Stylized Pattern of Structural Change and Economic Development in India – 1950-2020
New Delhi, July 29, 2020
The process of economic development has been historically linked with the general pattern of structural changes of the national economies in the globalized world. It occurs with changes in structures of broad economic sectors (agriculture, manufacturing and services) in terms of share of output and employment.
The sequence of structural change is associated with falling share of agriculture, which was, at first, offset by a rising industrial sector in the early stages of development, and, thereafter, services took over the lead role, only after a fairly high level of development had been achieved from manufacturing.
It is also argued that at early stages of development when a country is heavily dependent on agriculture, labour productivity is low and the economy is largely stagnant. With increasing labour productivity, there is economic growth and higher wages. However, the prospects for rapid productivity growth in agriculture are limited and, therefore, labour shifts to the non-agriculture sector (manufacturing and services), where there is greater scope for higher productivity and economic growth.
The structural change path of economic development was first derived by Arthur Lewis (1954) that focuses on transformation of underdeveloped economies from agrarian to industrial and services economies. This process of labour transfer and output growth from traditional agricultural sector to the modern urban industrial sector became the general development theory of most of the labour surplus developing nations in 1960s and 1970s and many still support it. This was subsequently confirmed by Kuznets (1957) and Chenery (1962).
Arrow (1962) and Kaldor (1967) extended the structural changes theory and viewed industry as the main engine of economic growth in the classical division of agriculture, industry and services. They argued that it is a central issue to understand the growth process of modern economies.
Timmer et al. (2012) further also suggest that structural change is a process by which (a) the shares of agriculture in Gross Domestic Product (GDP) and employment fall over time, and, (b) an agriculture and rural sector-based economy is replaced by an industrial and service sector-based economy, having an urban bias. Any existing dualism between the agricultural and the non-agricultural sectors and formal and informal sector gradually disappears over time.
This process of economic development is referred to as the ‘stylized pattern of structural change’. This stylized structural change development model has been historically experienced by developed countries and lately by some select East Asian countries namely South Korea, Taiwan, Thailand, and Malaysia, and, China.
Structural Change in India’s Economy
The question of structural change in India has returned to the forefront of policy debates.
The GDP contribution in the Indian economy, which was dominated by agriculture sector (52 per cent) followed by services (30 per cent) and industry (18 per cent) at the time it became a republic in 1950, also witnessed the stylized pattern of structural change between 1950 and 1980, when the primary sector share in GDP decreased by 17 percentage points and share of both industry as well as services increased by 10 percentage points and 7 percentage points, respectively.
However, after the eighties, from 1980 to 2020, the share of the agriculture sector in India’s GDP decreased again by 19 percentage points, but the share of industry decreased by 5 percentage points and services led the growth of the country with a 24 percentage points change. Today, agriculture and allied sector stands at 16 per cent, industry at 23 per cent and services dominate at 61 per cent share of GDP.
These two periods confirm the contradictory pattern and the fact that the recent period is deviating from the "stylized pattern" of structural change as discussed above. It was argued that India’s growth after the eighties, was services-led rather than the industry or manufacturing led growth. Unlike the East Asian economies, the transition of services sector came at an early stage of development, which oppose the historical pattern of "stylized pattern of structural change", where the services sector has bypassed the industrial sector in the development. In particular, the manufacturing sector contribution in the economy is stagnant and hovering to around 25 per cent during the last four decades.
Several scholars have argued and explained that India’s service-led growth is a short-term phenomenon and unsustainable in the long run. On the other hand, many scholars claim a significant positive relationship between the share of services and growth. Some recent studies seek to reconcile these contrasting views by explaining "two waves of service-sector growth".
The first wave consists of "traditional services" -- wholesale and retail trade, hotels and restaurants and transport and storage which emerged at an early stage of development. The second wave comprises of "modern services" -- communications (which include mobile telephone services), and business services (which include information technology services) that emerged at a relatively advanced stage of development.
India’s pattern of economic structure seems to confirm that the second wave of services growth led by "modern services" emerged on account of technological progress. Modern services - Information and Communications Technology (ICT) - in India grew at a very fast rate in recent decades. It is not only contributing to the economy but also has high spillover or multiplier effects in other sectors as well as backward and forward linkages.
These modern services are called the "growth engine" of the Indian economy. Jha (2012) also stated that modern services are responsible for India’s emergence as a global economic power. Importantly, the communications service with advent of mobile telephony has changed the definition of the service sector, which has characteristics of both manufacturing as well as service.
Structural Change in India’s Workforce
Changes in output structure have been accompanied by a corresponding shift of workforce, first to industry and then to services. As a result, today, developed countries have a GDP structure similar to their employment structure––in each of them agriculture accounts for less than 5 per cent, both in GDP and employment, and services contribute 70 to 75 per cent, and, industry 25 to 30 per cent, both in GDP and employment. Inter-sectoral productivity differences are thus rather insignificant.
Over the past five to six decades, India’s labour market has been characterized by certain unique features accompanied with economic development. With the declining share of GDP from agriculture, there has been a decline in its share in employment as well. The share of agriculture in GDP has declined from 41 per cent in the 1970s to 16 per cent in the 2020s (decrease of 25 percentage points), whereas, its share in employment has shrunk from 74 per cent to 44 per cent during the same period (decline of 30 percentage points). The bulk of the workforce is engaged in agriculture (44 per cent) but contributes only 14 per cent to the national economy, reflecting low productivity and unemployment in the agriculture sector.
Industry contributed 26 per cent to GDP and employed 11 per cent of the workforce in 1970. In 2020, the respective figures are 24 and 25 per cent. The share of services in GDP has increased sharply from 33 per cent in the 1970s to 61 per cent in 2020. Services' share in employment has increased but to a much smaller extent, from 15 per cent to 31 per cent, during the same period.
While the decline in agriculture’s share in GDP and to a lesser extent in employment is indicative of structural transformation, it has led to a sharp difference between output per worker in agriculture and non-agriculture. This disparity increased from 1:3 in 1970 to 1:6 at present.
The services sector has increased its share in GDP sharply but its share in employment has only marginally increased over the years. The share of industry, both in GDP and employment, has increased almost equally but at a slower pace. Thus, the increase in disparity between agriculture and non-agricultural sectors has primarily been a result of relatively slow growth of employment in the services sector in spite of a relatively high GDP growth and stagnant growth of manufacturing in the industrial sector.
The other important factor is employment elasticity (percentage change in employment associated with a one percentage point change in output or GDP growth, which indicate the ability to generate employment opportunity for the labour force in the development process) which is relatively high for the manufacturing sector only.
Since GDP growth in manufacturing has been almost stable, despite the higher employment elasticity, its employment growth has not been very high in the last three-four decades. Other sectors such as information technology and modern business services have high growth rate and contribution to GDP, but provide employment to only a few highly skilled individuals. This phenomenon has also been highlighted as "jobless growth" by many scholars in the last 2-3 decades.
In sum, structural transformation in India has been more successful in terms of GDP or output share and substantially less in terms of employment share. Almost 44 per cent of India’s labour force is still engaged in the extremely low productive agriculture sector, and a large number of the remaining non-agricultural workers in low paying informal activities.
The Indian economy has already achieved some structural change of shifting output — if not employment — away from agriculture. However, the economy deviated from the classical pattern by relying on services rather than manufacturing to achieve this shift. The reliance on services to fuel growth so early in its economic development causes India to stand out, relative to other developed nations, China and East Asia countries. There is a wide asymmetry between GDP and employment shares in the agricultural and services sectors resulting in extremely large and increasing productivity variation between the two.
India’s obvious factor abundance in labour implies comparative advantage in labour-intense activities. Instead, services led-growth has proven less labour-intensive than manufacturing-led growth. The industrialization experience has been limited and, particularly, the manufacturing sector growth is still limited in terms of employment generation. In addition, the abundance of low-skilled labour force is limiting India’s potential to generate more employment opportunities in emerging modern services such as information technology and other high-tech services sectors.
Moreover, the impact of the various initiatives of the successive governments for manufacturing and high productivity services-led growth has been limited. The focus on special economic zones (SEZs), ease of doing business, urbanization strategy along with infrastructure push and economic corridors (such as Delhi-Mumbai, Amritsar-Kolkata, Mumbai-Bengaluru), foreign investment, among others, has not led to envisaged results.
Major factors constraining these developments pertain to adequate governance, enabling eco-system and management of basic resources – land, labour, capital and entrepreneurship.
The current government’s emphasis on the vision of New India and AtmaNirbhar Bharat (self-reliant India) with the schemes like Make in India, Skill India, MSME, Startup India, Standup India, Digital India, Smart Cities Mission, National Infrastructure Pipeline, participation of private sector and foreign investors, innovation, vocal for local, among others needs to be further strengthened.
Furthermore, India needs a reinvigorated thrust for an effective and competitive economic reorientation to fully participate in and leverage from the global supply chain amidst the US-China trade war. With the advancement in technologies and as a fallout of the ongoing coronavirus (COVID-19) pandemic, modern economic sectors in manufacturing and services harnessing ICT, Artificial Intelligence, blockchain, etc. leading to Industry 4.0, gig economy, and future of work, needs prioritization.
The structural transformation of an economy is a complex process and its trajectory depends on the relative growth of productivity, employment, and value-added output in different economic sectors. It takes very different paths in different countries depending on how exogenous factors like the global economic outlook, local politics, or technological changes shape up in different periods. The potential for welfare improvements from successful structural change strategies has always been massive. Hence, the need of the hour is a national employment policy document with proper implementation plan for efficaciously harnessing the structural change benefits in India’s economic development.