Strengthening Innovation Can Boost India’s Productivity: IMF

India’s productivity growth over the past two decades has been impressive, reflecting rapid expansion in high-value services, gradual efficiency-enhancing reforms, and scale advantages from a large domestic market. That said, additional gains would support the country’s ambitions of becoming an advanced economy.

Better supporting innovation, including by removing business barriers, can boost the productivity growth rate by nearly 40 per cent, like adding the output of the state of Karnataka to India’s economy each decade.

Innovation has remained constrained as India invests less in research and development than the average for emerging market economies in the Group of Twenty, and few firms engage in it, with limited adoption of foreign technology. Larger firms tend to innovate more, while smaller ones have more barriers to scaling up and improving.

Artificial intelligence could reinforce these gains. Nearly 60 percent of Indian firms already use some form of AI—well above global averages. AI can make businesses more efficient, speed up technology diffusion, and strengthen innovation. But adoption remains uneven: employers cite skill shortages, inadequate tools, and integration challenges.

India’s productivity performance, measured by output per additional worker, has been uneven. Services have delivered strong productivity gains, benefiting from advances in adoption of digital technology and their integration into global value chains. Manufacturing, however, has seen only small productivity growth, while agriculture—still employing over 40 per cent of the workforce—remains far less productive than other sectors.

India’s unusually large share of very small firms is one reason manufacturing productivity has fallen behind. Nearly three quarters of factories employ fewer than five paid workers—almost double the US share. Even more striking, the smallest enterprises produce less than 20 per cent of the output per worker of large counterparts, compared with nearly 45 per cent in the United States.

India’s business dynamism remains low. The frequency of new business creation and when firms close or exit a market is far lower than in economies such as Korea, Chile, or the United States. Subdued dynamism discourages competition and slows the reallocation of resources toward more productive entities.

Further, a sizable share are zombie firms, which don’t generate enough earnings to cover their borrowing costs yet are continuing to absorb capital and labour.