Rural distress: Why structural transformation is the only cure

New Delhi | Updated: February 15, 2019 7:18:04 AM

The challenge is to increase both the scale and impact of financial resources, improve linkages, and build partnerships between the public and private sectors.

rural, rural indiaIndia’s rural distress is partly a symptom of its twin balance sheet problem and factor market distortions.

By Ejaz Ghani

A young population, entrepreneurial spirit, and stable macroeconomic outlook have made India one of the fastest growing economies in the world. This has lifted millions out of poverty, but India is still home to the largest concentration of poor people in the world. Most of them live in the rural areas with poor access to education, health, roads and electricity. Is increased rural distress a reflection of rising inequality associated with the fast pace of growth, or a concern on the lack of opportunities and unfairness in rural areas,where a majority of the people still live? Rural distress is both a cause and effect of India’s structural transformation and fast pace of growth. There are well-understood limits to the pace at which countries can accumulate physical capital. But there are no limits to knowledge diffusions, and the pace at which urban-rural gaps can be closed.

India’s fast pace of economic growth and increased rural distress is not a puzzle. Everyone can now see how others live. People in the rural areas have raised their aspirations and are now demanding a better quality of life. Although humanitarian aid is perceived by many economists as the most efficient way of dealing with rural distress, this may not be a substitute for a faster pace of rural structural transformation that India needs to accelerate growth and job creation.

Conventional wisdom suggests that industrialisation and urbanisation grow together and hand-in-hand. India’s industrialisation and urbanisation did grow together in the early 1990s. But the two trends have spatially dispersed in the last decade, and the manufacturing sector is now de-urbanising (bit.ly/2S48PYw). The share of the manufacturing sector in employment, output, and number of enterprises in the urban areas has declined but it has increased in the rural areas. This process of spatial transformation has brought about a more efficient allocation of enterprises across urban and rural locations. But this process has been too slow, as manufacturing enterprises find it hard and costly to locate to the rural areas due to inadequate physical and human infrastructure.

More than 40% of total employment is still employed in the agricultural sector in India, compared to less than 20% in China, and less than 2% in the US. People in rural areas depend on agriculture, not because it is remunerative, but because there are few alternative employment opportunities. There is room for improving agricultural productivity, but this is not a substitute for a faster pace of rural structural transformation that India needs to improve the quality of life. Declining importance of agriculture in development is an integral part of an inclusive growth process.

India’s rural distress is partly a symptom of its twin balance sheet problem and factor market distortions. Enterprises need three factors of production—labour, capital and land—to produce output. Is labour, capital or land more misallocated in India? Land is much more distorted than capital and labour. Less efficient firms manage to grab more land than more efficient firms. Because land is used as a collateral for most bank loans, capital is also distorted. Most bank loans require some form of collateral to guarantee the loan. Land is simply the best form of collateral due to its immobility (i.e., the debtor can’t run off with land). While borrowers can often pledge 80% of land values against loans, for most other forms of fixed investment, the loan-to-collateral value ratio is substantially lower (for example, 25%). While there may not be such a thing as a perfectly efficient factor allocation, there are huge gains to be made from reducing land misallocation. India is one of the most land scare countries in the world, and land is also the biggest asset in the rural areas. Reducing land misallocation will not only reduce rural distress, but also enable India to achieve double-digit growth rates.

India’s rural distress also reflects rising concerns of gender inequality. Conventional wisdom suggests that a faster pace of economic growth should reduce gender discrimination. But this is not the case in India. The share of females in manufacturing employment has barely increased over the last two decades, but it has increased in agriculture, as men leave rural areas in search of better jobs in the cities. India’s increased feminisation of agriculture has worsened gender equality, due to the heavy work burden in rural areas, and lack of access to basic amenities, including drinking water, sanitation, and much more. While agriculture has become increasingly feminised, the ownership of agricultural assets by women has not increased.

India’s green growth has worsened in the rural areas, if we measure green growth by the amount of energy used to produce an output. It is estimated that nearly 70% of the global carbon emissions is contributed by poor energy efficiency. Indian cities have increased energy efficiency, but it has deteriorated in the rural areas. These trends have been exacerbated by the de-urbanisation of the manufacturing sector. Athough the installed capacity of India’s power system is the fifth-largest system in the world, it is still insufficient to meet India’s rapidly increasing rural demand. Integrating the energy efficiency agenda with the rural structural transformation agenda is important not just for reducing rural distress, but also for improving the liveability of cities.

India’s future is in where one would least expect it to be. It is in the rural areas, that will continue to benefit from the demographic dividend. The infrastructure financing needs of rural structural transformation is huge. But the potential for attracting more private investment is also huge. The basic traits of rural infrastructure projects, such as market size, long-term steady revenue stream, and investment returns that exceed inflation make them attractive for most institutional investors. The funds managed by private institutional investors exceed $100 trillion, but their allocation for rural infrastructure projects is tiny.

Maximising finance for rural structural transformation will not come from a single financing instrument. Only by combining resources—Central and state, international and domestic, public and private, corporate and philanthropic—will it be possible to achieve the necessary levels of financing. The challenge is to increase both the scale and impact of financial resources, improve linkages, and build partnerships. Both markets and administrative institutions are weak in rural areas. This calls for increased coordination, not just increased competition between public and private sector, and between urban and rural areas, as India’s manufacturing sector is de-urbanising, and structural transformation is still evolving. Rural distress will not be resolved through humanitarian aid but through rural structural transformation that can benefit the demographic dividend, create more jobs and enable India to achieve double-digit growth rates.

The author is lead economist at the World Bank

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