Strengthening innovation and reducing business obstacles could significantly enhance India’s productivity growth, aiding its ambition to evolve into an advanced economy, as per a recent International Monetary Fund (IMF) study. The IMF report, led by Harald Finger and Nujin Suphaphiphat, indicates that by providing better backing for innovation and eliminating restrictive practices hindering firms, India’s productivity growth could surge by almost 40 percent. This advancement would be akin to incorporating the output of Karnataka, India’s fourth-largest state, into the economy every ten years.
The analysis reveals divergent productivity patterns among sectors, with services registering notable advancements due to digital technology adoption and global value chain integration. In contrast, manufacturing has experienced modest growth, while agriculture, despite employing over 40 percent of the workforce, remains less productive. The IMF underscores the potential gains from reallocating labor and activities to higher-productivity sectors, emphasizing the substantial productivity disparity between services and agriculture.
The prevalence of small-scale enterprises in manufacturing has impeded progress, with nearly 75 percent of factories hiring fewer than five paid employees, hindering output per worker compared to larger firms. Cumbersome compliance regulations, rigid labor laws, and market constraints have stymied growth, but recent labor code reforms in India could pave the way for further enhancements, notes the IMF.
India’s productivity is also hampered by low business dynamism, evidenced by subdued rates of firm creation, closures, and exits compared to economies like Korea and the United States. The presence of unproductive “zombie firms” further dampens productivity, necessitating a more dynamic business environment that facilitates the exit of inefficient firms and fosters the growth of innovative enterprises. Additionally, India’s innovation landscape faces constraints, with limited R&D investment and technology adoption, particularly among smaller firms.
The IMF estimates that elevating India’s innovation metrics to match top performers among emerging markets could elevate productivity growth by nearly 0.6 percentage points, representing a substantial increase from India’s historical average.
