Economic Growth in India and Bangalore

Economic Growth in India and Bangalore

An Analysis of Structural Change

7/30/2010

Economic History Master Thesis

Caroline Louie

Abstract

The goal of this paper is to investigate the changing nature of India’s and Bangalore’s economy. This study will assessIndia’s change in the allotment of resources between different sectors within the state and country. To investigate the shifts, this paper will disaggregate the economy into three broad sectors, primary secondary and tertiary. It is expected that the much of the success of India at present is a result of labour moving from low value added sectors into areas of high value added. To determine whether this is in fact the case, a shift share analysis of India will be conducted to determine the underlying reasons for the changing economy. From these results, inferences about Bangalore’s economy will be made. The analysis will be conducted through the lens of the Schön Cycle. The results will shed light on policy implications, as and will add to the discussion of convergence and divergence.

Contents

I.Introduction

I.IAim and Justification

I.IIContribution

I.IIIScope And Limitation

I.IVOutline

II.Theoretical Background

II. IDevelopment of Economic Growth and Innovation Theories

II.IIStructural Change

III.Historical Background

III.IThe Development of the Indian Economy and the Growth of IT

III.IITHe Growth and DeveLopment of Bangalore’s Economy

III.IIIThe Changing Economy: Comparing India To Bangalore

IV.Method

IV.IShift Share Analysis

IV.IIA note on the Data

V.Results

V.IStructural Change

V.IITotal Factor Productivity

V.IIIInvestments

VI.Discussion

VI.IThe Schön Cycle

VI.IIThe Inferences for Bangalore

VI.IIIConvergence or Divergence

VI.IVPolicy Implications

VI.VFuture Studies

VII.Conclusion

Bibliography

Table of Equations

Equation 1: Aggregate Production Function Model

Equation 2: Labour Productivity

Equation 3: Counterfactual Production if Employment is Kept Constant

Equation 4: Counterfactual Labour Productivity if Employment is Kept Constant

Equation 5: Counterfactual Production if Structure is Kept Constant

Equation 6: Counterfactual Labour Productivity if Structure is Kept Constant

Equation 7: Counterfactual Labour productivity

Equation 8: Strucutal Change

Equation 9: Percentage of Structural Change

Equation 10: Total factor productivity

Table of Figures

Figure 1: GDP Growth RATE (%) With 5 Year Moving Average Between 1950-2008

Figure 2: Labour Productivity in India Between 1960-2004

Figure 3: India Value Added Between 1950-2005. At Constant 1993-1994 Prices. 9 Sectors

Figure 4: Indian Value Added Between 1950-2005, At Constant 1993-1994 Prices. 3 Sectors

Figure 5: Percentage Contribution of Workforce. India 1970-2004.

Figure 6: Sector Share of GDP Bangalore vs. India (%)

Figure 7: Structural Change of Indian Economy Between 1970-2002 Using 1970 as a Base Year

Figure 8: Annual Structual Change of the Indian Economy Between 1970-2002

Figure 9: The Structural Change of the Indian Ecomony with and without the Tertiary Sector 1970-2002

Figure 10: The Structural Change in the Indian Economy Due to the TERTIARY SECTOR: 1970-2001

Figure 11: Capital-Output Ratio in the Indian Economy 1950-2007 at Fixed 1999 in INR prices. Index 1990=1

Figure 12: Indian GDP per Capita in Reation to World GDP per Captia 1960-2008. Constant 2000 USD PRICES

Table of Tables

Table 1: Annual Growth Rates, India Vs. Bangalore

Table 2: Sector share of GDP Bangalore Vs. India (%)

Table 3: Structural Change With and Without Tertiary Sector

Table 4: Total Factor Productivity in India- Aggregated and Sectoral Contributions

Table 5: Investment in Bangalore (Rs. Billion)

Table 6: Share of Investment in Bangalore (%)

I.Introduction

I.IAim and Justification

The prodigious rate of industrialization in Asia is a prominent issue in many areas of academia and policy. The effects of rapid growth are felt among many levels of analysis- intra-regionally, nationally and internationally- and are seen as a consequence of globalization. The phenomenon of ‘Globalization’ has increased interaction and connectedness internationally; however, it has also led to uneven growth patterns, stratifying the world into developed and developing nations. These complex attributes have caused two divergent views on globalization to surface. One school of thought emphasizes that the process of globalization integrates the world by creating a synchronized economy, while the other views this process as a mechanism for exploitation of resources, causing inequities in socio-economic status and cultural norms(Kalra 2007).

With such contrasting interpretations of the costs and benefits of globalization, it is not surprising that this debate influences national as well as regional government policies. The integration of the Indian economy with the global economy has manifested several spatial changes. These changes include; ‘the increasing specialization of urban regions, growing urban interdependencies, new patterns in the spread of technologies, changes in the product-mix of regions and changes in the sector mix of the economy’ (Kalra, 2007, p. 2).

Within the Western world, IT technology was introduced in the 1970’s, but it was not until the 1990s that the dot.com boom arrived (Wright 2006). The IT Revolution was felt broadly throughout the society, but especially in the service sector. The benefits were felt in many diverse industries and caused many new improvements, both in the process of production and product itself. This essay aims to determine whether a similar experience is occurring within Bangalore andIndia. India has led South Asia’s growth for the past three decades(Chowdhury and Mahmud 2008). During the 1980’s, India began a series of reforms which shifted the country into a much more market oriented economy. The benefits of moving into an open economy have been greatly debated. The different arguments will be outlined in the subsequent research section. Regardless, the growth rate of the Gross Domestic Product (GDP) has been rapid and undeniable. However, in order to understand the rapid GDP growth, urbanization and changing nature of the region, one must disaggregate different aspects of the economy.

Economic growth is used to describe a higher standard of living, on average, for the average citizen. The GDP represents the wealth of a nation and is a function of its inputs (labour, and capital). It was once thought that if the number of machines grew at a faster rate than the labour force, then the productivity would increase, since machines make people more efficient. However, what Robert Solow observed, was that the investment in machinery had diminishing returns. Therefore, when machines increased relative to workers, the value added of each additional machine decreased. Furthermore, the impact of each additional ingredient depends on its importance to the production (Easterly 2002). Solow calculated the share of capital input in comparison to worker input to be 1/3 to 2/3 respectively; therefore, machines, relative to labour, had a low contribution to the total GDP. Solow’s conclusion went against the conventional belief of capital fundamentalism, which viewed investment in machinery as the prime determinant for growth. While it was clear to Solow that investment in machinery was not the reason behind sustained economic growth, the United State had been advancing for two centuries. Thus the question then arose: How did the US continue to sustain such growth? This question led Solow to investigate this discrepancy in his renowned paper ‘Technical Change and the Aggregate Production Function’. In this paper Solow concludes that the main source of growth was in fact technological innovation (Easterly 2002). Technological change allowed the factor in fixed supply;labour, to become more effective, without having to increase it in absolute terms.

When economic growth is accelerated, an economy’s backbone gets realigned. There is a movement from necessity to luxury as wages increase and citizens have higher disposable incomes(Kalra 2007). Thus with a rapidly expanding economy, it is expected for there to be a reallocation of labour and resources. The economic structure of a city, region or nation, is comprised of different ingredients which make up the economy; such as production, employment, consumption, investment and trade. The structural change is thus a relative shift of these indicators from one sector to another. Moshe Syrquin outlines three fundamental stages of structural transformation. In the first stage the economy depends mainly on the primary sector, during the second stage the reliance shifts to the secondary sector, and the final stage is when production is primarily due to the tertiary sector(Syrquin 1988). The changes that are occurring in India reflect this transformation into the final phase.

The rapid urbanization and economic growth that has been occurring in India will be analyzed through the lens of the Schön Cycle, thus assuming that innovation is an impetus for change. The purpose of this study is to investigate the changing structure of the Indian economy and to deduce what is happening within Bangalore. This paper aims at providing some insight for governmental policy, both regional and national, and to add some depth to the debate on Convergence and Divergence.

I.IIContribution

This paper aims to determine if the Schön Cycle is applicable to the case of India. Through the analysis of India, inferences for Bangalore will be made with the aim of providing depth to the understanding of economic growth, both for the region and the nation. If these theories do in fact pertain to this case study, then predictions for future growth can be given. Furthermore, regional policy has recently shifted from a reactive measure towards the national economy, into a more proactive role(Asheim and Coenen, 2005). Rather than restricting policy to pertaining only to redistribution, governments now aim to stimulate and encourage innovative development and investment within the economy. Therefore, if Bangalore follows the general trajectory of these growth models, then policy suggestions can be drawn in order to both foster growth and prevent the negative impacts of crisis. If the data does not give support to the theoretical framework, then these models may not be appropriate for the development in Bangalore, and to a greater extent Asia. The failure of this case study to follow the pattern of these models would suggest that other factors not accounted for in the present theory must be addressed. Consequently, it may lead to more studies to determine what types of alterations and improvements would need to occur in order to have these theories better reflect the changes that are occurring. Whether the results support or oppose the theory used, this knowledge will be helpful for a more comprehensive understanding of the changes evolving in Bangalore, and India as a whole.

This essay will also touch upon the discussion of Convergence vs. Divergence. In order to address this issue, three levels of analysis will be conducted; first an intra-regional look at the changes in equality within Bangalore; second, the inter-regional differences between Bangalore and the rest of India will be considered. Finally, there will be a global comparison between Bangalore and other metropolitan cities. Through the macro analysis of Bangalore, this paper aims at adding both breadth and depth to this multidimensional debate.

I.IIIScope And Limitation

This paper will look at the structural change of Indian economy between 1970 and 2000. A shift share analysis will be conducted to look at the change in structural patterns since the onset of the IT Revolution in India to the present state of the economy. Due to insufficient data on labour allocation, the shift share analysis could not be complete for Bangalore. Instead, the results for India will be used as a guideline. Some generalizations will be made, which can be applicable to the investigation of Bangalore’s economy.

This study will assessIndia’s change in the allotment of resources between different sectors within the state and country. To investigate the shifts, this paper will disaggregate the economy into three broad sectors, primary secondary and tertiary. These sectors: primary (agriculture, and mining & quarrying), secondary (manufacturing, electricity, gas & water, and construction), and tertiary (trade, hotel & restaurants, transportation & communication, finance services & retail services, and other services) have been chosen in lieu of the nine sector approach. The major reason for this tri-sector categorization is for simplicity. The aim of this paper is to investigate the movement into a service based economy, therefore, these broad sectors allow for a clearer picture than the nine tier categorization. This paper will address the changes that have been and are occurring in India and Bangalore.

Furthermore, this study will limit itself to economic changes. Recently there have been concerns in Bangalore over waste management, as well as water and power shortages(Basant 2006). While these are all areas of concern, the purpose of this paper is to document alternations in the economy of India and Bangalore.

I.IVOutline

The primary goal of this paper is to address the economic growth of India and Bangalore. In order to obtain this aim, this paper will be broken down into five major sections; Theoretical Background, Historical Background, Method, Results and Discussion.

The Theoretical Background will provide the introduction and development of innovation theories. It will touch on the major changes that have occurred within this realm of economic history by outlining some of the most prominent research papers. Then the development of different methods of analyzing structural change will be presented. In this section, an explanation of the Schön Cycle will be provided, which will be later used for the analysis of results in the Discussion section.

The Historical Background section will outline the development of the Indian economy. This section will describe the introduction and development of IT and IT related technology within the India’s economy in relation to changing government policies. It will then describe the growth of Bangalore since independence and also trace the growth of the IT sector. Finally a comparison between these two economies will be made, highlighting both their similarities and differences. Through this comparison, the hypothesis of the results will be described and explained.

The Method section will describe the model that will be used to investigate the structural change that has been occurring in India. The Results section will present the results calculated using the method outlined in the previous section. The Results will also provide other indicators of technology and growth including; Total Factor Productivity (TFP), Capital-Output Ratio, and Investment patterns.

In the Discussion section, a variety of questions will be addressed. Firstly, the relevance of the Schön Cycle and the theory around it will be tested for the case of India. If the Schön Cycle is applicable, then government policies may be drawn. Then a discussion of Bangalore will be made. Given the results, as well as the qualitative research done, some inferences will be made in an attempt to better understand the economic situation of the city. Next a more holistic look will be presented in order to see what these results suggest in the ongoing convergence and divergence debate. Finally suggestions for future studies will be discussed.

II.Theoretical Background

The Theoretical Background section is broken into two related but distinct sections; innovation theories and structural change. While structural change does depend on an impetus like innovation and most innovation theories touch on structural change, for the purpose of clarity and ease. The first will the development of economic growth and innovations theories. In this sub-section a linear progression of the prominent theories on innovation and economic growth will be presented. The purpose of this is twofold; first to establish the importance that innovation has played in the realm of economic history as well as to create a better understanding of the framework this paper will work within. The second sub-section deals with different theories and methods used to measure structural change. This sub-section will set the stage for subsequent sections; both the Methods and Discussion.

II. IDevelopment of Economic Growth and Innovation Theories

The brief yet dense article ‘The economics of R&D and economic growth’ is an overview of the history of development of economic growth theories. This paper is a literature review that provides the beginnings and changes made in this area of economic history. It relates the importance of technology to the growth of economics. This section of the paper will summarize the developments discussed in the article and supplement the ideas with details from other relevant articles.

World War Two caused a renewed interest in economic expansion and policies that could be made to generate growth (Link and Siegel, 2007). Abramovitz was one of the first theorists to attribute the importance of technological change, an exogenous phenomenon, as a major source of productivity growth (Link and Siegel, 2007). Abramovitz measured productivity as a function of output verses input ratio. The changes in this ratio were thought to describe the changes in efficiency over time, which Abramovitz attributed to technological advances. In one study,Abramovitz noted that the increase in productivity was not a result of more resources for labour, but instead from a growth in stock knowledge (Link and Siegel, 2007). Abramovitz coined the phrase ‘measure of ignorance’ which refers to the determinants of productivity growth which rested on improvements in stock knowledge, such as education or research and development. Growth therefore also depends on the ability create new knowledge.

While Abramovitz was the first to postulate the importance of knowledge and technology, Solow was the first to try to test this theory with a quantifiable equation (Link and Siegel, 2007). Robert Solow, in his article ‘Technical Change and the Aggregate Production Function, attempts ‘segregating variations in output per head due to technical change and those due to changes in the availability of capital per head’ (Solow, 1957, p.312). His equation, known as the Aggregate Production Function Model made production a function of capital and labourthus giving one the ability to measure the technological change.