Growth accounting and theories applied to Manipur

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E-Pao! Education - Growth accounting and theories applied to Manipur

By: B. Moirangthem *

Failure of legal framework and poverty combined has led to such a situation in Manipur. Many organizations including the government have taken advantage of the poor and ignorant people in the past and ripped them off left and right instead of improving their situation. Now, in the name of freedom struggle, such poor and ignorant people are targets again and have been compelled to take steps of which they do not know the consequence.

The process of income (or output) growth and how it can bring an impact in Manipur through the concepts of growth accounting and growth theory is being discussed here. Growth raises the standard of living. It is important that Manipur raise its standard of living and increase its growth rate in order to converge absolutely and conditionally with other advanced states like Maharastra, Gujarat etc.

Not only growth is the solution to the many current chaotic conditions and problems in Manipur, it is also one of the solutions to bring normalcy and peace in the region as a raise in income will raise the standard of living for the mass and bring awareness to the people, lead to think in a positive manner.

What is growth, growth in what and what it has got to do with Manipur? Growth in terms of GDP (gross domestic product). GDP is the way the output of an economy is measured. It can be measured as output or as income but it is the value of goods and services produced within a country. Let's assume for simplicity, GDP in terms of Manipur, Maharastra etc.

A series of questions arises in one's mind.

Is growth that easy? How do countries (state) grow relative to each other? Why one country (state) has stagnant growth and why another has high growth?

Growth accounting and growth theories help explain these questions.

Growth accounting looks at factors of production. It says that changes in output (GDP)/income result from changes in input. An economy can't grow without changing the inputs into the model. Well then, if growth can't be achieved without changing the inputs, what are the inputs? In the most basic form, the model is:

Output/Income (GDP) = technology x F [capital,labor]

Increases in GDP result from:

Increases in the factors of production (a function of labor and capital. Capital is the investment we make e.g. buying machines etc.)
Improvement in productivity (it comes from technological improvement)

This model is very intuitive and by just having a glance at it, one can reason why there is stagnant growth in Manipur and why there is higher growth in other states. Do we have the technology required to grow? The answer is a big NO.

Are we investing in capital? Do we have the skilled labor required for growth? The answer is a huge NO.

The way an economy grows is to grow the labor force, make investments in capital and increase productivity which comes up with technological advances. None of these seems to be happening in Manipur which explains why there is zero growth in Manipur and the surrounding regions.

Another form of the model is:

Total economic output growth = (labor share x labor input growth) + (capital share x capital input growth) + growth of total factor productivity

Growth of total factor productivity is technological advances.

Labor and capital growth is weighted by factor shares: 1 - capital share = labor share
Therefore, capital share + labor share = 100%

Historically in developed countries, capital share has been 25% and labor share has been 75%. Since, labor is weighted more; increasing the labor force will have a bigger impact, it establishes that economic growth depends on where the growth comes from. It is important to note here that increasing labor force does not necessarily mean increasing the population.

There are lots of jargons just thrown, economics is full of jargons and I am sure there are other fields as jargony as economics. The concept is pretty simple but the jargons completely overwhelm you. I hope an example explain better.

Using growth accounting equation:

Labor's share of income = 80%, capital's share is 20% and growth in total factor productivity is 1%.
To calculate economic growth if labor increased by 2% and capital increased by 4%, it would be (0.8 x 0.02) + (0.2 x 0.04) + 0.01 = 0.034 or 3.4% growth.

We are more concerned about improving the income of the mass not just a few people in the state so we are concerned, in economic terms, about increasing the per capita GDP. Another form of the model is:

(per capita GDP growth) = (capital share x growth in capital-to-labor ratio) + (growth of total factor productivity)

Let's think of capital-to-labor ratio as number of machines per worker. It is a key determinant of the amount of output a worker can produce. Recall that capital share is approximately 0.25 percent, the equation tells us the impact of increasing capital-to-labor (machines per worker) by 1 percent as about a quarter of a percent growth in per capita output.

So far, a basic model of growth accounting has been discussed.

Natural resources and human capital have not been included. What role does natural resources and human capital play in increasing income level/growth? I am not sure of how much natural resources Manipur has, but natural resources can explain a significant part of GDP growth.

Much of the early growth of U.S.A. (from around 1820 to 1870) was due to abundant natural resources associated with the opening of the western part of the country. Similarly, Norway experienced big gains in output between 1970 and 1990 due to the discovery and development of large oil reserves.

Human capital is developed through education, on-the-job training and other means that enhance a worker's ability to produce output. Average years of schooling is sometimes used as a proxy for human capital. Adding human capital to the model:

Output/Income (GDP) = technology x F [capital, labor, human capital]

Nothing much can be talked about human capital in Manipur. Although, people go to schools, due to lack of industry and technological institutions, human capital does not contribute much in increasing income levels.

In the second paragraph, I mentioned about Manipur converging conditionally and absolutely to other more developed states like Gujarat and Maharastra. How do we converge conditionally and absolutely? Convergence is the process of one economy's standard of living catching up to another.

A conditional convergence does not necessarily mean absolute convergence. For example, Manipur can converge with Gujarat conditionally but not absolutely. It means that growth rate of Manipur and Gujarat is same but the two states' have different per capita GDP. It is important that we converge in both senses.

Internationally, Japanese economy converged with that of USA during the 1980's (it diverged again during the 1990's). The growth accounting equation (in per capita form) can show how this convergence came about. In the period from 1973 to 1992, the Japanese per capita GDP grew at only 3.03 percent while the U.S. per capita GDP grew at only 1.38 percent. What explains the difference?

In growth accounting terms, the Japanese also increased their capital-to-labor ratio at a rate of 6.05 percent compared with a US increase of 2.89 percent. Nearly half of the economic growth in Japan came from improvement in capital-to-labor (machines per worker). The remainder of the differential is attributable to growth in total factor productivity (i.e. technological catch-up by the Japanese).

Another splendid example of growth is that of the Asian Tigers (Singapore, South Korea etc.). They had a phenomenal economic growth and they did it the old fashion way. These countries did not converge with the developed countries but increased per capita income level to such an extent that citizens had much much more money to spend than before the growth and brought the income levels of the people far above the poverty line.

It is interesting to see how these countries achieved their growth. Total factor productivity (technological growth) is the most important factor in increasing income levels but these countries grew the old fashion way that is by increasing the input - Labor, capital and human capital.

There were no advancement in terms of technology in these countries; they increased other factors like labor, capital and human capital. Women folks started participating in labor force, they increased their saving rate and there was considerable investment in human capital like education.

Lets look at what the growth theories say. There are two important growth theories: Neoclassical growth theory and Endogenous growth theory.

Neoclassical growth theory assumes that growth is a function of capital-to-labor ratio only: no technological progress. There is diminishing marginal product of capital. It means that as you increase the capital investment you increase the output but at a diminishing rate (increasing at a decreasing rate). This theory predicts that increases in savings rate will not increase long run growth rates (you can't grow by just saving more) and increases in savings rate will increase income levels.

Endogenous implies that high savings levels will lead to higher economic growth. Savings and growth are positively related. Well, these two theories do not clash when one says saving level will not increase economic growth and another says savings level will lead to higher economic growth.

Higher economic growth can be attributed to social and private benefits which, when looked into details, is another big explanation. Whatever these two theories say it establishes that saving is related to economic growth. Promoting higher savings will definitely lead to higher economic growth.

What about population growth? Is high population growth good or bad? I think for states like Manipur and for other states in India, high population growth is not good for economic growth because of what we call a "Poverty Trap" that is high population growth and low income. Ways to escape the trap would be to raise productivity, savings rate and reduce population growth.

The following is a brief summary of what has been said so far. In order to achieve growth:

Encourage high savings/capital investment
Stabilize macro environment (create an infrastructure that supports business)
Develop effective legal framework (business operates much more effectively and efficiently in environments where there is a legal framework which is lacking in Manipur)
Encourage low population growth (avoid poverty trap)
Foster technological advancement

B. Moirangthem, an MBA from a University in NorthEast USA, contributes for the first time to e-pao.net
This article was webcasted on August 22nd, 2006

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