At the time when Atal Bihari Vajpayee was the Prime Minister, if a man was running a factory and he started scaling up its production. He had to invest 4 units as input/capital to gain 1 one additional unit of output from his factory. This capital (investment of 4 units) and output (1 additional unit) were in the ratio of 4:1. As the time passed and when Manmohan Singh became the Prime Minister of India in 2009 once again, the same man had to invest 8 units as capital to get same 1 additional unit of output from the factory. Thus, the cost of investment increased. His business became not only inefficient but a burden on his family as the capital-output ratio increased. In other words, capital investment increased from 4 units to 8 units to gain one additional unit of output, which ultimately led to the closure of his business.
Above hypothetical story is fairly a rough example to understand the economic concept of Incremental Capital Output Ratio (ICOR). This concept is a major economic indicator to track the efficiency or the productivity of the economy.
Graph: Economic Productivity of India during 2004-2014
*ICOR Values based on old GDP Series
Above graph clearly tells us that ICOR of India kept on increasing during the UPA Government. The last 3 years of the UPA Government starting from 2011-12 were so economically disastrous that Capital-Output ratio started touching 6 and reached as high as 8.5 in 2012-13, that is 8.5 units of capital were to be invested into the country, so as to earn 1 unit of output. If it is compared with the times when the UPA inherited government from former Prime Minister Atal Bihari Vajpayee, Indian economy became half as efficient of what it was in 2005-06. This completely ruined the productivity of the Indian economy.
How the Above Scenario Changed and India Became More Efficient
Prime Minister Narendra Modi inherited many economic legacy issues from the previous government and ICOR was one of them. For India to grow fast there was a need to bring down this economic inefficiency.
The Modi Government brought down the capital-output ratio to 4.3 in the fiscal year 2015. As outlined in a report published in The Diplomat which stated, “According to the new GDP series, India’s ICOR fell from 6.6 in fiscal 2013 to 4.3 in fiscal 2015. The fall appears to be much sharper if ICOR is calculated using non-agriculture GDP. This means that over the years investments did become more productive. Even in the old series (with 2004-05 base), ICOR was 7.5 in fiscal 2013 and fell to 6.8 in fiscal 2014.”
This momentum of efficiency in the economy has been sustained by Prime Minister Narendra Modi. According to a report of the Live Mint, “Between fiscals 2015 and 2018, ICOR averaged 4.3 compared with 5.5 between 2012 and 2014—a period of growth slowdown and policy paralysis.”
Therefore, the Indian economy has again been brought back on track and the man in the story above now again needs only 4 units of capital to produce 1 additional unit of output from his factory. If the positivity in the Indian economy generated by the present government continues, ICOR will further come down resulting in further increase in the economic productivity of the country.