The Planning Commission has announced an average GDP growth target of 8.2% for the Twelfth Five Year Plan period which runs from 2012/13 to 2016/17. While it is not as high as the 9% envisioned over a year back, it has not been dragged down to the 7% levels which some allude to as the ‘new potential’ of the economy. With the 8.2% target, the Commission seems to strike a balance between the current and the aspirational. In this paper, we disaggregate the 8.2% growth target into what could be achieved through a business-as-usual approach and what would need added effort. We outline a simple Cobb Douglas production function model which decodes India’s growth over the last two decades and helps us outline alternate paths to 8.2% as we gaze into the future. We discuss a variety of ‘extreme’ paths of growth which depend heavily on one particular input at a time. We then go on to outline a more plausible and balanced path, and discuss the key challenges surrounding it. We conclude that 8.2% growth will neither come automatically nor easily, but what needs to be set right
to achieve it over the next five years is clearly known.

Growth Experience in the Past

It is well recognized that high growth not only needs rapid growth in inputs such as physical and human capital, but also a high growth rate of Total Factor Productivity (TFP). TFP is not only driven by technological change, but includes the impact of policy environment, institutional infrastructure, transaction costs, level of financial intermediation, terms-of-trade shocks, etc. Anything that is not associated with the two inputs of production is captured by TFP. Put simply, growth in TFP is a combination of pure technical progress and the ability to utilise inputs more efficiently, the latter often being made possible by productivity enhancing economic and institutional reforms. In fact, much of the impact of the reform agenda pursued since 1991 has manifested itself through an increase in TFP. In accounting for the sources of growth, we calibrate the Cobb-Douglas production function to fit the economy’s growth path. GDP is assumed to be produced by combining physical capital, human capital and labor, operated at the economy’s overall level of productivity. The measure of productivity is the total factor productivity, measured as the “residual” not accounted for by the accumulation of physical or human capital.

Y = AK^α (HL)^(1-α)

Where

Y: Real Gross Domestic Product at Factor Cost [Data source: CSO]

A: Total factor productivity [Data source: Calculated as residual]

K: Real Net Fixed Capital Stock [Data source: CSO]

L: Labor employment [Data source: NSSO, Current Daily Status]

H: Labor quality proxied by average years of education of the population aged 15 years and above [Data source: Barro & Lee]

α: Factor share of capital; (1- α): Factor share of labor

By taking the difference in natural logarithms of Equation , we can derive the contributions of various inputs to output growth.

A’ = Y’ – αK’ – (1-α)H’ – (1-α)L’

where a dash above a variable denotes its time derivative

For the last two decades until 2011/12, we insert values for GDP, capital stock, labour and human capital to derive the TFP (A) as the residual. For the next five years (2012/13 to 2016/17), we insert different forecasts for TFP, capital stock, labour and human capital which give us an average GDP growth rate of 8.2%.

We assume competition in markets so that factor earnings are proportionate to the respective factor productivities. The shares of income paid to the factors are then used to measure their importance in the production process. Consistent measures of factor income are not available for individual countries, and we follow the generally accepted view that once statistical anomalies are corrected, the weights are similar across a  broad range of countries . Factor shares are assumed to be 0.33 for capital and 0.67  for labour, in line with the literature

Data on GDP and capital stock are available on a yearly basis. We pass both these series through the Hodrick-Prescott filter to iron out cyclical variations and get a handle on the trend. Data on labour employed and average years of schooling are only available for every five years and have been an impediment for a production function type analysis for India. To fill in these gaps, we extrapolate between the years using a constant growth rate. Another shortcoming of labour data is that the last available is 2009/10 for labour employed and 2010/11 for average years of schooling. To extend these two series till 2011/12, we use the same average annual growth rate as in the last five years for which the data is available.

Data on capital stock needs a special mention. We have time-series data on the net  fixed capital stock, and by taking a first difference, we can calculate net fixed capital  formation. We find that growth in net fixed capital formation correlates strongly with growth in gross fixed capital formation. This allows us to express our forecasts of net  fixed capital stock as gross fixed capital formation.

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Courtesy: Planning Commission Government of India