Productivity: The Promise of Progress1
I. Introduction
Good evening!
I welcome you all to the sixth Asia KLEMS Conference, to India and to the
Reserve Bank of India, henceforth RBI. We are honoured to host this
conference in physical mode after the arduous isolation imposed by the
pandemic. The hill town of Lonavala, an ancient resting place for travellers
and traders, is nestled in India's soon-to-be monsoon-drenched western
ghats - a chain of mountains running 30 to 50 km inland parallel to India's
west coast across six provinces. We do hope that its verdant ambience
will dispel all pandemic blues and provide a salubrious backdrop for this
Conference which has "Productivity, Growth, and Resilience in the Asian
Economies" as its theme. The Conference itself is a tribute to the fortitude
and perseverance displayed by Asian economies through the pandemic
and the war in Ukraine.
Before I turn to the subject of my address today, I thought a journey down
memory lane might be appropriate for the occasion. The Asia KLEMS has
a short but eventful history, replete with promoting the building of
databases and conducting international productivity comparisons among
Asian economies. The first Asia KLEMS conference was held in Tokyo in
2011. The abiding interest in that Conference was in productivity growth,
going by the papers presented, a theme to which we return today. The
next four Conferences were hosted in Seoul, Taipei, Tokyo and Beijing in
which attention diversified to setting up the KLEMS database and
accounting framework, structural change and sources of productivity
growth, methodological issues and productivity gaps, growth and
productivity, and the role of factors such as information and
communication technology or ICT, intangibles, trade and labour markets.
At the time of the fifth Asia KLEMS meeting in 2019, India was selected
as the venue for the next conference. Unfortunately, COVID-19-related
restrictions on international travel prevented the conference from being
convened in 2021 but finally, the sixth Asia KLEMS conference is being
held today.
India KLEMS, which is a part of Asia KLEMS and of the larger world
KLEMS initiative, aims to measure and analyse productivity growth in
India by using the KLEMS framework. It started in 2009 with financial
support from the RBI. From 2015, the India KLEMS Project was nurtured
at the Centre for Development Economics (CDE), Delhi School of
Economics, by Prof. K.L Krishna and his team, who have been making
valuable contributions to the greater KLEMS initiative right from its
inception. From 2022, the RBI is the home of India KLEMS and its
database, which consists of inputs (KLEMS), output (gross value added;
gross value of output) and total factor productivity (TFP) estimates from
1980-81 to 2019-20 (April-March). The next update of the database with
the incorporation of data for 2020-21 is scheduled for August 2023.
Talking KLEMS to hardcore KLEMS practitioners is a formidable
challenge and I shall not venture where angels fear to tread. In the rest of
my address, I will, therefore, try to provide a user's perspectives on how
we read KLEMS data for policy purposes.
II. Some Stylised Trends
It is widely believed that a structural slowdown has been spreading across
the global economy after growth peaked in 2010. About half of this
slowdown can be attributed to demographic factors: ageing population;
slowing working-age cohort increases; and declining labour force
participation. Alongside, growth rates of investment and total factor
productivity are declining. The engine of trade, which powered the global
economy in the 1980s and 1990s, has also weakened considerably. Gains
from better education and health have been diminishing as improvements
in education and health care systems go abegging for lack of investments.
More recently, powerful forces have accentuated the global slowdown -
financial crises recurring with disturbing intensity; the once-in-a-century
pandemic; and the war in Ukraine; all of which have left lasting scars.
Accordingly, the 2020s (2022-30) may turn out to be another 'lost decade',
preceded by the ten lost years from 2010. It has been argued that the
global potential growth rate - the maximum growth rate that an economy
can sustain in the long term at full employment and full capacity without
igniting inflation (its speed limit, if you will) - has fallen by close to a full
percentage point in 2011-21 relative to 2000-102.
The global slowdown has pulled down advanced economies (AEs) and
emerging and developing economies (EMDEs) alike, but it has imposed a
major setback on the latter, pushing back their chances of catch-up or
convergence. Consequently, their capacity to lift their populations out of
poverty, reduce inequality and achieve the aspirational goals of
development is endangered as well as their ability to harness the benefits
of newer technologies stemming from green transition and the digital
revolution. What is worrisome is that for EMDEs, all the drivers of growth
- factor re-allocations; human capital formation; the share of working age
population; investment growth - are losing strength at the same time. This
could stall the process of development that has been underway since the
middle of the preceding century. Meanwhile, policy uncertainty at the
global level has surged and forces of deglobalisation and trade and
finance disintegration have gained ground, vitiating the environment in
which EMDEs sought to harness developmental opportunities and
manage their challenges. The World Bank estimates that for EMDEs,
potential growth as defined earlier fell to 5.0 per cent a year during 2011-
21 from 6.0 per cent a year during 2000-10 and will slow further to an
average of 4.0 per cent a year during 2022-30. In particular, investment
growth is likely to be insufficient to reach pre-pandemic trends. In the view
of the United Nations Conference on Trade and Development (UNCTAD),
greenfield foreign direct investment in industry remains fragile, especially
in developing countries. There is significant risk that the momentum for
recovery in international investment will stall prematurely, hampering
efforts to boost finance for sustainable development3.
Turning to Asia, the real GDP growth surge in east Asia (which includes
the Pacific region) following the 1997-98 Asian financial crisis lost steam
during the period between 2011-21 in a largely cyclical downturn. With the
onset of the COVID-19 pandemic, there was a sharp fall in fixed capital
investment and labour supply, which still remain below pre-pandemic
levels. The weakening of human and physical capital will likely weigh on
medium to long-term growth prospects of the region in an environment of
reconfiguration of supply chains, elevated debt levels, tighter financing
conditions and uncertainty related to trade and technology transfer. Over
the period 2022-30, the region's potential output growth is projected by
the World Bank to slow to 4.6 per cent a year from 6.2 per cent a year in
2011-21. Falling TFP growth is estimated to account for about three-fifths
of the slowdown, with the remaining two-fifths attributable equally to
slowing labour supply growth and capital accumulation.
Economic activity in south Asia rebounded strongly from the recession
caused by the pandemic, when its large informal sector was hard hit by
job and income losses. Output in the region is on track to grow by about
6.0 per cent a year between 2022 and 2030, faster than the 2010s' annual
average of 5.5 per cent and only moderately slower than growth in the
2000s. This will make it the fastest growing EMDE region in the remainder
of this decade as demographic trends expand the working age population,
the investment rate remains elevated, and productivity growth continues
to benefit from the shift of resources away from agriculture and informal
activity. Although population growth is expected to moderate, labour force
growth will be supported by stabilisation of the participation rate after two
decades of decline. South Asia's potential growth is projected to slow only
marginally to 6.1 per cent a year on average in the 2020s from 6.2 per
cent a year in the 2010s. The forecast of potential output growth through
2030 is underpinned mainly by a projected recovery in TFP growth.
In central Asia4, the pandemic and the war in Ukraine have taken a
grievous toll, reversing recent progress in raising living standards and
leaving deep economic wounds among vulnerable populations. The
region's output is estimated to have shrunk by 0.3 per cent in 2022 and is
expected to flatten in 2023, weakened by erosion of labour productivity,
muted investment and scarred human capital. Potential output growth is
projected to slow from an annual average pace of 3.6 per cent per year
over 2011-21 to 3 per cent per year over 2022-30.
In west Asia5, GDP growth has been uneven over the past two decades,
slowing in the 2010s under the effects of political turmoil and military
conflict. The World Bank estimates that potential growth halved between
the 2000s and 2010s, with the slowdown driven by broad-based
decelerations in capital stock, in total factor productivity and in working-
age populations. The pandemic has further damaged these drivers, with
output contracting by 3.6 per cent in 2020. A rebound in 2021 was
insufficient to reverse the decline in output. Potential output growth is
projected to remain lacklustre, growing by about 2.5 per cent a year during
2022-30. A reduction in the contribution of labour to potential growth is
expected to be partly offset by an anaemic improvement in TFP growth
and stronger investment. Human capital accumulation is projected to slow
owing to weaker growth in the working-age population.
To sum up these trends, global growth was slowing down ahead of the
pandemic relative to its performance up to the global financial crisis
(GFC). This loss of speed was led by AEs but EMDEs were pulled in by
2010-2011. Only east and south Asia proved resilient and maintained
historical growth trends. Even in these regions, the share of labour in
output and its contribution by way of quality has fallen while capital
accumulation has moderated. It is said that east and south Asia will
become the world's centre of gravity and capital accumulation will
continue to contribute more than half of GDP growth6. The rest will have
to come from productivity, a subject to which I will turn shortly.
Potential growth is weakening broadly across Asia with all drivers - TFP
growth, labour force growth, and capital accumulation - slackening. East
Asia is expected to be the EMDE region with the sharpest decline in both
aggregate and per capita potential growth during 2022-30, mainly
reflecting slower capital accumulation and TFP growth. The second
largest decline in potential growth in 2022-30 is projected for central Asia
from the continued weakness in labour force growth. Potential growth is
projected to rise in west Asia in 2022-30 as strengthening TFP growth
offsets demographic headwinds to potential growth.
The secular slowdown over the last decade and expectations of another
slow decade ahead warrants a renewed exploration of the linkages
between physical capital investment, improvements in human capital, and
exploitation of technological advancement. In an environment in which
populations across the world are either ageing or declining, and
investment rates are trapped in a long-term deceleration, including foreign
direct investment, it is perhaps an opportune moment to focus on
productivity growth as the means of arresting the downturn and charting
a new trajectory of pushing outwards the growth possibility frontier. It has
been observed that productivity is not everything but in the long run, it is
almost everything7. This is the theme of my address today.
III. The Paradox of Productivity
Globally, productivity growth has undergone a prolonged slowdown since
2010, after a brief recovery in the years immediately following the GFC.
This deceleration in TFP is more pronounced in EMDEs than in their AE
peers. India has also suffered a decline in TFP growth, although moderate
relative to the global experience - the average TFP growth rate in India
slowed from 1.3 per cent during the period 2000 to 2007 to 1.2 per cent
during 2011 to 2019, as against the EMDE average of 0.2 per cent and
the global average of 0.1 per cent8. TFP growth accounted for about 20
per cent of India's aggregate GDP growth during this period, coinciding
with the contribution of both capital and labour declining. GDP growth in
India has remained relatively resilient, averaging close to 7.0 per cent
during 2000 to 2022 with some ebbing of capital formation and
employment growth in sync with the deceleration in TFP growth. For the
period 2022-30 the World Bank projects India's potential growth to reflect
the outlook for south Asia.
Underlying the generalised productivity slowdown are several
confounding puzzles, at least from the policy practitioner's point of view. I
will focus on a few important ones in the interest of time. First, the
slackening of productivity is synchronised across jurisdictions, apparently
impervious to differentials in levels of development, inherent
heterogeneity in country characteristics and differences in policy
responses9. As the economist Alistair Dieppe points out, "in a factor
modelling framework, TFP growth is shown to be the one of the most
important correlates of common developments in GDP growth". Second,
this co-movement of TFP across geographies suggests that it could be
driven by common factors. In this context, it has been pointed out that
cyclical factors, including changing factor utilisation, accounted for a third
of the slowdown in the productivity in the post GFC period10. This suggests
that fluctuations in productivity are actually demand-driven, calling into
question the received wisdom on the long run neutrality of demand with
respect to productivity11. It also does not fit well with the observed long
run slowdown in productivity which suggests that structural factors may
be at work whereas cyclical drivers are more short-run and reversible by
definition. Third, the fall in productivity growth is co-existing with a slew of
new technological developments such as cloud computing, big data
analytics, robotics, fintech and the digital revolution to name a few. Once
again, the Solow paradox of the 1970s and 1980s - "you can see the
computer age everywhere but in the productivity statistics"12 - seems to
have come alive.
Some proximate hypotheses compete for explanatory power in
unravelling the productivity puzzle. First, there is the 'mismeasurement'
view which would seek further refinements in the manner in which factor
inputs and their quality are measured so as to yield 'uncontaminated'
estimates of TFP13. As Dale Jorgensen, a founding father of the KLEMS
framework used to emphasise, the lesson of decades of experience is that
these parameters are highly sensitive to methods of measurement. There
are also the output effects of adding newer inputs like digitalisation to be
considered. As the OECD has argued, digital technologies are
transforming our economies and seem to offer a vast potential to enhance
the productivity of firms14. Second, it is argued that new technological
11
Herwartz, H., (2019), Long-run Neutrality of Demand Shocks: Revisiting Blanchard and
Quah (1989) with Independent Structural Shocks, Journal of Applied Econometrics, 34(5),
811-819.
12
Solow, R., (1987) We'd better watch out, New York Times Book Review, July 12, page 36.
13
Brynjolfsson, E., (1993), The Productivity Paradox of Information Technology,
Communications of the Association for Completing Machinery, 36(12), 66-77.
Brynjolfsson, E., Rock, D., and Syverson, C., (2018), Artificial Intelligence and the Modern
Productivity Paradox: A Clash of Expectations and Statistics, The Economics of Artificial
Intelligence: An Agenda, University of Chicago Press, pp. 23-57.
14
OECD (2019), Digitalisation and Productivity: A Story of Complementarities, OECD
Economic Outlook
developments are still in the 'installation' stage and hence they are
producing only localised gains in productivity15 - "a GPT16 does not deliver
productivity gains on arrival"17. Raising productivity will need a sufficiently
large stock of the new capital, and complementary business process
changes involving human capital and organisational changes in
investment decisions have to be in place to integrate it into production in
order to harness its benefits18. For instance, it has been found that
investments in IT yields substantial benefits but over a gestation period,
peaking after about seven years19. Moreover, access to cutting edge
technologies remains uneven among countries and between firms -
nearly half of SMEs and about a third of large firms in emerging and
developing Asia report difficulty in obtaining financing as the major
impediment to technology adoption20. Commensurately, aggregate R&D
expenditure has slowed down in Asia and the world at large21. Other
explanations of the productivity slowdown have also been offered in terms
of the leapfrogging of many EMDEs over the relatively productive and
labour-absorbing manufacturing sector to the relatively less productive
services sector; trade and technology fragmentation; disruptions in global
value chains; and the possibility of dissipation of profits - innovative firms
15
Van Ark, B., (2016), The Productivity Paradox of the New Digital Economy, International
Productivity Monitor, (31), 3.
16
General Purpose Technology or GPT is a term coined to describe a new method of
producing and inventing that is important enough to have a protracted aggregate impact (for
instance, electricity and information technology).
17
Jovanovic, B. and Rousseau, P. L., (2005), General Purpose Technologies, Handbook of
Economic Growth, Vol. 1, pp. 1181-1224. Elsevier.
18
Brynjolfsson, E., Rock, D. and Syverson, C. (2018), Artificial Intelligence and the Modern
Productivity Paradox: A Clash of Expectations and Statistics in The Economics of Artificial
Intelligence: An Agenda, pp. 23-57. University of Chicago Press.
19
Brynjolfsson, E., and Hitt, L. M. (2003), Computing Productivity: Firm-level Evidence,
Review of Economics and Statistics, 85(4), 793-808.
20
Dabla-Norris, E., Kinda, T., Chahande, K., Chai, H., Chen, Y., Stefani, A., Kido, Y., Qi, F.
and Sollaci A. (2023), Accelerating Innovation and Digitalization in Asia to Boost Productivity.
Departmental Paper, 2023/01, International Monetary Fund. January.
21
World Intellectual Property Organization (WIPO) (2022), Global Innovation Index 2022:
What is the Future of Innovation-driven Growth? Geneva.
displace lagging firms from the market but without adding
commensurately to output22.
IV. Conclusion
Given that multiple factors could be at work, a multi-pronged approach
woven into a comprehensive policy intervention is needed to reignite and
sustain productivity growth. The policy response has to be powered by
technological capital deepening, accompanied by long term investment in
research and development to nurture a competitive innovation ecosystem,
skill development through sustained educational attainments and training,
and building up the physical infrastructure. EMDEs need to leverage the
potential of the services sector to drive productivity growth. Investing in
ICT infrastructure, securing reduction in trade costs like those associated
with shipping, logistics and regulation and supportive business-enabling
reforms could help to engage the private sector in partnering in this
endeavour. In addition, raising labour force participation rates, especially
among women and older workers, could also boost productivity, but this
will require investments in workability, retraining and acquisition of new
skills in step with changing technology. The OECD has cited digitalisation
as a key avenue for future productivity growth by harnessing the power to
rapidly diffuse and replicate ideas, informational goods and business
processes at near zero marginal cost. Easing and expanding access to
finance for small and medium enterprises can generate productivity
bursts, especially in EMDEs.
Central banks are stakeholders in this effort in view of their mandates of
macroeconomic and financial stability. A deeper understanding of
productivity trends is needed by them in order to judge the position of the
economy on the business cycle so as to fashion appropriate policy
responses that ensure sustained non-inflationary economic growth. In
turn, this will promote financial market confidence and the overall flow of
finance in the economy.
Against this backdrop, the theme of this Conference is indeed timely and
relevant. Your deliberations will surely provide deeper insights into the
structural drivers of productivity and factor accumulation that create the
conditions for sustainable development. New challenges, including
climate change, digitalisation and the reshaping of global value chains,
have to be addressed and new opportunities have to be seized. The
Conference brings together the best minds, experiences and learnings on
a subject of topical importance. I am sure that your discussions will enrich
our understanding of productivity and growth in Asia and lead to better
policy outcomes. I thank you all for your participation and wish you
success in crossing another milestone in the journey of Asia KLEMS.
Thank you.