2001) also provide evidence of a declining productivity growth in the first half of 1990s. Productivity growth in the SSIs also witnessed a decline, with the labour productivity growth decelerating to 3.7 per cent during 1990-96 from 6.2 per cent during 1980s and the capital productivity growth declining to (-)1.6 per cent from 2.6 per cent during the same period (SIDBI, 2000). Regarding trend in productivity in the unorganised manufacturing sector, Unni et al (2001) have observed a rapid decline in the TFPG to (-)3.1 per cent during the reform period (1990-95) from 11.4 per cent in the latter half of 1980s. The TFPG for the entire period of study, i.e. 1978-95 is estimated at (-)2.5 per cent. This reflects, inter alia, low technological change in the unorganised sector in the reform period.

Broad assessment of partial factor productivity for the industry can be based on an analysis of the changes in input intensities. The material intensity of the manufacturing sector which remained high during the 1980s and the first half of the 1990s, witnessed a sharp decline in the latter half. This is indicative of a shift away from material inputs as also the rationalisation of the production process, ensuring efficiency in use of material inputs. The labour intensity index (at constant prices), in contrast, witnessed almost a secular decline from the peak of 114.5 per cent in 1980-81 to 73.6 per cent in 1990-91 and further to 40.8 per cent in 1999-2000. A similar trend is discernible in the labour intensity index at current prices, though the extent of decline has been less. This can be attributed to the relatively high increase in the CPI of industrial workers than in the prices of manufacturing goods. On the other hand, the capital intensity has significantly risen during the 1990s as compared with the 1980s.

The productivity growth in the manufacturing sector seems to have declined during the 1990s and, more so, in the latter phase of the reform period, primarily as a sequel to the faltering pace of implementation of structural reforms, the binding infrastructure constraints, and the lack of required industrial restructuring - all impinging on the competitiveness of the Indian industry. The input intensity indices show that the production process in the manufacturing sector has become more capital intensive, possibly in view of the adoption of capital-intensive new technologies in response to the inflexibilities that characterise the labour market. The efficiency in use of material inputs has, however, shown improvement in the latter part of 1990s.

The major objective of reforms in the industrial sector was to attain faster industrial growth aided by improved productivity and efficiency, so as to be competitive, domestically as well as globally. The instruments to achieve these objectives included removal of industrial licensing which abolished restrictions on investment and capacity expansion, de-reservation of industries reserved for the public sector, substantial opening of foreign direct investment and trade liberalisation through elimination of quantitative restrictions and reduction in custom tariffs. These measures resulted in significant removal of entry barriers and provided greater access to foreign technology and capital. Realistic exchange rates and industrial restructuring helped improve the competitiveness of the manufacturing units. The evolving post-reform industrial structure was anticipated to be both more labour and technology-intensive. Enhanced demand for skilled labour was expected to provide positive externalities for the rest of the industry and services sector.

In retrospect, Indian industry upgraded technology and product quality to a significant degree and met the challenge of openness after being protected for decades. This was reflected in high growth of the industrial sector in the initial phase of reform. This exuberance reflected in high growth in investment and production in industry during 1993-94 to 1996-97, particularly in manufacturing, however, could not be sustained. Although the growth process has been to some extent influenced by global business cycles, the persisting deceleration in Indian industrial growth is, in part, attributed to the slowdown in reform momentum and inadequacy of certain major structural reforms. Today, the industrial sector confronts challenges of a continued slowdown, stagnation in contribution to GDP, and a sluggish employment growth. When benchmarked against other fast growing emerging economies, the performance of the Indian industrial sector appears a bit lacklustre. In an increasingly global environment, the sector continues to face structural constraints, such as inadequate, relatively inefficient and high cost infrastructure, high cost of borrowed funds, inflexibilities in labour markets and other institutional rigidities that inhibit the pace of industrial restructuring. Ultimately these factors impinge adversely on the cost structure of industry, thereby hampering its competitiveness.

The prolonged lull in the equity market resulted in financing of corporates through high cost leveraged funds. This has led to a debt overhang for the corporate sector. In addition, the decline in international prices of manufactured goods in recent years has had adverse implications on the corporate balance sheet, in terms of squeezed profit margins. The proportion of interest to total costs for Indian corporates is among the highest in emerging market economies. The possibility of changing terms of borrowing from fixed to floating interest rates could thus be beneficial for the corporates. The measures for corporate debt restructuring that have already been initiated need to be accelerated. The development of a liquid market for impaired assets now enthused by the new Act for securitisation and restructuring would facilitate their restructuring or write-off.

Furthermore, the manufacturing sector is facing internal and external competition due to withdrawal of quantitative restrictions on imports and the continuing reduction in peak tariff levels. In order to meet these challenges, there has to be industrial restructuring through mergers and acquisitions, amalgamation, takeovers and technical collaborations. This would achieve quicker investment reallocation geared towards activities with comparative advantage. The process of corporate restructuring has so far been confined to a few segments, such as basic goods, and has not permeated to other major segments.

The ongoing process of restructuring would be strengthened if the pace of institutional reforms is accelerated. This would entail institution of more rapid bankruptcy procedures, flexibility in labour use, and reforms in urban land ceiling and small-scale reservation policies. Putting into place an effective social security mechanism and a programme for retraining/re-deployment of labour is a necessary condition for removal of the rigidities in the labour market. Contextually, benchmarking domestic labour laws with other Asian and similar emerging economies may be advantageous in improving the operating environment for industry. The capital market would also have to be made pro-active to facilitate industrial restructuring. Judicial reform and creation of an economic regulatory structure would contribute to efficient restructuring and closure, concomitant with the development of a market for distressed assets. Legislative measures have been initiated to remove the regulatory/judicial hassles inhibiting restructuring and to remove the rigidities in the labour market. The recent enactment providing for securitisation of assets and steps towards improvements in bankruptcy law may also facilitate industrial restructuring.

The continued reservation of small-scale industries (SSI) after the removal of quantitative restrictions on imports is a stark anomaly (Mohan, 2002). This policy prohibits large Indian firms from manufacturing reserved SSI items domestically, which in any case can be freely imported from large foreign producers. Most of the SSI areas have high export potential, if economies of large-scale production are properly reaped . The process of SSI dereservation currently underway is, thus, a step in the right direction and needs to be accelerated to foster scale economies, enhance efficiency and promote competitiveness. Firms, which preferred to remain stunted in order to benefit from the policy of SSIs, are expected to upgrade in size and technology in the wake of dereservation. Dereservation would, however, have to be complemented by provision of finance and technical assistance, which requires banks to upgrade credit assessment capabilities to avoid the problem of adverse selection. This policy would also promote a symbiosis between large and small firms in terms of ancillarisation – as experienced in the East Asian countries.

Acceleration in industrial growth to double digit levels is essential for the achievement of 8 per cent GDP growth as targeted in the Tenth Five Year Plan. The removal of the remaining rigidities in the industrial sector would not only regenerate the required production growth but also promote much greater industrial employment.