Capital misallocation and its implications for India’s potential GDP: An evidence from India KLEMS

  • Rajib Das
  • Siddhartha NathEmail author


In this paper, we estimate ‘distortions’ in the allocation of capital across various economic sectors in India, which has certain predictable impacts on the potential output of an economy. We calibrate our model using the India KLEMS dataset. We show that several industries in India, broadly in the services segments, are possibly ‘over-capitalised’ in a sense that capital usages here are too high for the output that they produce. In other words, the same level of output in these sectors could also be produced by much lesser capital. On the other hand, several manufacturing sectors are ‘under-capitalised’ by the similar criteria. Together, it implies that the aggregate output would have been higher if a redistribution of the excess capital from ‘over-capitalised’ services to the ‘under-capitalised’ manufacturing sectors was possible. In other words, a shift in the investment that focus away from select services segments to the manufacturing activities may potentially lift the growth momentum of Indian economy, by correcting some of these ‘distortions’. By eliminating this ‘distortion’ alone, India’s aggregate output could have been possibly increased by 30–35% between 1990 and 1999 from their observed level and by even greater extent of nearly 40% after 2000. Alternatively, if we are able to reduce the ‘distortion’ to the levels observed before 2005 in India, we may be able to generate an additional 30% output over and above the levels observed between 2005 and 2015. We, therefore, conclude that the government may conduct any further policy on the ease of capital movement with some caution with respect to industries that are ‘over-capitalised’.


Capital misallocation Distortion Factor share Potential GDP 

JEL Classification

O32 O38 O47 



The authors sincerely acknowledge the suggestions received during the presentation of this paper in the 13th Annual Conference on Economic Growth and Development, Indian Statistical Institute, New Delhi, December 18–20, 2017.

Supplementary material

41775_2019_55_MOESM1_ESM.xlsx (906 kb)
Supplementary material 1 (XLSX 906 kb)


  1. Allen, F., Chakrabarti, R., De, S., Qian, J., and Qian, M. (2012). Financing Firms in India. Journal of Financial Intermediation, 21, 409–445CrossRefGoogle Scholar
  2. Bai et al. (2007). The return to capital in China, NBER Working Paper No. 12755.Google Scholar
  3. Banerjee, A., & Esther D. (2005). Growth Theory through the Lens of Development Economics. In Handbook of Economic Growth, Vol. 1 A, (Elsevier, Chap. 7).Google Scholar
  4. Bosworth, B., & Collins, S. M. (2008). Accounting for growth: Comparing China and India. Journal of Economic Perspectives, 22(1), 45–66.CrossRefGoogle Scholar
  5. Das, D.K. et al. (2015). Measuring productivity at the industry level: The India KLEMS database. In: Data Manual 2015, Version 2.Google Scholar
  6. Das, D.K. et al. (2017). Measuring productivity at the industry level: The India KLEMS database. In: Data Manual 2017, Version 4.Google Scholar
  7. Das, D.K., Erumban, A.A., and Das, P.C. (2016). Productivity dynamics in Indian industries—input reallocation and structural change. Paper prepared for the 34th IARIW General Conference Dresden, Germany, August 21–27.Google Scholar
  8. Das, A., & Ghosh, S. (2009). Financial deregulation and profit efficiency: A nonparametric analysis of Indian banks. Journal of Economics and Business, 61(6), 509–528.CrossRefGoogle Scholar
  9. Dollar, D. & Wei, S. (2007). Das (wasted) Kapital: firm ownership and investment efficiency in China. In: IMF Working Paper, No. WP/07/9.Google Scholar
  10. Farrell, D., & Susan, L. (2006). China’s and India’s financial systems: A barrier to growth. McKinsey Quarterly, 2006, 1–12.Google Scholar
  11. Hsieh, C., & Klenow, P. J. (2009). Misallocation and manufacturing TFP in China and India. The Quarterly Journal of Economics, 124(4), 1403–1448.CrossRefGoogle Scholar
  12. Melitz, Marc J. (2003). The impact of trade on intra-industry reallocations and aggregate industry productivity. Econometrica, 71, 1695–1725.CrossRefGoogle Scholar
  13. Restuccia, D., & Rogerson, R. (2007). Policy distortions and aggregate productivity with heterogeneous plants. In: NBER Working Paper, No. 13018.Google Scholar
  14. Singh, M., & Kaur, K. (2014). India’s services sector and its determinants: An empirical investigation. Journal of Economics and Development Studies, 2(2), 385–406.Google Scholar

Copyright information

© Editorial Office, Indian Economic Review 2019

Authors and Affiliations

  1. 1.Reserve Bank of IndiaMumbaiIndia
  2. 2.The University of TokyoTokyoJapan

Personalised recommendations