Rise Of Manufacturing In Rural India
It has long been argued that urbanisation and industrialisation grow together, with a fast pace of urbanisation associated with a fast pace of industrialisation. But this is no longer the case in India.
India’s manufacturing sector is de-urbanising and many more enterprises in the manufacturing sector locating in rural areas. Has this divergence between urbanisation and industrialisation helped or hindered India?
The rise of the manufacturing sector in rural areas has helped India by reducing misallocation in different factors of production (labour, land and buildings and other fixed assets) in the manufacturing sector. It has reduced ‘frictions’ on economic development and in particular the misallocation of land.
The shift of plants from urban to rural areas has improved land allocation and reduced spatial disparities in output per worker variation across districts and states. The biggest constraint to plants in the manufacturing sector was land availability and land misallocation which have been larger in India than the differences found in many other countries.
Districts and states that have experienced improved land allocation with higher output per worker are largely concentrated in Gujarat, Rajasthan, Haryana, Punjab, and Maharashtra. Low output per worker is more prevalent in the eastern and poorer lagging regions of India (Bihar, UP, and Orissa).
Land misallocation within India is striking, as land misallocation is worse than the misallocation in other factors of production like capital and labor. The adverse impact of land misallocation on productivity growth has always exceeded the adverse impact of capital and labor misallocation.
Even though land and building account for a small fraction of final output and value-added, they seem to play a disproportionate role in explaining the misallocation of a final output. Misallocation of capital appears to account for very little of the misallocation of the final output.
The biggest friction to the expansion of the manufacturing sector originated from the misallocation of land. While the gains from expanding supply, and particularly the supply of land are large, the profits from a better land allocation are even larger.
Shaping the future
Although the spatial shift of the manufacturing sector from urban to rural areas has increased land availability and improved land allocation, poor physical and human infrastructure in the rural areas has hampered the rise of manufacturing in rural areas and reduced the overall pace of India’s industrialization. Unlike China and USA, India’s growth drivers are still concentrated in its megacities.
The rise of manufacturing in rural areas has opened new doors for growth. To realize its growth potential, India needs to scale up infrastructure investments in rural areas. Although India has increased infrastructure investments, it has gone mainly towards the urban areas, where the manufacturing sector is contracting.
The next phase of growth will come from better aligning industrialisation with the rural development agenda, and recognising that there is a strong link between rural infrastructure and manufacturing growth.
Investments in physical infrastructure--electricity, roads, telecoms, and water/sanitation facilities—increase agglomeration economies that can boost entrepreneurship and expand the manufacturing sector. A good physical infrastructure is essential to supporting a growing sector, as goods and services cannot be produced and delivered without roads, railways, electricity, and telecommunication. Moving people is as important as moving goods and services for the economic health of the firms.
India is well positioned to continue to grow during this global downturn, given India’s huge youth bulge, the rise of the middle class, and shifts in global supply chains. This growth momentum can be accelerated if land availability can be increased and land distortions reduced.
This is important as land markets remain highly distorted in India compared to capital and labour markets. These distortions created huge urban-rural disparities in access to finance, with rural locations lagging their urban counterparts.
Huge distortions in land markets have also made growth less inclusive, especially for women. Women entrepreneurs have historically had much lower access to land, and because the land is used as collateral for most bank loans, their access to capital is also low. Financial liberalisation policies are needed to help break the strong link between distortions in land and loan markets.
The spatial location of plants, and the rise of the manufacturing sector in rural areas, have implications for policy, and policymakers wishing to promote industrialization need to act now. Policymakers should focus less on firm chasing and more on scaling up investments in rural areas to attract more enterprises in the manufacturing sector.
Policymakers should continue to give importance to factor accumulation, but improved factor allocation, particularly land, can be an even bigger driver of growth. The misallocation of factor inputs hampers firm performance, and land and building distortions appear to be especially important. The land is the least flexible factor of production, and its misallocation also likely breeds the misallocations of other factors and output.
The rise of manufacturing sector in rural areas and increasing industrial land allocation has also big implications for India’s climate change agenda. India’s structural transformation and economic growth is taking many intriguing twists and turns.
Energy efficiency has improved in urban areas as urban settings have reduced the cost of electricity use per output level due to denser customer bases and more efficient plant sizes for local energy producers. But large manufacturing enterprises that are now de-urbanizing and moving into rural areas in search of lower land costs have experienced a worsening in energy efficiency when compared with urban regions. This deviation is growing over time.
This would suggest that the climate change agenda will now need to focus on the rise of the manufacturing sector in rural areas.
India’s next budget will be presented during a challenging time, given a worsening global economic downturn, rising geo-political uncertainties and changes in global supply chains.
India can overcome this downturn with an increased allocation of infrastructure investments going into the rural areas to help the manufacturing sector, and the climate change agenda. This will also help India to benefit from a global drive to diversify supply chains in manufacturing investments away from China and into India.
