As
growth slows, inflation returns and the rupee depreciates,
India's growth story seems at an end. There are two
questions being posed. The first is whether the downturn
is the result of international factors, especially
the crisis in Europe, or is partly or largely internally
driven. The second is whether the current downturn
is an exception or the high growth that preceded it
an abnormal interlude in India's recent economic history.
It is often argued that the higher growth experienced
since the 1980s, and especially after liberalisation
in 1991, had lasted far too long to be dismissed as
an exceptional, short-run phenomenon. But there are
a number of difficulties with that argument. To start
with, it does not take account of the fact that the
drivers of growth during the 1980s were significantly
different from that in the 1990s and after. The second
is that even the period after 1991 was by no means
one of consistently high growth. There was a mini-boom
during the four years starting 1993-94, a slowing
down of growth after that and then a sharp revival
after 2002-03. The revival was so marked and remarkable
that it speaks of a break in the growth process in
the early years of the last decade. For a period of
five years or more after 2002-03, not only was GDP
growth in the 8-9 per cent range, savings and investment
rates were much higher, the current balance in the
external account was reasonably comfortable, foreign
exchange reserves were high and rising, and manufacturing
was once again a part of the growth process. In sum,
the evidence seemed to point to a new growth paradigm.
Associated with this episode of remarkable growth
was one new feature. These were the years when there
was a surge in cross-border capital flows across the
world with the so-called ''emerging market economies''
being major beneficiaries. India too experienced a
surge, facilitated by more liberalised investment
rules and encouraged by the abolition of capital gains
taxation on investments held for more than a year.
Foreign investment inflows rose from around $6-8 billion
at the turn of the last century, to $20-30 billion
during 2005-07 and $62 billion in 2007-08. This not
only gave the government a degree of manoeuvrability
with regard to its spending, but also infused liquidity
into the system and supported a substantial expansion
in retail credit. Lending to individuals for housing
investments, automobile purchases and consumption
registered a spike. The resulting credit-financed
investment and consumption helped expand demand and
drive growth, including growth in manufacturing. The
government catalysed that growth with multiple concessions
at central and state levels for private investors,
important among which were easy access to and low
taxes on imports of technology, capital equipment
and intermediates and low cost access to land and
mineral and other scarce resources.
Chart
1 >>
(Click to Enlarge)
The
result was an increase in the private sector's ability
to garner higher profits. Consider trends emerging
from the official Annual Survey of Industries relating
to the organised manufacturing sector depicted in
Chart 1. To start with, since the early 1990s, when
liberalisation opened the doors to investment and
permitted much freer import of technology and equipment
from abroad, productivity in organised manufacturing
has been almost continuously rising. Net value added
(or the excess of output values over input costs and
depreciation) per employed worker measured in constant
2004-05 prices, rose from a little over Rs. 1 lakh
to more than Rs. 5 lakh. That is, productivity as
measured by net product per worker adjusted for inflation
registered a close to five-fold increase over the
30-year period beginning 1981-82. And more than three-fourths
of that increase came after the early 1990s.
Unfortunately for labour, and fortunately for capital,
the benefit of that productivity increase did not
accrue to workers. The average real wage paid per
worker employed in the organised sector, calculated
by adjusting for inflation as measured by the Consumer
Price Index for Industrial Workers [CPI(IW) with 1982
as base], rose from Rs. 8467 a year in 1981-82 to
Rs. 10777 in 1989-90 and then fluctuated around that
level till 2009-10 (Chart 2). The net result of this
stagnancy in real wages after liberalisation is that
the share of the wage bill in net value added or net
product (Chart 1), which stood at more than 30 per
cent through the 1980s, declined subsequently and
fell to 11.6 per cent or close to a third of its 1980s
level by 2009-10.
A corollary of the decline in the share of wages in
net value added was of course a rise in the share
of profits. However, the trend in the share of profits
is far less regular than that of the other components
in net value added. Between 1981-82 and 1992-93, the
ratio of profits to net value added fluctuated between
11.6 per cent and 23.4 per cent. During much of the
next decade (1992-93 to 2002-03) it remained at a
significantly higher level, fluctuating between 20.4
per cent and 34.3 per cent, but showed clear signs
of falling during the recession years 1998-99 to 2001-02.
Chart
2 >>
(Click to Enlarge)
However, the years after 2001-02 saw the ratio of
profit to net value added soar, from just 24.2 per
cent to a peak of 61.8 per cent in 2007-08. Unfortunately
for manufacturing capital, the good days seem to be
at an end. There are signs of the profit boom tapering
off and even declining between 2006-07 and 2009-10.
But this latter period being short, we need to wait
for more recent ASI figures to arrive at any firm
conclusions.
As of now, what needs explaining is the remarkable
boom in profits at the expense of all other components
of net value added. An interesting feature that emerges
from the chart is that the ratio of profits to value
of output, or the margin on sales, tracks closely
the irregular trend in the share of profits in value
added described above. Increases in profit shares
have clearly been the result of a rise in the mark
up represented by the profit margin to sales ratio,
or the ability of capital to extract more profit from
every unit of output.
Interestingly, the periods in which the ratio of profits
to the value of output has risen, leading to sharp
increases in profit shares, were also the years when
the two post-liberalisation booms in manufacturing
occurred. The first of those was the mini-boom of
the mid-1990s, starting in 1993-94 and going on to
1997-98, which was fuelled by the pent-up demand in
the upper income groups for a range of goods that
had remained unsatisfied prior to the liberalisation
of imports and foreign investment rules. The second
was the stronger and more prolonged boom after 2002-03,
led by new sources of demand. That boom lasted till
the global financial crisis in 2008-09. The coincidence
of the rise in profit margins and profit shares and
the output booms suggests that, in periods of rising
demand, the organised manufacturing sector in India
has been able to exploit liberalisation in two ways.
First, it has been able to expand and modernise using
imported technologies, raising labour productivity
significantly in the process. Secondly, it has been
able to ensure that the benefit of that productivity
increase accrues almost solely to profit earners,
because of the conditions created by the ''reformed''
economic environment. As a result, the mark up rose
significantly or sharply in these periods and delivered
a profit boom.
Chart
3 >>
(Click to Enlarge)
An interesting feature is the way in which this process
feeds on itself. As Chart 3 depicting trends in the
different components of net value added shows, while
the nominal value of rent, interest and wages rose
only marginally over a long period, the increase in
emoluments, which include managerial salaries, was
substantial. Profits of course soared as noted earlier.
The increase in non-wage salaries and incomes not
only directly drives manufacturing demand, but also
provides the basis for the expansion of credit-financed
investment and consumption expenditure. Thus the boom
creates conditions that also help prolong that boom.
Seen in this light, there are reasons to believe that
certain recent developments could be constraining
growth in the manufacturing sector. The first is the
reduction and even reversal in foreign capital inflows
into the country as a result of both global and domestic
uncertainty. This is putting pressure on the government
to reduce its fiscal deficit and the level of public
debt, which has a deflationary impact. Moreover, the
liquidity crunch resulting from the lower levels of
foreign inflows and the uncertainty arising from increase
debt defaults in the retail market is reducing the
volume of credit and hence the volume of debt-financed
investment and consumption.
Finally, there has been an increase in allegations
of large scale corruption. The instances to which
such allegations relate are many, varying from the
sale of 2G spectrum and the mobilisation and/or disposal
of land and mining resources to purchases made as
part of large and concentrated public expenditures
(as in the case of the Commonwealth Games). What this
has done is increase the reticence and limit the ability
of the government to openly favour private capital
with concessions that deliver high and rising profit
margins.
When the effects of such developments combine they
could restrict demand and dampen investment considerably
leading to a reduction in the rate of growth of manufacturing.
They are also possibly reducing profit margins and
profitability so that we may well be at the end of
the profit-inflation led growth of manufacturing production.
*
This article was originally published in the Business
Line on 28 May 2012.
