Tuesday March 9, 2021

Update - Productivity - March 2021

Author:  Adit Jain, IMA India March 2021

Productivity is everything

The Finance Budget 2021 placed the fiscal deficit at 9.5% of GDP. Whilst this may at first glance seem unusually high, the fact is that the Treasury appears to have come clean on government finances. This can only be construed as a good thing. Governments in India have, over the decades, made a habit of cloaking borrowings so as to comply with fiscal limitations. Off balance sheet drawings include those through state enterprises such as the Indian National Railways, the Food Corporation of India, Power Grid Corporation, National Highways Authority amongst others, resulting in bloated balance sheets for such entities. Banks are happy to lend to them in the assurance that they constitute sovereign risk. Be that as it may, such borrowings are a part of the consolidated liability of the nation and is treated as such by bond markets and rating agencies. Estimates suggest that the government spends a quarter of its annual expenditure on interest payments.

Some liberal economists have been crying out for higher borrowings with a view to enlarging spending and consequently boosting economic output, or so they believe. The recent budget answered their prayers, with the fiscal deficit for the coming year placed at 6.8% of GDP. In reality, this may end up higher as the assumptions of a rise of 17% in taxes is, under current circumstances, somewhat generous. It is true that government pump priming does help the economy grow, but not as much as it should. A dollar of debt creates only twenty cents of increased output. Higher spending, through borrowings, works only when there is an ensuing rise in productivity. In India, productivity has never kept pace with higher expenditure. Effectively, a situation presents itself where there is an upsurge in imports, or a jump in inflation or usually both. In the absence of productivity gains, governments need to constantly up spending programmes to maintain the same level of growth in GDP. To contribute to growth, the deficit cannot just be big. It must be bigger than it was the year before.

Productivity is not everything, but it is nearly everything. Gains are possible only when industrial manufacturing and support services can operate in an unhindered environment without burdensome bureaucratic hassles, usually those exercised by provincial authorities. The simplification of compliance procedures and taxes also help. Broadly speaking, productivity is a measure of the efficiency with which resources, both human and material, are converted into goods and services. Acording to an estimate by India Ratings & Research, India’s productivity has been consistently falling from 14% during 2004-08 to 7.4% during 2011-15 and finally to 3.7% during 2016-18.

India’s public debt is approximately 68% of GDP. In two years, analysts believe, this will rise to 85%. There is a line of thought that suggests that when public debt exceeds 80% of GDP, growth rates fall. Consequently, it is conceivable that sustainable growth would fall from 8% to about 5.5% to 6% in the longer term. In order to ensure that such a situation does not present itself, the government must eventually reduce its fiscal deficit to about 3.5% of GDP. In addition it must incessantly carry out structural reforms, so productivity rates may increase by 8-10% each year.

Understandably, the compelling circumstances such as the ones that we currently grapple with require a bout of government spending to generate consumption and consequently investment. Higher deficits in the short term are a sort of a jab in the economy’s arm, administered in the hope of accelerating growth. However, these are at best temporary measures and, as this paper has explained, come with unpleasant consequences. In the longer term, the only thing that really counts is to aspire for productivity gains. Nothing else matters as much.