IMF: Innovation & Reforms Can Boost India's Productivity by 40%

India's productivity growth over the past two decades has been strong, according to an IMF report authored by Harald Finger, the IMF's mission chief for India, and Nujin Suphaphiphat, a senior economist in the Fund's Asia and Pacific Department.

The Fund's 2025 Article IV analysis shows that better support for innovation, including removing constraints that hold back firms, could lift India's productivity growth rate by nearly 40 per cent. The gain would be equivalent to adding the output of Karnataka, the country's fourth-largest state by output, to the economy every decade.

Productivity trends vary widely across sectors. Services have delivered substantial gains, helped see the adoption of digital technology, and closer integration with global value chains. Manufacturing has seen only modest productivity growth. Agriculture remains far less productive, even though it still employs more than 40 per cent of the workforce.

The gap between sectors is significant. An additional worker in services produces more than four times the output of a worker in agriculture with the same level of education. The IMF says this highlights the significant potential gains from shifting labour and activity to higher-productivity sectors.

A key reason manufacturing lags is the dominance of tiny firms. Nearly three-quarters of factories employ fewer than five paid workers. That is almost double the share in the United States. The smallest enterprises produce less than 20 per cent of the output per worker of large firms, compared with nearly 45 per cent in the United States.

Many of these firms remain small for decades. Complex compliance rules, rigid labour regulations, and product market restrictions discourage growth. Easing these constraints would help firms expand and lift productivity. The IMF notes that India's recent announcement to implement new labour codes could help set the stage for further reforms.

Low business dynamism is another drag on productivity. Rates of new firm creation, as well as firm closures and exits, are far lower than in economies such as Korea, Chile, or the United States. Limited entry and exit weaken competition and slow the movement of capital and labour toward more productive firms.

The analysis also points to a sizable share of zombie firms. These firms do not earn enough to cover borrowing costs but continue to absorb resources. Firm entry and exit currently have only a small effect on productivity in India. The IMF says this underscores the need for a more dynamic business environment, where unproductive firms can wind down, and innovative firms can grow.

Innovation remains constrained. India invests less in research and development than the average emerging market economy in the Group of Twenty. Few firms engage in R&D, and the adoption of foreign technology is limited. Larger firms innovate more, while smaller firms face barriers to scaling up.

The IMF estimates that raising India's innovation indicators, including business sophistication and creative outputs, to the 90th percentile among emerging markets could boost productivity growth by nearly 0.6 percentage points. That would amount to almost a 40 per cent increase relative to India's long-term average.

- IANS