Long-run relationship between output, capital, labour and productivity in emerging market economies

Abstract

Long-run relationship between the variables involved in the production function is an issue that is important particularly in developing countries, as the neoclassical production function is best suited for developed countries and its applicability to developing countries is questionable in various ways. This motivates us to do this based on time-series analysis, taking Indian textile industry as an example, which is currently at its crucial stage as a critical industry in an emerging economy, with the phasing out of Multi Fibre Arrangement in 2005. This study documents existence of cointegration between capital and output, negative impact of employment shocks on output changes, substitutability between changes in capital and labour, negative effect of shocks to changes in capital stock on productivity and negative effect of employment shocks on future productivity. These results are in line with the general perceptions about this industry and with the standard neoclassical propositions, as explained in this article.

Notes

¹ This involves testing for unit roots for two sub-samples pre and post the hypothetical break. For our data, 1982 and 1991 were the possible years for break, as delicensing and reforms took place in these 2 years in Indian manufacturing sector as a whole. However, for textiles, the major break came only in 2000 when the MFA phasing out was intense and de-reservation of major textile items from SSI gained momentum.

² These results are not shown in this article because of space constraint. Nevertheless, they are readily available with the author, on request.

³ All possible meaningful combinations have been attempted for the cointegration analysis and it was found that only capital and output are cointegrated.