Incorporating Regional Variations in a Macroeconometric Model for India: A Production Frontier Approach

Regional dimensions of a national economy are important in policy making when there are large inter-regional differences in the level of development, growth and resources. In the Indian context, inter-state variations in economic growth and development have attracted continued research and policy attention. Regional balance in development has been one of the key objectives of national economic policies. Assessment of economic performance of the states, however, has not been as systematic as at the national level. In this article, we incorporate regional dimensions in a macroeconometric model for India based on the production frontier (PFR) approach. The approach also provides a plausible link between policy and improvements in productivity. This article presents the use of PFR to modelling the supply side in a macroeconometric model. The approach is applied to the Indian economy using state-level data on output of one sector, namely, agriculture, for estimating technical efficiencies, which relate state-level production functions to the PFR. All the other sectors of the economy are modelled at the aggregate or national level. With human capital development and infrastructure as the possible means of improving efficiency, the model also provides an explicit role for policy to improve the growth potential of the economy at the state level.