MacroScan (Printable Version) - Of Profits and Growth

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.

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.

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.

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.



Themes > Features	29.05.2012


Of Profits and Growth*

C.P. Chandrasekhar and Jayati Ghosh

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. 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. 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. 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.



© MACROSCAN 2012