Factor Hoarding and Productivity: Experience from Indian Manufacturing

Growth in the neoclassical framework stems from two sources: factor accumulation and productivity growth. The growth driven by increased factor accumulation cannot be sustained because of the non-availability of factor inputs in future as well as diminishing returns to factors. Hence, economists have emphasized on productivity growth. Total factor productivity (TFP) growth is important even for developing countries like India with relatively abundant labour, as these economies face an acute shortage of some other productive resources. Many studies have been undertaken to examine the trends in productivity in India. Most of the empirical studies on productivity in India have focused on the TFP growth (TFPG) of the manufacturing sector in the post reform period. Some of these studies include Brahmananda (1982), Ahluwalia (1991), Golder (1986,1990, 2004), Srivastava (1996, 2001), Chand and Sen (2002), Unel (2003), Das (2003), and Topalova (2003). Evidence on TFPG in India as brought out by these studies vary considerably. This is due to the use of different estimation methods of TFPG, as well as the use of different data sets. None of the above studies has considered variation in input utilization rates over business cycles to compute TFP or Solow residual. In this paper, I have considered variable input utilization — variable capital utilization and variable labour efforts derived explicitly from a partial equilibrium model on Indian data. Variability of factor inputs can occur over a business cycle when firms are not able to disinvest capital or lay off workers in a downturn. It is particularly important for Indian industries which have operated till 1991 under a rigid license, permit and quota regime. During an expansion period, capital is fully utilized while in recession period, there is under utilization of capital stocks. Firms were known to hoard capital above their optimal level as they could claim a lower capital requirement for later expansion, and hence strengthen their claim for production license. On the labour front, labour protection laws have made it virtually impossible for the firms to lay off workers even when they have stopped producing. Also, training new workers is costly and firms encourage workers to work harder in the expansion period. In the typical TFP calculation, labor/capital inputs are measured as higher than ‘real’ in recessions, and as lower than ‘real’ in expansions. Accounting for factor hoarding or surplus can thus have a significant impact on TFPG estimation since the standard computation of the Solow residual fails to filter out cyclical variation in input utilization rate, assigning it to fluctuations in technology.