Does Kaldor’s hypothesis hold in India?

Issues relating to the interaction between the industrial sector of an economy and the overall economic activity under Kaldor’s hypothesis have been an interesting area of research. While a number of empirical studies have been carried out to test Kaldor’s hypothesis in many industrial and emerging economies, a similar study in the Indian context is conspicuously absent. With a series of comprehensive economic reforms initiatives introduced in India during the last two decades, there has been greater market orientation in the overall economy, and the inter-linkages between the industrial sector and the overall economy have assumed new dimensions. Against this backdrop, the present study empirically examines Kaldor’s hypothesis in the Indian context. For the empirical investigation, various time series econometric techniques such as Johansen and Juselius co-integration test and Granger causality test are applied to examine the relationship between industrial output and overall economic growth measured in terms of Gross National Product. The co-integration analysis takes into account the non-stationarity problem in the data, which is generally observed in various macroeconomic time series. It examines the presence of long-term stability in the relationship between two or more time series when they are integrated of order 1. The associated error correction mechanism explores the short term dynamics along with the adjustment process. We have used Indian annual data covering the period 1970-2011 for the empirical exercises. From the estimated results, it was revealed that both our time series under investigation, viz., industrial sector output and overall GNP were non-stationary and integrated of order 1. But the Johansen-Juselius co-integration test established long-term stability in their association. The error-correction mechanism revealed that any short-term discrepancy in the relationship was corrected over time. The results also showed a unidirectional causality running from economic growth to growth in industrial sector. Thus, GNP-led industrial growth pattern exists in India, and our findings fail to provide evidence supporting Kaldor’s hypothesis in the context of fast-growing Indian economy. The findings of the present study have important policy implications. Given the fact that the industrial sector is the backbone of the overall economy, it needs to grow consistently. Particularly, the policy makers in India should strive to promote India’s manufacturing exports along with the service sector.