India’s productivity crisis and ways to solve it

India’s economic growth is often discussed in terms of two factors: capital and labour. Capital includes land, machinery, and tools, while labour is the workforce using them. More capital and labour generally mean higher output, boosting GDP and national wealth. However, there is a third factor, often overlooked, that is equally important: Total Factor Productivity (TFP). TFP measures how efficiently capital and labour are used, including improvements from better techniques, technology, and management.

For example, in agriculture, yield depends on the land and workers available. But modern techniques, such as drip irrigation, allow farmers to produce more with the same resources. This is productivity at work. Historically, TFP has played a key role in economic development. In the United States, only 50% of the workforce was in agriculture in 1880, while today it is less than 2%. Yet the country produces far more food due to improved productivity. Similarly, India’s Green Revolution in the 1960s increased crop yields without proportionally increasing land or labour.

Despite these lessons, India’s TFP growth has been weak. From 1955 to 2019, productivity growth averaged only about 0.8% per year, similar to the US in the same period. This is worrying because countries that are behind the technological frontier can usually boost productivity quickly by adopting proven methods. Slow TFP growth limits India’s potential GDP growth and keeps the country from fully benefiting from its labour and capital resources.

Several factors contribute to low productivity. One major issue is resource misallocation. Highly productive firms often cannot access the capital, land, and labour they need because policies favour smaller businesses. For example, the government provides special credit and regulatory benefits to micro, small, and medium enterprises (MSMEs). While helpful to small businesses, these incentives discourage growth beyond a certain point. Larger, more efficient firms face higher costs and regulatory burdens, so they remain small, reducing overall productivity.

Other policies, such as Priority Sector Lending by banks, force financial resources toward sectors like agriculture and small businesses, often at the expense of more productive firms. Subsidized electricity for agriculture also causes waste and increases costs for commercial users, further limiting capital efficiency. Studies estimate that if India allocated resources as efficiently as the US, TFP could rise by 30–50%, meaning the same investment would produce far more output, lowering costs and raising consumer purchasing power.

Solutions: Agriculture, cities, and efficient firms

Agriculture is one of the least efficient sectors in India. Productivity per worker is extremely low compared to developed countries. For example, agricultural output per worker in Canada and Australia exceeds $120,000, while in India it is only about $1,500. Rice yields illustrate the problem: India produces around 4 tons per hectare, while the US and China produce 7–8 tons on the same land. Inefficient land use, unclear land titles, electricity and fertilizer subsidies, and delayed court resolutions discourage long-term investment and innovation. Improving productivity here would free resources for industry, housing, and infrastructure, reducing costs and improving overall economic efficiency.

Urban density and infrastructure also matter for productivity. Cities enable knowledge sharing, innovation, and access to skilled labour. Dense cities reduce commuting times, improve logistics, and lower costs. However, Indian cities have strict low-density rules, limiting these benefits. For instance, most Indian cities allow much lower Floor Area Ratios (FAR) than global cities like New York, Tokyo, or London. Allowing higher density in cities would support more productive firms, create larger labour pools, and enhance economic efficiency. World Bank studies suggest removing these constraints could increase worker output by up to 25%.

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Higher productivity is often feared because it may reduce jobs, but this is a misconception known as the “lump of labour fallacy.” Increased productivity lowers production costs, leading to cheaper goods, higher demand, and new employment opportunities. For example, automation in factories may reduce some manual jobs but creates new positions in design, management, and technology. More productive agriculture allows food abundance, freeing labour for other industries and enabling leisure and entertainment sectors to grow, creating further employment.

In conclusion, India’s productivity crisis is a critical challenge limiting economic growth. Solutions include improving resource allocation, encouraging firm growth, reforming agriculture, and building denser, more efficient cities. High productivity increases national wealth, lowers costs, and expands opportunities, benefiting every citizen. By focusing on efficiency rather than just capital and labour, India can unlock its economic potential and achieve sustainable prosperity.