Growth problems for India’s medium-size cities

In countries like the US and China, they are engines of economic progress—but in India, megacities still dominate

Although India has experienced rapid growth over the last two decades, spatial disparities have increased. India’s growth is concentrated in mega cities. This stands in sharp contrast with the spatial development in China and the US, where intermediate cities have become the new drivers of growth and job creation. Why is economic activity concentrated in high-density clusters in India? Have the manufacturing and services sectors shown similar or different patterns of spatial development? Will megacities experience decreasing returns in future? Why are medium-size cities not growing? Do they suffer from poor infrastructure? We examined these questions with the help of enterprise data in 900 districts (Klaus Desmet, Syed Ejaz Ghani,Stephen D. O’Connell and Esteban Rossi-Hansberg, The Spatial Development Of India, policy research working paper series 6060, World Bank).

Spatial transformation

The spatial development of the manufacturing and services sectors behaves very differently. Globally, manufacturing has been dispersing from high-density clusters to less-dense areas, whereas services have been experiencing increasing concentration, except for the densest locations where congestion is the dominating force.

Empirical evidence has shown that “young” industries tend to become spatially more concentrated, whereas “old” industries have a tendency towards greater dispersion. The manufacturing sector is now an old industry. The fourth Industrial Revolution is still evolving, with informational technology making services more tradable and a young industry.
The services sector in India shows some similarities with the services sector in the US, with both exhibiting agglomeration economies. However, there are also some differences. In the US, agglomeration economies in services dominate in medium-density locations. Three of the main high-tech counties in the US are in Santa Clara, California (Silicon Valley); Middlesex, Massachusetts (Route 128); and Durham, North Carolina (Research Triangle). In contrast, in India, agglomeration economies are more dominant in high-density locations, such as Hyderabad and Chennai.
The evidence of agglomeration in the services sector in the US is in cities with densities of employment below 150 employees per sq. km, while in India, agglomeration is found in cities with densities above this threshold. In other words, if the US is used as the efficient benchmark, then 150 employees per sq. km is the ideal density to take advantage of agglomeration economies. In India, these medium-density cities are the worst places.
For Chinese locations with a density above 150 employees per sq. km, service employment growth strongly decreases with size, indicating important congestion costs. China looks more like the US, where congestion costs also dominate for locations above the 150 employees per sq. km threshold. Given that the overall level of local infrastructure is better in China than in India, this finding is consistent with the interpretation of frictions holding back the growth of medium-density cities in India, but not in China.
Identifying the frictions and barriers to growth in medium-density cities in India can be a challenging task. There is evidence to suggest that two policy variables have the potential to account for the relative advantage of high-density clusters—the percentage of the population with post-secondary education and the percentage of households with access to telecommunication services. Controlling for either of these two variables, there is no longer evidence of high-density service clusters growing particularly fast. In other words, if all locations had the same percentage of their population with post-secondary education, or if households’ access to telecommunication services in all locations was the same, then high-density service clusters would lose their attractiveness in India.
If India had the same scale dependence in growth rates as the US, different areas of the country would benefit from growth in the services sector. Growth would be more concentrated in the coastal regions, especially in southern states such as Tamil Nadu and Kerala, as well as in northern states such as West Bengal, Bihar and Uttar Pradesh. Of the well-known IT clusters in India, the medium-density cities such as Ahmedabad and Pune, and especially Bengaluru, would grow much faster in the future, whereas the high-density cities, such as Chennai and Mumbai, will face slower growth.
What should policymakers do?

India’s rapid growth has been accompanied by increasing spatial disparities within India. India’s megacities have continued to grow, fed by a steady stream of migrants from the countryside. The spatial evolution of India has continued to favour districts with high levels of employment density. This is especially the case in services. The evidence in manufacturing is more mixed. In the services sector, agglomeration forces still dominate dispersion forces in high-density areas. In other words, these high-density clusters of economic activity continue to be India’s engines of growth.

This raises a number of important policy questions. Should India focus on the development of infrastructure, and in general facilitate the location of employment, in its large cities in order to exploit the still important agglomeration effects? Or should India develop infrastructure in medium-density locations in order to remove some of the impediments to growth present in these areas?
The future drivers of growth and jobs will be the medium-size cities in India, just like in China and the US. But the medium-density locations currently are the worst places. What is preventing medium-density locations in India from growing and taking full advantage of agglomeration forces? Why is their evolution so different from that in advanced economies? This is a major concern in India’s spatial development.