The implications of India’s spatial development

 

Ejaz Ghani

World Bank

eghaniwb@gmail.com

Mahatma Gandhi once said, “poverty is the worst form of violence”. In this piece, Ejaz Ghani highlights India’s poverty burden, its regional disparities and convergence thereof. He highlights how the growth process, as well as government transfers currently benefit leading over lagging regions. He discusses how growth doesn't necessarily reduce poverty and encourages policymakers to not wait to adopt direct interventions. He concludes with crucial policy suggestions around decentralization, labour mobility, and investments in agriculture to enable lagging regions. 

India is a densely packed country – with less than 3% of the world’s surface area, it supports 20% of the world’s population. It is also home to the largest concentration of poor people on the planet. The spatial divide within India between leading and lagging regions is monumental. Rapid economic growth in the leading regions¹ has lifted millions out of poverty, while in the lagging regions², underdevelopment remains an intractable challenge. As a result, India’s development challenge is spatially concentrated in these lagging regions. Reviving growth in the lagging regions will take time and will not be easy. Under current growth conditions, the lagging regions may fail to achieve sustainable development goals. 

How India has achieved growth

India has challenged the ‘iron law’ of development³. Although both India and China have achieved rapid growth, they have followed different growth paths. While China followed a conventional growth pattern, starting with agriculture and then moving on to manufacturing led growth, India took an alternative growth path, helped by young demographics and the Fourth Industrial Revolution, and made the big leap straight from agriculture into services, sidestepping manufacturing. 

The growth of the service sector in India took off because the infrastructure needs for services are different from manufacturing. Roads and ports are not as important as telecommunications for the service sector, and internet and telephone costs have fallen more dramatically than transportation costs. India’s emphasis on tertiary education has also provided it with the skill base needed for modern service exports. 

The jury is still out on whether initial spurts of growth acceleration in India can be transformed into sustainable growth dynamics. Nearly 10 million new workers will continue to join the labour force and most of them will come from the lagging regions. This could become a demographic disaster if enough jobs are not created. India may have already plucked the low-hanging fruits on growth. 

Growth, job creation, and poverty reduction are likely to become more challenging in the future. Policymakers will have to deal with unpredictable problems, as demographic pressures, changes in technology and financial flows brought about by globalisation, and climate change spring new surprises.

The leading and lagging regions in India face very different in their geographic and social characteristics. The leading regions, located largely in coastal areas, have global market access, are more urban and dynamic, and tend to have per capita incomes that exceed national average. For instance, Tamil Nadu, a leading region in India with a diversified export base and the most skilled labor force in India, is an envy of middle-income countries. 

On the other hand, lagging regions, have lower per capita income compared to national average, and are dependent on agriculture – and agricultural growth rate has fallen over the last two decades. Bihar, where I was born, is a lagging region in India, and has poverty rates which are much higher than some countries in Sub-Saharan Africa. Poverty rates in lagging regions are nearly double those of leading regions, and both the incidence of extreme poverty and poverty density are much higher. 

Variations in spatial development

The persistence of poverty, dismal social outcomes, and gender disparities has raised concerns about whether lagging regions will be able to catch up with leading regions, or whether they will fall further behind. This is an important question from a policy perspective because a divergence in poverty would suggest that lagging regions may suffer from poverty traps, while a divergence in social outcomes would suggest social traps. Poverty traps exist when poverty itself becomes a constraint to growth. This can happen if poor regions display lower savings or investment rates, and display poor education and health outcomes. These traps prevent economic agents in poor areas, whether individuals, households or firms, from fully expressing their economic potential, thus reducing social and economic efficiency. This could become a vicious cycle with poverty feeding into no income growth, more conflict, dismal social outcomes, and more new entrants to labor force joining the ranks of poor. If poverty traps exist, there is cause to revisit our prior beliefs about development theory and practice – if growth fails to pull people out of poverty traps, then policy will need to focus more on poverty, rather than just on growth. 

Poverty and social traps have strong spatial characteristics, but not all social outcomes are driven by spatial income trends. Education traps could be non-spatial. The poor in leading regions may never receive an education and hence never get out of poverty. Some spatial social outcomes, such as health, are relatively independent of spatial income. Non-income factors may be as important as trends in spatial incomes to health outcomes. Some poverty traps may be local rather than regional. 

Our analysis uncovers four main findings regarding poverty convergence (Ghani et al. 2012). First, per capita incomes are not converging across regions. Despite this, areas with higher levels of poverty have managed to achieve a greater reduction in the percentage of people living below the poverty line, as well as in measures of poverty depth and severity. However, they did not achieve faster proportionate reductions in these poverty indicators. Second, there is substantial convergence in education indicators, but not in measures of health. These results provide for cautious optimism about progress in the lagging regions. However, we do not see lagging regions catching up with leading regions in terms of per capita income or even in proportionate terms for poverty.  

Why are there such huge development disparities between leading and lagging regions? The economic geography of lagging and leading regions is different. Economic mass is concentrated in the coastal leading regions, while poverty mass is concentrated in the lagging regions in the hinterlands. The asymmetry in the spatial locations of economic mass and poverty mass is in part explained by low mobility rates in India. 

While globalisation (through trade and financial channels) has contributed a great deal to growth, and trade liberalisation is indeed associated with reduced poverty,  the effect is smaller in lagging regions. Our empirical findings suggest that although external trade liberalisation brings gains, its benefits are concentrated in leading regions (Ghani 2018). The expected transmission of international prices to domestic prices with openness to trade is seen to be less perfect too in lagging states than in leading ones. Because production benefits from economies of scale, market forces induce production to agglomerate in leading regions. The lagging regions do not have the same level of access to international trade, as transportation costs and cost of doing business are too high. 

Institutional disparities

Do institutions differ between leading and lagging regions? We document important institutional differences using microdata, and find that lagging regions exhibit a substantially poorer institutional environment (Ghani et al. 2011). Firms are more difficult and more costly to set up in those regions, and once set up, they have greater difficulties in raising formal external finance than their counterparts in leading regions. Property rights are less secure– stolen property is far more difficult to recover in Bihar as compared to Punjab, for example. Due to this, financial markets and transaction institutions perform poorly which make it difficult to enforce contracts. Employment protection laws seem to be more restrictive in lagging states than in leading states– however, lagging regions have developed many peculiarities to overcome labour market rigidities. They have a large informal labour sector, a low female participation rate, a slow pace of urbanisation, and higher external migration rates as workers look for jobs outside their country (Ghani 2010a). 

Weak institutions limit the choices of households, firms, and workers in poor regions. Farmers, who constitute the majority of the labour force in lagging regions, find risk hard to bear. They tend to spread their risk by not specialising in any one occupation. They work part-time outside agriculture to reduce their exposure to farming risk, and keep a foot in agriculture to avoid being too dependent on their non-agricultural jobs. Their access to credit is either restricted, or the cost of credit is too high.  The poor also have very little collateral to secure loans, and therefore lenders hesitate to trust them with a lot of money. 

Improving institutions takes time, but a better business environment is not the only route to escape poverty. Two additional critical instruments are education and health. Evidence shows that schooling indicators in lagging areas are worse than in leading areas, with the disadvantage being particularly large for girls. With the exception of primary school participation and completion, the gaps between leading and lagging areas has not narrowed. The battle of closing the educational divide has now shifted from the primary level to the secondary level and higher education. 

Overall, the benefits of economic geography, globalisation, and institutions have not spread evenly. However, policymakers thinking of adopting spatially interventionist regional development policies to promote growth in lagging regions should be careful for two reasons. First, empirical evidence shows that convergence of per capita income between lagging and leading regions is neither a necessary nor a sufficient condition for achieving poverty reduction and social convergence. Second, regional policies that aim to achieve balanced income growth could potentially lower overall GDP growth rates if they restrain scale economies, specialisation, and externalities. 

Policies aimed at reducing regional disparities which target the creators of wealth and concentration of economic activity, hamper growth and poverty reduction. There are numerous examples of failed regional equity-driven policies. Chief among them is License Raj, which promoted investments in the lagging regions but failed to equalise growth between regions. Many fiscal subsidies aimed at encouraging production in lagging regions are regressive across states and benefit leading regions instead. Decades of poor quality roads have failed to connect lagging regions with the leading ones. Given that economic mass is concentrated in leading regions while poverty mass is concentrated in lagging regions, what should policymakers do to reduce poverty? 

Policy suggestions

Given the limits to growth in lagging regions, growth alone can’t be a total solution. In the short run, policymakers should focus their attention on direct policy interventions that increase welfare and reduce poverty. Policy interventions that improve cooperation or reintegration (as a way out of conflict), decentralisation (to overcome informational asymmetries, promote peer monitoring, and increase participation of women and marginalised people in political process), financial redistribution to increase welfare programmes (reduce fuel, fertilizer, and food subsidies to create fiscal space for lagging regions), labour mobility (as a safety net through private remittances), and stimulate agriculture growth to reduce poverty and secure development. 

A high priority should be given to reshaping decentralisation arrangements so that they benefit the poor regions. Fiscal policy through a system of interstate transfers ensures equity across sub-national regions. This equity is important for both economic and political reasons. Economically, poorer regions have a lower base of economic activity to tax, and typically these regions end up having lower revenues. This revenue constraint can prevent them from investing in human and physical capital and can hamper the delivery of government services. 

Achieving horizontal equity through fiscal transfers is a way to ensure a level playing field. This equity can be particularly important if government services are important inputs into future growth potential, such as in developing a healthy and educated workforce. Growing regional disparities can be a source of political tensions, but fiscal transfers can offset some of these disparities. India’s performance in achieving horizontal equity is mixed – looking at the different components of fiscal transfers in India, it is clear that horizontal equity is being achieved only through the tax-sharing schemes of the Finance Commission. The state plan grants administered by NITI Aayog do not seem to be directed toward the poorer states, whereas the discretionary schemes show higher per capita expenditures in the richer states (see Figure 3 of Ghani et al. 2013)

Food subsidies per capita are roughly uniform across poor and rich states, if we assume that all the subsidies are spent for the sale of food by the Food Corporation of India. On the other hand, if we allocate food subsidies on the assumption that all the subsidies are spent in food procurement through above-market procurement prices, then we see that highest levels of subsidies are given to the leading producer states of Punjab, Haryana, and Maharashtra. The true picture is probably a mix of production and consumption subsidies, but the conclusion is that these food subsidies are not significantly higher in poorer regions. If we look at the second-largest source of subsidies – fertiliser – we see that this subsidy benefits richer regions too, because they tend to consume more fertiliser. In this sense, if the subsidies are meant to improve welfare programmes and investment levels in lagging regions, they need to be targeted to those regions, rather than to goods or services that may be consumed more in richer states. 

India should also encourage mobility and migration and remove policy distortions that discourage mobility (such as the spatial location of safety net programs, distortions in low-income households, etc.). Labour migration benefits lagging areas through two channels: remittance flows and a wage-pull effect, as excess lower skilled labour from one area migrates to another. Most migrants maintain strong links with their home communities and send remittances. These transfers some of the benefits of growth to the lagging areas. Migration also appears to have contributed to reducing differences in non-agricultural wages across provinces by integrating labour markets and pulling up wages in lagging regions–migration benefits non-migrants in these regions. 

Internal mobility is quite low in India, and interstate migrants rarely constitute more than 6% of any given state’s population. Despite large potential gains, people stay in their regions. This is not the case in other developing countries, especially China, where migration from lagging to leading regions is part of the overall development process. Among the impediments to internal mobility are social and cultural barriers, as well as policy-induced restrictions. In the case of India, linguistic barriers can create significant costs, especially for the unskilled and the uneducated. The fact that mobility increases with education level indicates the importance of these factors. Various policy-induced barriers include labour market restrictions and state-specific social welfare programs. If migrants are not eligible for certain welfare programs outside their own state, then they have lower incentive to move. Similarly, rural land ownership laws and rules and urban housing markets create additional mobility costs.  

There is a range of evidence about the positive impacts of migration on human development, through such avenues as increased household incomes and improved access to education and health services. There is further evidence that migration can empower traditionally disadvantaged groups, particularly women. 

National and local policies can play a critical role in enabling better human development outcomes for both those who choose to move in order to improve their circumstances, and those forced to relocate due to conflict, environmental degradation, or other reasons. Host country restrictions can raise both the costs and the risks of migration (Ghani 2018). Similarly, negative outcomes can arise when basic civil rights, like voting, schooling and health care are denied to those who have moved across provincial lines to work and live. A human development approach can be a means to redress some of the underlying issues that erode the potential benefits of mobility and/or force migration. 

Greater investment in agriculture in transforming lagging regions is vital. The challenge is to recast agriculture in the new environment of globalisation, rising prices, growing domestic demand, and greater private sector involvement. This will require greater investments to increase farmer yields and profitability, and in rural infrastructure such as irrigation, roads, power, and markets. The concern is not about the lack of resources, but about the fact that the flow of resources into agriculture has not helped improve land and labour productivity. 

Agriculture can be a key source of growth and poverty reduction, provided there is improvement in the asset position of the rural poor; smallholder farming is made more competitive and sustainable; income sources are diversified toward the labour market and the rural nonfarm economy; and successful migration out of agriculture is facilitated. Farming regions need to rebuild social capital and networking through farmers associations, self-help groups, and water user groups to transform poor and marginalised farmers into an organised market. 

Conclusion

What should be done about this spatial divide in development? The solutions for lagging and leading regions are not the same. Rather than wait for economic growth to reduce poverty, policymakers should take direct policy interventions to reduce poverty. Such direct policy interventions, in turn, could spark growth, and unleash a virtuous cycle of development. The causality may run from poverty reduction to growth, rather than from growth to poverty – the challenge is to find out what works best. 

Notes:

1. States with per capita income below the national average
2. States with per capita income above the national average
3. According to this ‘law’, industrialisation is the only route to rapid economic development for developing countries, with this potential for growth primarily seen in the manufacturing sector (Ghani 2010b).

Further Reading 

• Aghion, Philippe, Robin Burgess, Stephen J Redding and Fabrizio Zilibotti (2008), “The Unequal Effects of Liberalization: Evidence from Dismantling the License Raj in India,” American Economic Review, 98: 1397-1412.
• Dehejia, R and A Panagariya (2010), ‘Services Growth in India: A Look Inside the Black Box’, School of International and Public Affairs, Columbia University, Working Paper 2010-4.
• Desmet, Klaus and Esteban Rossi-Hansberg (2009), “Spatial Growth and Industry Age”, Journal of Economic Theory, 144(6): 2477-2502.
• Desmet, Klaus and Marcel Fafchamps (2006), “Employment Concentration across U.S. Counties”, Regional Science and Urban Economics, 36(4): 482-509.
• Fernandes, AM and G Sharma (2012), ‘Together We Stand? Agglomeration in Indian Manufacturing’, World Bank, Policy Research Working Paper No. 6062.
• Fernandes, AM and A Pakes (2008), ‘Factor Utilization in Indian Manufacturing: A Look at the World Bank Investment Climate Surveys Data’, NBER Working Paper No. 14178.
• Ghani, E (2010a), The Poor Half Billion in South Asia: What is Holding Back Lagging Regions?, Oxford University Press.
• Ghani, E (2010b), ‘The Service Revolution in India’, VoxEU, 25 February.
• Ghani, E, L Iyer and S Mishra (2013), 'Boosting shared prosperity in South Asia', Ideas for India, 4 March.
• Ghani, E (2018), ‘The Global Talent Race’, Project Syndicate, 20 November.
• Ghani, E, AG Goswami and WR Kerr (2012), ‘Is India’s Manufacturing Sector Moving Away from Cities?’ NBER Working Paper No. 17992.
• Ghani, E, WR Kerr and SD O’Connell (2011), ‘Spatial Determinants of Entrepreneurship in India’, NBER Working Paper No. 17514.
• Hasan, A and KRL Jandoc (2010), ‘The Distribution of Firm Size in India: What Can Survey Data Tell Us?’, ADB Economics Working Paper No. 213.
• Kathuria, Vinish, Rajesh Raj Seethamma Natarajan, and Kunal Sen (2010), “Organized versus Unorganized Manufacturing Performance in India in the Post-Reform Period”, Economic and Political Weekly, 45(24): 55-64.
• Lall, SV, HG Wang and U Deichmann (2010), ‘Infrastructure and City Competitiveness in India’, UNU-WIDER Working Paper No. 2010/22.
• Nataraj, Shanthi (2011), “The Impact of Trade Liberalization on Productivity and Firm Size: Evidence from India’s Formal and Informal Manufacturing Sectors”, Journal of International Economics, 85: 292-301. 

 

 

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