TFP of a country is like the profit of a company. It measures efficiency with which a country manages its resources.
The ongoing Indian elections have been marked by an explosion of analyses comparing the performances of the UPA governments from 2004 onward with that of the NDA government during the period 1998-2004. A large part of this debate turns on the issue of how to judge the performance of a government. Different commentators highlight different indicators, making comparisons inherently subjective.
The problem facing the voter is a bit like the problem facing an investor choosing between the stocks of different companies. The voter needs to invest in a party, while the investor needs to invest in a company. How does an investor decide? The first indicator of company health are profits as a share of revenues. An efficient company tries to raise the profit rate by increasing revenues and/or lowering costs through reduced input usage. Higher profit rates tend to indicate greater efficiency and future growth.
Is there a counterpart for company profits for evaluating governance of a country? A measure that economists use to judge the economic efficiency of an organisation is Total Factor Productivity (TFP). TFP of any entity is the difference between what it produces and what it uses as inputs. For a country, output is Gross Domestic Product (GDP), while inputs are the capital used, employed labour, the skill level of the employed labour, etc. Thus, TFP of a country is like the profit of a company. It measures the efficiency with which a country manages its resources.
This efficiency depends on myriad factors, including economic policies, institutions and governance. More efficient, better managed economies with strong institutions that protect individual and economic freedoms are able to produce more GDP with fewer inputs, i.e., through higher TFP. In principle, then the voter could use TFP as an indicator of government efficiency.
Just as profits, rather than revenue growth is the key for stockholders, TFP growth, rather than GDP growth should be key for the voter.
For the past three decades, the Center for the International Comparisons of Production, Income and Prices at the University of Pennsylvania has been compiling internationally comparable data for a number of countries. Its latest data release is the PWT 8.0. It provides data on income, output, input and prices for 167 countries covering the period 1950-2011. Two welcome additions in the latest release are data on the capital stock and TFP for a number of countries.
The GDP and TFP growth numbers for India reported in PWT 8.0 make for interesting reading.
First, they confirm the overall view of India having been a relatively low growth, inefficient economy till 1991 that saw a big increase in growth post-1991, accompanied by more efficient economic management ushered in by economic reforms and liberalisation. Between 1960 and 1991, the economy grew at an average annual rate of 4.3%. This growth rate rose to 6.8% between 1991 and 2011. Correspondingly, TFP growth in India, which averaged 0.65% a year between 1960 and 1991 almost tripled to 1.64% between 1991 and 2011. Put differently, while TFP growth only accounted for about 15% of annual GDP growth during 1960-1991, it accounted for 24% of the higher average GDP growth during 1991-2011. Clearly, the economy became a lot more efficient in managing its resources post-1991.
What do the GDP and TFP growth figures suggest about the periods 1998-2004 and 2004-2011?
Annual growth during 2004-2011 under the UPA regime was 8.1%, which was 2 percentage points higher than during the NDA government that preceded it. The difference between the two regimes though is the share of TFP growth in total GDP growth. Under the NDA regime during 1998-2004, this share was 21%. Under the UPA dispensation during 2004-2011 TFP's share of growth declined to 17.5%.
Looking under the surface of these numbers provides even greater perspective on the efficiency of the two regimes. During the UPA-1 regime of 2004-2009, TFP's share of growth was 15.4%, which was exactly the contribution of TFP to growth during the low growth period of 1960-1991, a period riddled with economic inefficiencies. Moreover, the source of the current disaffection of many voters with the UPA-2 can be seen in the figures for 2011 (the last year of the sample in PWT 8.0). Growth declined sharply as did TFP. What is perhaps most disconcerting is that TFP's share of GDP growth went below 14% in 2011. This is a historic low in TFP's contribution to economic growth in India. One can only imagine how much worse the figures for the period 2011-2014 are going to be given the economic slowdown and policy paralysis that has epitomised this phase.
Why might growth remain strong despite tepid TFP growth? The typical reason is a high investment rate which, in turn, indicates that investors perceive high returns in the economy.
Low TFP growth however, indicates that some of this potential may have been squandered through management inefficiencies and resource misallocations.
The growth and TFP numbers in India over the past few years suggest that the potential remains high but management and governance continues to be a major worry.
Sometimes a single number is more informative than multiple indicators. The behaviour of TFP for judging the quality of governance may be an example of this even though voting decisions depend on much more than just economic efficiency.
Article Courtesy, Amartya Lahiri,The sunday-guardian