India's Potential Growth Rate: A Harrod-Domar Perspective Including Technological Progress.....

The Harrod-Domar (H-D) model, a foundation of growth theory, posits that the potential growth rate (𝐺𝑝) of an economy is determined by its savings rate (s) and the efficiency of capital investment, expressed as the Incremental Capital-Output Ratio (ICOR or 𝑣). Specifically, the model holds that 𝐺𝑝=𝑠/𝑣. In the context of India, this model implies that to sustain higher, non-inflationary, long-term growth, the country must boost its savings and improve the productivity of its capital. While the traditional model assumes constant technology, integrating capital-saving and labour-saving technology adjustments—which alter the ICOR and labour productivity—provides a more nuanced, modern interpretation of India’s potential, which is currently estimated to be around 6.5% to 7% in the medium term.

The Core Harrod-Domar Framework for India

The potential growth of the Indian economy is fundamentally linked to its investment rate (Gross Fixed Capital Formation or GFCF) and the productivity of that capital.

•           Data Profile (2023-25): Recent data shows India’s Gross Fixed Capital Formation Rate (GFCFR) hovering around 31% to 34.5% of GDP.

•           ICOR (2018-2025): The ICOR, which measures capital inefficiency (higher means lower efficiency), has averaged around 5.2 to 5.3 in recent years.

•           Potential Growth Calculation: Using the formula  

                                                            Gp=s/v                                                            

With a 34% investment rate and an ICOR of 5.2, India’s potential growth rate is calculated to be roughly 6.5%.

Incorporating Technological Progress

Technological progress significantly alters the standard H-D model, enabling a higher growth rate for a given savings rate by reducing the required capital per unit of output or enhancing labor efficiency.

1. Capital-Saving Technologies

Capital-saving technology improves the efficiency of capital, effectively reducing the ICOR (𝑣).

•           Impact on India: Increased digitalization (e.g., UPI, digital infrastructure), AI, and automation in manufacturing reduce the amount of physical capital needed to produce an additional unit of output.

•           Effect on Growth: If AI and advanced manufacturing lower the ICOR from 5.2 to 4.5, for example, the same 34% investment rate could drive a higher potential growth rate is appproximately equal to 7.5 % reducing the "knife-edge" instability of the model.

•           Data Trend: While investment has been high, inefficiencies and regulatory delays have occasionally increased the ICOR (reaching up to 8.5 in FY13), acting as a drag on potential growth.

2. Labour-Saving Technologies (and Productivity Enhancements)

While often associated with replacing workers, labor-saving technology in a developing country like India mainly manifests as increased labor productivity or “efficiency of labor.”

•           Impact on India: The adoption of modern technology in agriculture and services reduces the labor required per unit of output, increasing output per worker.

•           Effect on Growth: In the context of India's large, relatively low-skilled workforce, labor-saving technology (such as mechanization) must be balanced with capital-intensive technology to prevent structural unemployment. When successful, it boosts the Total Factor Productivity (TFP) component, enhancing the numerator of the H-D model indirectly by increasing overall economic capacity.

•           Data Trend: India’s shift toward services (high-tech IT, finance) demonstrates this, where labor productivity is much higher than in traditional sectors, allowing the economy to exceed the 6.5% mark in specific, favourable environments.

Recent Trends and Potential

•           Current Potential: India's potential growth rate is currently seen around 6.5% to 7.0%.

•           Positive Influences: Robust public sector investment in infrastructure has boosted capacity, while the tech sector (contributing 7.3% to GDP in FY24) provides a strong, capital-efficient, high-productivity boost.

•           Negative Factors: The aging of older capital stock and the high cost of adopting new, cutting-edge technologies might create a "replacement cost" issue, offsetting some gains from technological progress.

According to the Harrod-Domar model, India's potential growth rate is fundamentally a product of its ability to sustain a high savings-to-investment ratio, currently at a robust 34.5% of GDP, and its capital efficiency. While the traditional model suggests a 6.5% potential, the inclusion of technological progress, particularly capital-saving digital infrastructure (like AI and digitization), acts as a significant accelerator, allowing India to maintain a higher growth ceiling (6.5%–7.0%) than otherwise possible. To sustain a higher potential, India must continue to lower its ICOR through structural reforms and efficient technological adoption, reducing the capital needed for growth and maximizing the output from its expanding labor force.