India’s urbanization bonus

India’s urbanization bonus

The 21st century is set to become India’s urban century. According to our projections, an estimated 140 million people will move to cities by 2020 and a whopping 700 million will urbanize by 2050. The number of cities with population above one million will nearly double by 2020, and may increase fourfold by 2050.

Urbanization is generally a force for growth, development, and modernization. However, it needs to be harnessed. Is India ready for its urbanization bonus?

Cities are centres of economic activity and wealth generators. Estimates of the contribution of cities to total output in India range from 60% to 80%. Urbanization adds about 1% to growth each year, from the productivity gains from the movement of rural workers to urban areas.

The benefits from urbanization to the economy come from the clustering of firms and businesses which allow them to learn from each other and attract workers. Examples include the clustering of software firms in Silicon Valley or auto component firms in Gurgaon. There are also economies of scale for businesses to be close to each other and to consumers, as the variety of goods and services offered is greater, competition is stronger and search and travel costs are reduced.

Cities are also centres of innovation. People can absorb knowledge from contact with more skilled individuals in their own industry.

Other benefits of moving to cities include political access, enhanced by proximity to the administrative and governance centre, as well as the anonymity that city life brings. The latter is especially true in the case of India, where urbanization can often mean freedom from the oppressive caste system of the villages.

In India, most cities are too small and thus do not fully avail of the benefits of urbanization. India’s urbanization rate is slower than the rest of Asia. At 28%, India’s urbanization rate is lower than China’s (over 40%) and Korea’s (over 75%). In part, this is due to an anti-urbanization bias in policy as well as in public perception. Policies such as the Rural Employment Guarantee Act, the non-taxation of agricultural income, and especially the relatively poor state of municipal governance, and the meagre investment in urban infrastructure, illustrate the anti-urban bent in policy. This prevents the realization of the gains from urbanization and leads to sub-optimal city size. There is a misconception that urbanization will lead to only the growth of mega cities and increase congestion and other costs. Most urbanization actually occurs in small towns. To achieve the full gains from urbanization, it is imperative that it is, at the very least, not discouraged by government policy.

Urbanization is associated not only with increases in individual city population, but also growth in city numbers. It is a fallacy to presume that urban growth is dominated by mega-city development. The four largest cities in India have only 5.5% of the country’s total population. The fastest growing cities in India, in terms of population, such as Surat and Ghaziabad, are not the largest ones.

Much of urbanization occurs through the development of new cities and growth of smaller metros. There were 12 cities with population greater than one million in 1981. By 2001, that number had grown to 35. According to our projections, there may be 68 such cities by 2020. There will also likely be a large increase in the number of mega-cities (above five million) to 10 by 2021 and 36 by 2051.

The great centres of civilization, commerce and administration have been urban—from Mohenjo-daro and Rome to Constantinople and London. Urbanization is a concomitant of growth and industrialization and they all feed off each other. Asian economies such as Korea and China have urbanized rapidly during their high-growth periods. The continued movement of workers from low-productivity rural agriculture to high-productivity industry and services is critical to the growth process and needs to be welcomed.

India’s low initial stage of urbanization implies that the gains from this inevitable process are only in their initial stages and have a lot of distance left to run. Indeed, urbanization in India is likely to be enhanced by economic growth, favourable demographics—younger workers tend to migrate more than older workers— low initial stage of development and urbanization, better transport, especially roads, and better communications and openness.

Policies which enhance this movement, including urban governance reforms and a determined push to build the houses, roads, schools, sewerage and sanitation systems which can house, sustain and transport India’s moving masses, will be critical. Otherwise, India’s “urban bonus" may be frittered away.

Tushar Poddar is vice-president for Asia economic research at Goldman Sachs. Comment at