McKinsey Global Institute contends that cities in India have the potential to generate 70% of the countrys new jobs and GDP over the next 20 years, a process that could drive a four-fold increase in per capita incomes. While promising and greatly desired, such urbanisation imposes unprecedented managerial and policy challenges. However, in spite of the potential for urbanisation in the country, research on spatial location and concentration of economic activity in cities is still at an early stage.
Given the great challenges ahead, we looked backward to describe how the urbanisation process has proceeded (or not) for the Indian manufacturing sector over the 1989-2005 period. We had two goals. The first goal was to trace the trends and depth of Indias manufacturing urbanisation across states and industries. This description can yield important insights for researchers and policymakers going forward.
Our second goal was to examine whether localised education and infrastructure are linked to urbanisation and more efficient spatial allocation of Indias industries and plants since 1989. There are many explanations for urbanisation drivers in India, too many in fact for one study to accurately assess. We sought to quantify whether and how these local conditions, along with other factors like wage costs, promoted or discouraged the urbanisation process.
Our study combined data from the Annual Survey of Industries for the organised sector and from the National Sample Survey for the unorganised sector. On the whole, Indias manufacturing sector became more urbanised, with the share of workers in urban areas rising from 33% of employees in 1989 to 41% in 2005. Urbanisation growth was most dramatic from 1989 to 1994, but slowed down from 1994 to 2000. The urbanised employment share was basically flat from 2000 to 2005. This pattern of increasing urbanisation was also present when looking just at manufacturing plant counts, but the opposite trend is observed for manufacturing output. The latter has increasingly moved towards rural areas. We investigate several features of these trends in detail.
Our first investigation focused on the relative movements of the organised and unorganised sectors. The differences are striking. Throughout the 1989-2005 period, the organised sector moved from urban to rural locations, with its urban employment share declining from 69% in 1989 to 57% in 2005.2 On the other hand, urban employment share for the unorganised sector increased from 25% to 37%. Since the unorganised sector accounts for about 80% of employment in Indias manufacturing sector, the total urbanisation level increased for the employment measure. Likewise, the organised sector accounts for over 80% of Indias output, so the aggregate output series instead becomes more rural. Next, upon examining the differences across states and industries within India, we found the urbanisation process and trends to be very heterogeneous at the micro level.
We found substantial evidence that links greater urbanisation to districts with more educated workforces and better infrastructure levels. Further, we found evidence that higher costs, or sharper differences in urban-rural cost levels, decrease the rate of urbanisation. These effects are most pronounced in the unorganised sector and before 2000. We also used interaction regressions to show that industries with high capital and land intensity are more likely to locate in rural areas in districts with strong education and infrastructure levels.
By itself, there is no guarantee that the increased urbanisation associated with education and infrastructure is optimal. Our final exercise was to construct simple spatial mismatch indices to test whether these urbanisation trends are associated with more efficient allocation for districts between urban and rural settings. The spatial mismatch index compared the observed industry distribution of district employment across urban and rural locations to a counter-factual where plants or employment in the district were allocated (in some sense optimally) to urban and rural locations according to national propensities by industry to be in urban settings. Higher mismatch values for a district indicate that plants that would have been expected to be in urban areas are in rural areas, and vice versa. Encouragingly, we found there has been an aggregate decline in spatial mismatch since 1989, primarily driven by improved allocation of the unorganised sector. Additional regressions identify that the urbanisation shifts associated with better education and infrastructure have improved the spatial allocation of industry.
To underline, we find that while the organised sector is becoming less urbanised, the unorganised sector is becoming more urbanised. This process has been most closely linked to greater urbanisation changes in districts with high education levels; a second role is often evident for public infrastructure as well. On the whole, these urbanisation changes have modestly improved the urban-rural allocation of industries within Indias districts.
Our findings suggest that policies that take an inclusionary approach to the urban informal economy may be more successful in promoting local development and managing its strains than those focused only on the formal sector. It is very important for Indian policymakers to recognise that much of the urbanisation that is occurring is in the unorganised sector. Moreover, education and infrastructure investments, regardless of original motivation, are primarily operating through the unorganised sector. Going forward, adequate provision of infrastructure is necessary for the informal sector to develop. The more Indian cities recognise this influx and design appropriate policies and investments to support it, the more effective the policy interventions will be. Examples of inclusionary policies are mechanisms to ensure that urban informal livelihoods are integrated into urban plans, land allocation, and zoning regulations; that the urban informal workforce gains access to markets and to basic urban infrastructure services; and that organisations of informal workers participate in government procurement schemes and policymaking processes.
It is something of a paradox that India, among the most densely populated countries in the world, is also among the least urbanised. An important aspect for Indias continued growth is better and deeper urbanisation over the next two decades than it has achieved over the past two decades.
Ghani is economic advisor and Goswami is consultant economist at the World Bank. Kerr is an associate professor at the Harvard Business School
This is an edited extract of the World Banks policy research working paper of November 2012, titled, Is Indias Manufacturing Sector Moving Away From Cities