Conventional wisdom suggests that industrialization and urbanization go hand in hand. Policymakers often adopt an active “industrial policy" to accelerate growth. They also embrace an active “urban policy", since industrialization without urbanization gets stalled. This has changed.

India’s industrialization and urbanization did grow together in the early 1990s. Manufacturing growth was initially concentrated around the mega cities. But it has dispersed in the last decade. The share of the manufacturing sector in employment, output, and number of enterprises has declined in urban areas. The share of manufacturing has increased in rural areas.

This de-urbanization of the manufacturing sector has been much steeper in the organized sector compared to the unorganized sector. Large-scale manufacturing enterprises, that account for 80% of output, are moving into rural areas in search of lower land costs to remain competitive. However, the unorganized manufacturing sector, that creates the majority of jobs, is still concentrating in cities, in search of better physical infrastructure.

India’s de-urbanization of the manufacturing sector raises potential concerns. Will the manufacturing sector moving away from cities compromise economic growth and job creation? Will low levels of infrastructure investments in rural areas slow down the pace of spatial transformation? Is there a need for a better integration of the rural-urban development agenda, as India proceeds with the next phase of urbanization?

India’s future economic growth may not be in its mega cities, which are already dense, but in its secondary cities, where there is substantial untapped potential. Two-thirds of India’s population still lives in the rural areas. Inter-urban competition between tier I and II cities could be India’s big driver of economic transformation and growth. Some have argued that the next phase of urbanization could result in a four-fold increase in per capita income.

With all its promises and desirability, urban-rural integration also imposes unprecedented financial, managerial and policy challenges. India’s renewed emphasis on rural development, and the current trend of the manufacturing sector moving away from densely populated urban areas, opens new doors and provides immense potential for regional and spatial development.

Improved spatial allocation

In the early 1990s, when India’s manufacturing started growing rapidly, it was concentrated around the mega cities. This trend has reversed. We examined these trends in some 600 districts using enterprise data (Is India’s Manufacturing Sector Moving Away From Cities? by Ejaz Ghani, Arti Grover Goswami and William R. Kerr, Policy Research Working Paper Series 6271, the World Bank). A detailed examination has shown the spatial dispersion of the manufacturing sector. This dispersion is associated with a more efficient allocation of enterprises between the urban and rural settings. It has improved India’s spatial development.

Spatial mismatch of the manufacturing sector has declined since the early 1990s. Most districts with an initial spatial mismatch have experienced improved spatial allocation. However, districts with better physical and human infrastructure have experienced a faster pace of decline in the spatial mismatch in the manufacturing sector.

The trends in the pace of decline in the spatial mismatch differ across organized and unorganized sectors, and large and small enterprises. It is small enterprises in the unorganized sector that are primarily driving a faster pace of decline in spatial mismatch. The improvement in spatial location mismatch is less prominent in the organized sector. Overall, the pace of decline in the spatial mismatch has increased.

Shaping the future

Unlike in China and US, the growth drivers in India are still concentrated in mega cities. Secondary cities have yet to become engines of growth and job creation in India. Building a smart tier II and tier III city calls for scaling up investments in physical and human infrastructure to make them more competitive, attract new enterprises, and create more jobs.

As a latecomer to urbanization, India can also draw upon other policy levers to make tier II cities more competitive. New technology can play a more dynamic role in urbanization. It can deliver better outcomes to entrepreneurs and citizens. It can reduce congestion costs, make cities green and sustainable, and increase the efficiency of local government programmes.

Making tier II cities more competitive does not mean ignoring rural economic transformation. New urbanization should build more bridges with rural areas. India’s agricultural productivity growth has remained low compared to manufacturing and services. Agriculture is not catching up with other sectors. This is a major policy concern, as this could compromise the goals of reducing poverty, given that agriculture remains the main income source for 40% of people in India. The good news is that India has the potential to become a major part of the global agricultural value chain through continued expansion of commercial farming on to uncultivated land, shifting some production from grain crops to higher-value crops, such as horticulture and biofuels, and by improving the productivity and yields of especially smallholder farmers.

Ejaz Ghani is lead economist at the World Bank.