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An ageing world needs workers; A young country has workers

Nandan Nilekani, chairman of the Unique Identification Authority of India, through the above quote, tried to bring out an opportunistic competitive advantage that India possesses as a result of its demographics. This competitive advantage, better known as the demographic dividend, is the rise in the rate of economic growth due to a rising share of working age people in a population. And Mr. Nilekani is not the only person who has been vocal about this fact. In India, it is almost fashionable to include the demographic dividend in a discussion and feel good about the future. But, in my opinion, the demographic advantage alone can't be India's ticket to the elite "Superpower Club." Let us analyze this further.

Long-term growth depends ultimately on two factors - the number of workers in the economy and their level of productivity. The aggregate production function puts this fact in a simple mathematical function:

Aggregate Production Function = f(total workable population, labor productivity)

Workable Population

Clearly, India has an advantage in this aspect. Charting the total workable population (defined here as the population between 15-60 years) suggests that India's working population will surpass China's working population by 2040.

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Labor Productivity

One way of defining labor productivity is the amount of value added (goods or services) per person employed in the economy. India, understandably, does not fare very well on this measure with respect to the developed economies. Developing economies are characterized by large productivity differences from that of developed economies. It is, however, the difference in the rate of labor productivity growth between China and India that presents a far more interesting reading.

Presented below is the historical productivity data of India, China and U.S. along with a simple interpolation over the next 30 years. The labor productivity number is presented in purchasing power parity (PPP) adjusted 2012 U.S. dollar terms. The simple polynomial curve fitting is done to project the data. The assumption (that labor productivity will follow the same trend) that I have taken here might be debatable but it presents a simple case for analysis.

(click to enlarge)

If my assumption is true, the gap in economic output (calculated here by the product of total workable population and labor productivity) between China and India would widen much more. This indicates that the demographic dividend alone cannot propel India into the superpower club. An increase in labor productivity would be required to complement the demographic dividend. The importance of improved labor productivity is shown in the chart below. The economic output of India dramatically improves when we hypothetically use China's productivity rate for calculation.

(click to enlarge)

Bottom line: India needs to substantially improve its labor productivity. And how is this going to happen? Also, what is causing China's labor productivity to grow so rapidly?

The answers lie in the industry-wide analysis of the economy. Productivity for a country can improve by one of two ways (also illustrated in the picture below):

  1. Within Effect - Productivity increases within the sector. This generally happens with advancement in technology and hence takes time.
  2. Between Effect - The movement of labor from low-productivity to high productivity activities also raises economy-wide labor productivity. This is more of a structural change in the economy. A manufacturing boom of the kind that helped China, South Korea and Taiwan out of poverty, or the IT services boom that we saw in India is considered a structural change.

(click to enlarge)

Manufacturing and infrastructure are the two sectors that increases overall labor productivity of a developing economy and at the same time generates employment in huge numbers. The focus of the Chinese economy on manufacturing was the major reason for its increased labor productivity. India is also desperately looking for such a structural change. India cannot just rely on the increase in workable population for a brighter future. It also needs a simultaneous increase in labor productivity. And in my opinion, only a strong leadership that has a vision and can take hard decisions can get us there.

Source: How Can India Seize The Demographic Advantage