AGGLOMERATION ECONOMIES IN INDIAN STATES: AN ASSET TO PRODUCTIVITY?

Abstract

India, like many countries in the Global South finds itself in the midst of a demographic transition. Though lagging behind some nations like China, India is rapidly urbanizing and is set to cross the majority-urban mark in 2050 according to the UN. For a nation of 1.1 billion people, this movement into and growth of cities will bring with it great challenges but also great promise. As the growth of cities worldwide draws the attention of policymakers, theoretical explanations for how cities work also deserve a revisit. Much of the current urbanization movement is heralded as a sign of the maturation of developing country economies, emulating the urbanization movements that preceded the industrialization and modernization phenomena of Europe and North America. However, increasingly, it is becoming apparent that many developing economies face "urbanization without industrialization"(Gollin et al 2013), in which the movement into cities happens more because of marginally higher incomes in urban areas, instead of productivity gains in rural areas that free up labor. This alternate phenomena is feared to contribute to congestion, countering many of the positive agglomeration effects that should result from urbanization, as predicted by the literature so far. In order to ground this argument in evidence, I am examining returns to scale and total factor productivity of manufacturing firms at the Indian state level across variously urbanized states using Annual Survey of Industries (ASI) data, using Lall et al 2003 as inspiration. The results of my analysis do not lend themselves to parsimonious conclusions, yet overall, agglomeration economies do not seem to have a net positive effect on returns to scale and total factor productivity, which supports existing research by Lall and underscores the need to conduct further research into returns to scale and productivity in Indian cities. Depending on the robustness of these results, investments in transportation, enabling firms to more efficiently allocate resources, and making labor markets more efficient should be the first priorities of policymakers.