The recently concluded Stanford Conference on ‘Challenges of Economic Policy Reform in Asia’ debated a variety of issues that concern Asia’s future. One that affects India and China in particular—fiscal federalism—was the subject of my last piece. Two other areas that generated vigorous discussion were the comparison of productivity in India and China as well as energy, environment and sustainable development.

On productivity trends, the main issue was why total factor productivity in China has accelerated far more than India. The broad conclusions converged on two factors: barriers to technology diffusion, and misallocation of resources across firms. Total factor productivity could be doubled if capital and labor could be allocated efficiently and bigger plants were allowed to expand. Medium-sized plants could also become more efficient. The key policy to enable diffusion of technology and improved resource allocation? Flexible labour policies and provisions for quicker entry and exit for firms. This would not only permit optimal technology use but also enable growth in a wider variety of geographic locations. Other policy priorities to address included minimising financial distortions, reducing disproportionate taxes (based on equity considerations) on efficient firms, and scaling back specific policies which limit the size of firms (such as reservations for small-scale industries). All of these inhibit prospects for improving technology.

Whatever the route, India must improve total factor productivity, or its incremental capital-output ratio, to realise the somewhat daunting growth targets contemplated for the Eleventh Five Year Plan. Simply increasing savings and investment will not be sufficient. The ICOR rates in India have barely moved over the past years. This is an area where the returns from some policy changes will have greater, and faster, impacts on growth than efforts in other directions.

... contd.