Productivity Growth of Indian Manufacturing Sector: Panel Estimation of Stochastic Production Frontier and Technical Inefficiency

Abstract Applying a Stochastic Production Frontier to sector-level data within manufacturing sector in India, this paper examines Total Factor Productivity (TFP) growth during 1979-80 to 1997-98. The analysis focuses on the trend of technical progress (TP) and Technical Efficiency Change (TEC). The stochastic frontier production function approach, applied in this paper, allows us to separate out these two components, and to identify productivity growth due to either improvement in efficiency or progress in technology. The most important difference between the frontier approach and the traditional index number approach to productivity growth analysis lies on assumption: the existence of an unobservable and idealized production possibility frontier with production-unit specific one-sided deviation from the frontier, i.e. explicitly allowing for inefficiency. If a production unit operates beneath the production frontier, then its distance from the maximal measures it's technical inefficiency. Hence, the frontier approach is capable of capturing both efficiency change and technological change as components of productivity change, which introduces an additional dimension to the analysis from the policy perspectives. The empirical result suggests that the total factor productivity growth in a large number of industries have improved during 1997-98 compared to 1980-81. TFP growth is mainly driven by technological progress not by technical efficiency change in case of Indian economy since all TECs are negative. In the light of empirical results, the policy implication is that the priority to boost economic growth should be in the enhancement of productivity based catching-up capability. In this direction, an efficiency oriented action plan aimed to improve productivity efficiency of manufacturing sector is required to be implemented for removing the fiscal and financial constraints faced by the enterprises which are located in industrially backward area. JEL Classification Numbers: D24, L60, O30, O53, O47 Key words: Total Factor Productivity, Technical Efficiency change, Technological Progress, Stochastic Production Frontier, Indian Economy