Human Capital and Manufacturing Productivity Growth in India

Empirical studies on total factor productivity growth (TFPG) in developing countries highlight trade openness, research and development and market structure as being the most important determinants of TFPG. The role of human capital remains overlooked in the literature on the determinants of TFPG of Indian manufacturing sector. In this paper, we look into the role of human capital formation as proxied by literacy rate in influencing TFPG, using Indian manufacturing as a case-study. To compute TFPG, we use firm level data for both the formal and informal manufacturing sector. We correct for the simultaneity bias associated with the production function approach for TFPG estimation by employing a method recently developed by Levinsohn and Petrin. We compute period-average adult literacy rate for 15 Indian States over the period 1994-2005, and then use them in TFP growth equations to estimate the effect of literacy on TFPG. The results indicate that literacy has positively affected the TFP growth of Indian industry. The effect however is primarily for the formal sector.