What is Total Factor Productivity (TFP)?

Why in news? Chief Economic Advisor V. Anantha Nageswaran has raised India’s “potential” economic growth rate from 6.5% to 7%.

• Definition: Unlike the annual growth rate (how fast an economy grows in a specific year), the potential growth rate is the speed at which an economy can grow without triggering high inflation.

• Significance: * Growing faster than the potential rate risks inflation.

  • Growing slower implies the country is not optimizing its resources.

Factors Driving Potential GDP Growth:

The potential growth rate depends on three primary components:

1. Capital Stock: All physical assets like roads, bridges, and machinery that generate growth.

2. Labour Input: Refers to both the quantity of the workforce and their capacity/skills.

3. Total Factor Productivity (TFP): The efficiency with which labour and capital are used within the economy.

Growth Rate Projections (FY26–FY30 Estimates):

Component	Estimated Growth Rate
Growth in Capital Stock	7.60%
Growth in Labour Input	2.60%
Growth in Total Factor Productivity	1.90%

The Road to Growth Revival:

Historically, India’s potential growth rate has fluctuated:

• 2003–2008: Peaked at 8%.

• 2009–2015: Fell to 7%.

• Pre-Covid (up to 2020): Fell further to 6.5%.

Reasons for the Current “Green Shoots”:

The survey attributes the lift to 7% to the “cumulative impact of policy reforms” over the last three years:

• Manufacturing Initiatives: Success of PLI (Production-Linked Incentive) schemes, FDI liberalization, and logistics reforms.

• Labour Reforms: Consolidation of labour laws and reduced regulatory compliance.

What is Total Factor Productivity (TFP)?

Total Factor Productivity (TFP) is one of the three core pillars used to determine a country’s potential GDP growth rate.

• Definition: TFP refers to the efficiency with which both labour and capital are utilized within an economy.

• The “Efficiency” Factor: It measures the portion of output not explained by traditionally measured inputs of labor and capital. Essentially, it tracks how much more a country can produce using the same amount of workers and machinery through better technology, innovation, or smarter processes.

• Role in Growth: It is a key indicator of technological progress and organizational improvement.

• India’s Current Metrics: According to the Economic Survey data, India’s TFP growth remained steady at 1.70% between FY23 and FY25, and is estimated to rise to 1.90% for the FY26–FY30 period.

The Three Pillars of Potential Growth:

To see where TFP fits, the survey highlights how it works alongside other factors to raise the growth ceiling to 7%:

Component	Role in the Economy
Capital Stock	Physical assets like roads, bridges, and machinery.
Labour Input	The number of people working and their skill levels.
TFP	The efficiency and synergy between the assets and the people.