India's GDP Growth May Be Discrepancy-Based

June 14, 2016Indiaby East Asia Forum

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India's GDP growth may be misleading.

India’s real GDP growth increased by 0.7 percent from the last quarter of 2015 to the first quarter of 2016, rising from 7.2 percent to 7.9 percent. While both foreign and national media view this as a leap forward, the data and methods on India’s growth story should be taken with a pinch of salt.

What is interesting in the latest data on India’s growth rate is how, instead of aggregate production, the amount of ‘discrepancies’ in India’s growth accounting has drastically increased.

Therefore, what are these ‘discrepancies’? GDP can be calculated using different methods, such as the value-added, income and expenditure approaches, which can generate different GDP values. This leads to discrepancies in growth accounting — that is, the correction value computed from the differences in these GDP values. The higher this amount gets, the more difficult it becomes to realistically believe the data provided.

If GDP estimates are to be believed, the ‘discrepancies’ between calculation methods should be minimal. In India’s case, these discrepancies are large indeed. At constant prices, the discrepancies were 1.43 trillion rupees (US$21.4 billion) in the March 2016 quarter, while in the March 2015 quarter they amounted to only 299 billion rupees (US$4.48 billion).

The reason for the rapid rise in India’s current growth rate can be explained by this rise in the ‘discrepancies’, rather than by actual production numbers. This becomes clear if we examine relevant macroeconomic aggregates, like the index of industrial production and GDP from manufacturing, and control for disproportionate changes in the base year prices.

As others have observed, a closer look at the industrial output in India reveals that ‘the percentage increase in output was a meagre 0.1 percent year-on-year in March of 2016; slowing sharply from a 2 percent rise in the previous month and much lower than market expectations of a 2.5 percent gain.’ Growth in industrial production in India averaged only 6.36 percent from 1994 until 2016.

Growth in the manufacturing sector is also lagging. In March of 2016, the sector grew at a rate of only 1.2 percent. The production of electrical machinery and food and beverages actually fell, with the growth rate in these areas dropping by 36.2 percent and 15 percent respectively. Growth in publishing and media industries was also down, by 9.9 percent, while the mining sector fell 0.1 percent. One notable increase was in electricity production, where the growth rate jumped 11.3 percent.

Despite its widespread use, certain growth accounting methods — including a reliance on GDP as the main measure for economic growth — have done surprisingly little to clarify debate in the development literature. Countries like India thus need to be wary of obsessing over growth numbers as the ultimate indication of genuine development.

For example, one of the main purposes of growth accounting is to explain the impact of changing capital per worker on per capita income. Yet the empirical research has thrown up widely divergent views on the importance of capital accumulation to a country’s economic growth.

There are three issues in current growth accounting methods that policymakers in developing economies like India need to acknowledge and correct.

First, total factor productivity (TFP) is measured by the difference between output that is explained by capital and labour, and total output. This doesn’t explain why TFP changes.

There are many additional factors needed to determine what has caused changes in productivity — such as increased technological innovation, higher levels of education and experience, changes in government policies and institutional changes.

Second, as Susan Collins and Barry Bosworth explain in their essay, ‘The Empirics of Growth’, growth accounts in countries can very easily be constructed or manipulated to yield estimates of TFP that vary from the underlying value and deeper determinants of the production process. For example, a disproportionate change in base year prices can inflate growth numbers very easily. We must either stop focusing on production numbers alone when designing policies aimed at encouraging capital investment or ensure that more robust data on factor shares of income is made available.

Finally, policymakers and economists should recognise that growth metrics that quantify production or output levels couldn’t fully explain the causes of growth or its impact on a country’s development.

It is crucial that policymakers and economists act to widen the discourse on how we understand economic growth and its benefits. Rather than concentrating on only the proximate determinants of growth, such as capital accumulation, deeper determinants of growth, including institutional development, individual and collective property rights as well as socio-economic integration, should also be taken into account.

Policymakers and economists must be extremely careful in analysing both growth trends and the underlying data that shapes them.

Is unsound growth accounting bolstering India’s GDP? is republished with permission from East Asia Forum

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