More on India's structural transformation

The previous post was on India's structural transformation challenge. An important part of structural transformation is the progress of industrialisation and urbanisation and the interaction between the two. 

Douglas Gollin, Remi Jedwab, and Dietrich Vollrath have an excellent paper which examines the relationship between urbanisation and industrialisation in 116 resource exporting and non-exporting countries for the 1960-2010 period. They find that resource exports cause a significant increase in urbanisation rates, and there is no link between urbanisation and industrialisation. 

The patterns of urbanisation observed in the developing world in the last few decades have diverged significantly from historical trends. For Europe and the Neo-Europes, significant urbanisation was associated with industrialisation; with the cities came the factories. Today, however, many developing countries, though highly urbanised, lack large industrial sectors. Nigeria, for example, has the same percentage of its population living in cities as China... we find that the historically tight relationship between urbanisation and industrialisation breaks down for much of the developing world. In particular, this divergence is reflected in the large number of natural resource exporters that have urbanised without industrialising... Several resource-exporters reach 80% urbanisation rates, despite having only 20% of their GDP come from manufacturing and services.

They use a framework to compare between cities of resource exporters and non-exporters 

We characterise resource-exporting urban centres as “consumption cities", where a larger fraction of workers are employed in non-tradable services such as commerce and transportation or personal and government services. In contrast, urban centres in China or other historical cities are best characterised as “production cities”, where a larger fraction of workers are engaged in manufacturing or in tradable services, such as finance. This does not imply that resource-exporting cities are necessarily poorer.

Unconditionally, natural resource exporters have lower poverty rates and slum shares than non-exporters. If we control for income levels and urbanisation rates, however, resource exporters appear to have higher poverty rates and slum shares. The results of our comparison suggest that the effect of income on living standards is lower for resource exporters. Consumption cities arise from an increase in natural resource revenues flowing into a country. Greater income from resources does not translate directly to improvements to living standards. Production cities are by contrast the result of productivity improvements... 

They make the distinction between urbanisation driven by income shocks due to resource incomes and industrial productivity improvements,  

The basic logic is that urbanisation is driven by income effects. Any income shock - whether caused by industrial productivity or resource revenues - will cause a shift away from economic activities in rural areas and encourage the movement of production and people into urban areas. The source of the shock, though, does matter for which sector the new urban workers will be employed in, through substitution effects. With a resource shock, there is a Dutch Disease outcome. Workers substitute away from the tradable goods sector and into non-tradeable. Hence the cities grow into “consumption cities", dominated by non-tradable employment. In contrast, a productivity shock in the tradable sector pulls workers into that sector, and away from rural areas, leading to urbanisation in “production cities" dominated by tradable production. Resource-exporting countries thus urbanise without acquiring the industrial sectors that we typically associate with development.

Now replace "countries" with "regions" and "resource exporters" with "remittance incomes", and the findings may explain economic trends in rural India. The remittance incomes lead to the development of "consumption cities". Like the resource exporting countries, rural areas which experience income shocks from remittance incomes, tend to experience a crowding out of tradables.

It would not be correct to characterise it as a form of Dutch Disease. In this case, it's a low level productivity-cum-poverty trap. The poor find it worth to migrate for unskilled and semi-skilled labour which brings back subsistence remittances which, along with low productive farming and without any productive industrial activities, in turn keeps the economy going. 

A good example of something closer to a Dutch Disease is Kerala and the effect of much larger , some very big, remittances from the Gulf. As I have blogged here, the flush of remittances going into villages ended up in large houses and non-traceable sectors. These investments and expenditures crowded out investments in productive activities like manufacturing or services. It also led to higher services sector wages, thereby further displacing investments from manufacturing.

So what do we takeaway from these two papers? The first paper informs that it was not migration to larger cities, not even daily commutes to the nearest urban centres, but the creation of new urban localities centred on manufacturing that helps to achieve structural transformations. The second paper points to the link between urbanisation and industrialisation, with many developing countries experiencing the former without the latter. 

Taken together and given the structure of India's economy and its growth trends, it can be argued that the concentration of industrialisation around a few urban centres and the acute problem of lack of a broad-base of economic growth may be interlinked. In simple terms, to get broad-based economic growth India needs to take industrialisation to its hinterlands. It needs to ensure urbanisation is accompanied with industrialisation.  

The typical Indian district is a relatively large entity. However, a large number of them do not have any underlying productive economic activity apart from low productivity activities, government, and general services (including construction) that support any population centre. The problem is compounded by the poor quality of human resource development, in major part due to weak state capacity and lack of political demand for good quality provisioning of these services. This results in poor quality of labour entering the workforce. 

In the circumstances, people migrate to urban centres and other places in search of less-skilled and lower-paying service and construction sector jobs which provide slightly higher (than farm labour) but still largely subsistence incomes. This does not this improve household incomes or economic output in any meaningful manner. A low-level poverty-cum-productivity trap gets perpetuated. 

Is the idea of one-district one-product which the government is currently promoting, whereby each district identifies one economic product it has a comparative advantage and focuses on its development, the right response to this problem? While I'm generally sceptical of one-size-fits-all approaches, it can be argued that taking industrialisation to districts should be the broad direction of thinking.

The country needs to geographically spread out its industrial base to ensure broad-based economic growth. This requires industrial policies that promotes large anchor industries which can provide the basis for knowledge spill-overs and eco-system development; labour intensive manufacturing sectors like textiles, footwear, toys etc; agriculture secondary and tertiary processing etc. Equally, if not more importantly, it needs to address the poor quality of its public services especially in health and education.