Agricultural Economics Research Review Vol. 25(No.

2) July-December 2012 pp 351-354

Research Note

Returns to Scale and Elasticity of Substitution of Labour in Unorganized Food Processing Sector of India
Shiv Raj Singha, Sumit Mahajanb and K.K. Dattab*
b

SDAU, Sardarkrushinagar, Gujarat Dairy Economics, Statistics & Management Division, National Dairy Research Institute, Karnal-132 001, Haryana

Abstract
The paper has estimated the returns to scale and elasticity of substitution for different subsectors of unorganized food processing sector by using Cobb Douglas and constant elasticity of substitution functions. The study has found that the unorganised food processing sector is transforming from labour to capital intensive structure and therefore, there is a tendency to employ more skilled labour to manage the increasing capital. Most of the subsectors in the unorganized food processing are facing decreasing returns to scale. Two subsectors production, processing and preservation of meat, fish, fruits, vegetables, oils and fats (Code 151); and manufacturing of grain mill products, starches and starch products and preparation of animal feeds (Code 153) have been found to have substitutability of labour for capital which implies that still there is a scope for employment of skilled labour force. To boost processed food manufacturing, two policy areas require immediate attention, viz. infrastructure and entrepreneurship development. Key words: Returns to scale, elasticity of substitution, employment, unorganized, food processing JEL Classification: J21, L70, Q00

Introduction
The manufacturing sector, the third largest sector of Indian economy, is dominated by the unorganized manufacturing and employs around 84 per cent of the total workforce engaged in manufacturing field. Within the unorganized manufacturing, around 17 per cent (highest) of the workforce is engaged in the unorganized food manufacturing sector (NSSO, 200506). Unorganized manufacturing includes all those units/factories which are not covered under the area of organized manufacturing (based on Factory Act, 1948). These units typically operate on a small scale with little or no distinction between labour and capital as factors of production. A large section of farmers do not like farming because it is not profitable and given a choice, they * Author for correspondence
Email: kkdatta2007@gmail.com

would take up some other occupation (NSSO, 200506). It means that a huge workforce is ready to move from agriculture to some other sectors for employment. The movement of people from agriculture to other sectors of the economy may bring efficiency gains. Since most of the workforce in the agricultural sector is semi-skilled or unskilled, their employability in other sectors is uncertain and limited. A look at the unit level NSS data from Unorganised Manufacturing for the 56th (2000-01) and 62nd (200506) rounds as well as from Annual Survey of Industries (ASI) reveals that the productivity of labour is not only higher in the organized sector but it has also increased at a faster rate than in the unorganized sector. It may be due to better utilization of capital which helps to increase the labour productivity in the organized sector as its scale of operation is higher in using the resources efficiently and optimally. The productivity of capital

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has increased at a faster rate in the organized sector than in unorganized sector. This may be due to a faster diffusion of new capital-intensive technological changes in the organized than unorganized sector. However, the unorganized units always try to employ more labour which might be the reason of labour intensity being higher and the productivity being lower in this sector. With this background, this study is mainly focused on finding returns to scale and elasticity of substitution of labour in the unorganized food processing sector of India and to examine the scope of substitutability between capital and labour for employment generation.

food processing sector. There are many empirical studies on the elasticity of substitution between labour and capital which may be referred to for details (Goldar, 1986; Gujarati, 1966; Ahulwalia, 1981; Upender, 1996).

Results and Discussion

Returns to Scale The results of Cobb-Douglas function fitted to the cross-sectional data of Indian unorganized food processing sector are presented in Table 1. The elasticity of output with respect to capital and labour has been found to be statistically significant at 1 per cent level of significance. But, the magnitudes of elasticity varied for different sub-sectors. For example, except in the subsector codes-152 and 153, the elasticity of output with respect to labour for all other sub-sectors was higher than of the capital. The sign of elasticity of output with respect to labour and capital was positive in all the cases. The returns to scale in all the subsectors (except subsector-152) of less than one implies that the unorganized food processing/ manufacturing sector was subject to decreasing returns to scale. This also indicates that these enterprises were utilizing the factors (capital and labour) beyond the optimum scale of production. Therefore, it would not be profitable to increase the employment in the aggregate; particularly the level of capital invested during the period 2000-01 to 2005-06 was quite high compared to the labour force, showing the growing presence of capital-intensive techniques in the unorganized food processing sector. However, during the same period, hired labour absorption (mostly skilled) in the sector increased from 0.32 to 0.54 per enterprise (NSSO, 2000-01; 2005-06). It shows that the new capital investment required skilled labour to handle the machinery. This observation also shows the growing need for knowledge-based hired labour. In recent years, the food processing sector has come out with several new food products like functional foods. These products required series of research innovations and technical expertise. It means there is not much scope for the absorption of unskilled labour in the existing labour-capital structure. Transformation of unskilled labour to skilled labour, if focused under the employment programmes like MGNREGS, will certainly fuel the growth of manufacturing which presently faces the shortage of

Data and Methodology

The study is based on the National Sample Survey (NSS) unit level data on Unorganized Manufacturing for 62nd round (2005-06). Food processing refers to the sector that processes raw materials from the agricultural sector. Unorganized food processing includes mainly five sub-sectors based on the products manufactured by them. Sub-sector code 151= Production, processing and preservation of meat, fish, fruit, vegetables, oils and fats Sub-sector code 152= Manufacturing of dairy products Sub-sector code 153= Manufacturing of grain mill products, starches and starch products, and preparation of animal feeds Sub-sector code 154= Manufacturing of other food products Sub-sector code 155= Manufacturing of beverages In this study, Cobb-Douglas production function has been used to estimate the elasticities which have given an idea about the nature of returns to scale (R) in the unorganized food processing sector. In order to solve the problem of unitary elasticity of substitution in the Cobb-Douglas function, we have used constant elasticity of substitution (CES) functional form. This helps in diagnosing the proportional change in labour productivity (V/L) due to a small proportionate change in wage rate (W/L) which may not necessarily be unity and can take any value that may help to identify the scope of employment opportunities in the unorganized

Singh et al. : Returns to Scale and Elasticity of Substitution of Labour in Unorganized Food Processing Sector Table 1. Input elasticity and returns to scale in unorganized food processing: 2005-06 Subsector code 151 152 153 154 155 Overall Elasticity of labour 0.52 (0.036) 0.515 (0.042) 0.405 (0.017) 0.623 (0.021) 0.584 (0.024) 0.514 (0.011) Elasticity of capital 0.288 (0.029) 0.539 (0.037) 0.45 (0.015) 0.36 (0.018) 0.39 (0.019) 0.377 (0.009)

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Returns to scale 0.808 1.054 0.855 0.983 0.974 0.891

Source: Authors estimates from the unit level data on Unorganized Manufacturing, NSSO 62nd round, Ministry of Statistics and Programme Implementation, New Delhi. Note: Figures within the parentheses indicate standard errors of estimates

skilled labour, particularly in the food processing units/ factories located in the rural areas. Elasticity of Substitution In the labour surplus economy like India, the extent of substitution possibilities of labour for capital has to be investigated with a view to provide clues to the policymakers for generating maximum employment in different sub-sectors of unorganized food processing. It is well known that the Cobb-Douglas function assumes the elasticity of substitution between capital and labour to be equal to unity which may not always be true because of the existence of lot of disparity in factor payments. Therefore, the elasticity of substitution was estimated through CES function to test the hypothesis of unitary elasticity ( = 1). Hence, the Equation

was fitted to the cross-sectional data and results have been presented in Table 2. The value of elasticity of labour productivity with respect to wage rate was found to be positive, except for the subsector code-155. The results show that the elasticity of labour productivity with respect to wage rate in the unorganized food processing sub-sector was less than unity. Therefore, it can be inferred that the marginal labour productivity in relation to wage rate was lower than that of the average labour productivity in relation to wage rate. Hence, there is not much scope for substitution possibilities until the marginal productivity of labour is less than the average labour productivity. A close look at the unorganized food processing sector at the disaggregate level reveals that there are some subsectors (like under codes-151 and 153) where substitution possibility does exist. The results of subsector codes 151 and 153 have shown that the elasticity of labour productivity with respect to wage rate was more than unity. Therefore, it can be inferred

Table 2. Elasticity of labour productivity with respect to wages in different subsectors of unorganised food processing sector: 2005-06 Subsector code 151 152 153 154 155 Overall Constant -2.02 2.99 -3.38 5.64 7.47 0.206 Elasticity of substitution 1.143 0.526 1.22 0.228 -0.058 0.84 Elasticity of labour productivity -0.125 0.901 -0.180 3.386 -18.241 0.190

Source: Authors estimates from the unit level data on Unorganised Manufacturing, NSSO 62nd round, Ministry of Statistics and Programme Implementation, New Delhi.

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that the marginal labour productivity in relation to wage rate was very high than that of the average labour productivity in relation to wage rate. Hence, the substitution possibilities will exist till the marginal labour productivity becomes equal to the average labour productivity. The value of elasticity (>1) suggests that if the wage rate (W/L) is increased by 1 per cent, the output (GVA) per worker in the subsector codes-151 and 153 of unorganized food processing would increase by more than 1 per cent. In other words, labour productivity is an increasing function of wage rate. This suggests greater possibility of labour substitution for capital. Therefore, in subsector codes151 and 153, it is profitable for the entrepreneurs to substitute the abundant labour for scarce capital till marginal productivity of labour becomes equal to the wage rate. It was estimated from the NSS (2005-06) Unorganised Manufacturing unit level data that on an average, a worker earned `14000 per annum in the food processing sector. These wages are higher than the 100 days assured wages per annum in the MGNREGS. With the launching of this scheme, there may be some scope of shifting the family labour (disguised unemployed) from the food manufacturing unit/factory to the MGNREGS in order to reduce the crowding effect at the household level food processing enterprise. In course of time, these additional earnings may encourage the small entrepreneurs to enhance their scale of operation.

The unorganized food processing industry provides vital linkages and synergies between industry and agriculture. Following policy interventions are required for improving the performance of unorganized food processing industry: Participation of unskilled labour is more common in workforce of unorganized food processing industry. To improve its performance, there is need to develop necessary skills among the 6.3 million workers of food processing industry. The current capacity of the skill development programmes is 3.1 million. India has set a target of capacity building of 500 million people by 2022. Concerted efforts should be focused on this programme. Transformation of unskilled labour to skilled labour under employment programmes like MGNREGS will certainly fuel the growth of manufacturing which presently faces shortage of skilled labour, particularly in food processing units/factories which are mostly located in the rural areas.

References
Ahulwalia, I.J. (1981) Productivity Growth in Indian Manufacturing, Oxford University Press. Gujarati, D.N. (1966) A test of ACMS production function: Indian industries, Indian Journal of Industrial Relations, 2(1): 95-97. Goldar, B.N. (1986) Productivity Growth in Indian Industry, Allied Publishers, New Delhi. GoI (Government of India) (2010) Economic Survey 201011, New Delhi. NSSO (2000-01) Unorganised Manufacturing, Round 56th Ministry of Statistics and Programme Implementation, Government of India, New Delhi. NSSO (2005-06) Unorganised Manufacturing, Round 62nd Ministry of Statistics and Programme Implementation, Government of India, New Delhi. NSSO (2005-06) Situation Assessment Survey of Farmers in India , Round 59 th Ministry of Statistics and Programme Implementation, Government of India, New Delhi. Upender, M. (1996) Elasticity of labour productivity in Indian manufacturing sector, Economic and Political Weekly, XXXI(21): M7-M10.
Received: December 2011; Accepted: June 2012

Conclusions and Policy Suggestions

The study has revealed that the unorganised food processing sector is passing through the transition from labour to capital intensive structure and therefore, there is a tendency to employ more hired labour (knowledgebased) to manage the growing capital structure. Nonetheless, still different subsectors (except subsector code-152) of agriculture sector are facing decreasing returns to scale which means that this sector is employing the factors (capital and labour) beyond the optimal scale of production. As a result of liberalization, Indian economy has moved in the high growth trajectory which has resulted a tremendous growth of processed food manufacturing. At the subsector level, there are two sub-sectors (codes-151 and -153) where possibility of substitutability of labour for capital does exist, which suggests that still there is scope for employment of skilled labour force.