Economists are good at conceptualising abstract models of the economy, and making them empirically useful. This applies to growth models as well. The simplest view of growth is that capital investment is what matters: more capital per worker means more output per worker, which is what economic growth is about.
This view underlay the “Mahalanobis model” that influenced Indian policymaking and implementation from the early years after independence.
The key conceptual driver in putting the abstract ideas into practice was that the public sector had to lead the process of increasing investment.
There is some consensus among economists that this approach was not the best possible, in various policy dimensions, with the evidence for suboptimality including high incremental capital-output ratios, or, equivalently, a low marginal productivity of capital.
At a deeper level, economists have continued to disagree about the details of India’s growth story, including normative goals as well as growth processes (for example, Bhagwati and Panagariya 2014, Drèze and Sen 2013).
Sometimes, the empirical backing for choosing between academic and policy positions has been lacking, but empirical analyses do exist. One I have found useful is that of Sen (2007), which empirically examines the factors that determined growth in India’s per capita GDP (gross domestic product) from 1955 to 2004, and finds the only component of investment that was statistically significant was the ratio of private sector equipment investment to GDP.
Furthermore, the significant determinants of private sector equipment investment were total public investment as a ratio of GDP; financial deepening, as measured by the ratio of private sector bank credit to GDP; and a fall in the relative price of equipment (triggered by changes in trade policy towards greater openness).
These are plausible pillars of good government policy: public infrastructure, a robust financial sector, and getting prices right.
Economists’ growth accounting takes a different approach than Sen’s econometric analysis, trying to measure the contributions of labour, capital, and other inputs to growth in output, using national income accounts.
In these calculations, the quality of inputs is adjusted, so that labour input can take account of education levels, for example – what economists call human capital. The portion of output not explained by quality-adjusted inputs is known as Total Factor Productivity (TFP), and is taken to reflect factors such as innovation and efficiency of input use.
Several studies have been undertaken for India (for example, Goldar 1986, Ahluwalia 1991), and in Sen’s work, there turns out to be a strong positive correlation between TFP and private equipment investment, perhaps suggesting knowledge or efficiency spillovers from such investment.
In growth accounting exercises, changes in human capital can be captured to the extent they are measured by educational attainment. But human capital is a very broad category, and it includes not only the skills that industrial and clerical workers have, which might be proxied by education levels, but also managerial skills.
India has produced a well-recognised elite of managers, some of whom have demonstrated their capabilities outside the country, in premier US firms such as Alphabet (Google), Microsoft, MasterCard, and Pepsi, even drawing attention from Chinese policymakers in this respect. Can one empirically assess the impact of such managerial skills on economic growth?
Managerial Skills and Economic Growth:
One problem in assessing the impact of management is that it is an amorphous and multifaceted category, including a variety of possible activities. This problem has been addressed by the work of economists like Nicholas Bloom and John Van Reenen, who were leaders in creating a survey of management practices in 12,000 firms across 34 countries, spanning a decade and a half (Bloom and Van Reenen 2007). They have systematised, and quantified to a considerable extent, the measurement of management practices and quality.
In essence, this work allows management to be thought of as a technology (Bloom, Sadun and Van Reenen 2017), so higher quality management leads to greater output or value added. This contrasts with alternative views of management as a contingent activity, responding to particular sets of circumstances, and not something that can be reduced to a single quality scale.
The newer empirical work based on the World Management Survey supports the ‘technology’ interpretation of management, and goes further, to estimate that 30% of the productivity difference across countries that is not explained by variations in labour (adjusted for skill levels) and physical capital (such as plant and equipment) can be attributed to differences in management quality.
Essentially, quantifying and allowing for management quality explains some of the heretofore unexplained TFP residual across countries.
Within countries, as well, differences in management quality across firms are substantial. India has very well-managed firms, as well as poorly managed ones: the point is that this is not necessarily because of innate ability differences or external constraints, but factors that can be identified, measured, and therefore, potentially fixed. This is important for policy thinking and conceptualisation.
Evidence from India:
Several years ago, Bloom et al. (2013) undertook experimental interventions for improving management practices in a small set of textile firms in Mumbai. Indeed, better management practices improved the firms’ output and productivity significantly, as benchmarked against a control group of similar firms.
Recently, four of these authors (Bloom et al. 2018) have found a considerable degree of persistence in the use of improved management practices and of performance, and some diffusion to other plants within the same company: this was as many as nine years after the original experiment.
Many of the management improvements in this experiment were low cost and relatively simple, amplifying the puzzle of why poor management persists. The answer to this puzzle includes lack of product market competition, which allows for slackness in management.
Another factor is labour regulations that constrain management flexibility, in areas such as the assignment and compensation of employees, aside from the more extreme decisions of hiring and firing. Sometimes, managers are not even aware of the weaknesses of their practices, or if they are, what remedies are available. Matters are made worse when family or ethnic ties constrain the selection and evaluation of managers.
The Bloom et al. (2013) work is direct experimental evidence for the importance of good management for the performance of Indian firms, albeit for a small sample in a specific industry. Sharma and Singh (2013), building on Gangopadhyay et al. (2008), found indirect evidence in a large panel of Indian manufacturing firms.
These studies looked at the use of information technology (IT) and its impacts in Indian manufacturing plants. They found evidence that plants with higher gross value added had higher levels of IT capital stock, controlling for other inputs.
However, this effect was considerably reduced when controlling for some of the unique characteristics of the plants themselves – what economists call ‘plant-level fixed effects’. This result can be plausibly interpreted as an indication that unobserved managerial quality is an important factor in the impact of IT capital on productivity.
Even here, of course, there is a step further to claims about the aggregate economy and the contribution of manufacturing to productivity, but all the evidence from different sources is consistent.
Implications for Policy:
One can argue that deficiencies in management in India represent a failure of its elites, whether in the public or private sector: those who occupy the managerial positions that matter. This post has been about management in the private sector, but one can make qualitatively similar arguments about public sector management in India (Singh 2008, 2017).
Public policies that increase product market competition and relax constraints on the provision of training for management skills (including the nuts and bolts of operations management and accounting, and not just what constitutes an elite MBA curriculum) ought to be at the forefront of policy thinking.
Just as the World Bank’s “Ease of Doing Business” survey has influenced policymaking in India, so too, perhaps, should the World Management Survey.
Indeed, one can argue that the financing of firms and the skilling of workers – important activities if Indian firms are to grow and compete – are both activities that can be done more efficiently with better management. In that case, systematically improving management practices can catalyse the relaxation of other constraints on the performance of the economy.
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Published with permission from Ideas For India (www.ideasforindia.in), an economics and policy portal.