India:Myths and Reality

Myth 1: Faster economic growth in urban India, rather than in rural India, is driving rapid migration to the cities. In reality, India’s rural economy has grown on average by 7.3% year-over-year over the past decade, against 5.4% in the urban sector. Per capita rural income growth has been more than double that of urban India (though admittedly starting from a significantly lower base). Our calculations using the latest Central Statistic Organization figures suggest that the rural economy accounted for 51% of India’s national domestic product in 2005-06, up from 49% in 2000 and 46% in 1993-94.

The process of urbanization is actually slowing down as economic growth is taking off—a peculiar trend for a developing country. For that, thank federal and state government policies which have discouraged urban industrial employment—rigid labour laws that govern hiring and firing in larger organizations, lengthy bureaucratic notifications, restrictions on overtime—and a critical lack of urban infrastructure investment. On a more local level, city governments haven’t managed their books prudently, and don’t have capital to invest.

The effect of India’s slowing urbanization isn’t yet known. But if the cities aren’t able to absorb and employ unskilled workers, then rural economies may have to play an even more significant role in transitioning workers from agriculture into more productive parts of the economy. And for them to do so, they’ll need more tax breaks, more simplified regulations and less corruption at the state level—all issues that policymakers rarely address.

Myth 2: Rural India is still an agricultural economy. As of 2000, agriculture accounted for just over half of rural economic activity, down from 64% in the early 1980s and 72% in 1971. Services, on the other hand, now account for 28% of rural activity, up from 21% in 1981, while manufacturing, utilities and construction have nearly doubled their share in the rural economy to 18% in 2000 from just under 10% in 1971. The growth has been led, in large part, by three industries: manufacturing; construction; and trade, hotels and restaurants.

The manufacturing trend is especially encouraging, as many of India’s rural workers don’t have the skills to win jobs in the country’s fast-growing services sector. Since 1971, real manufacturing output in rural India has grown by five times, against two times for urban India. The rural economy accounts for 42% of total manufacturing output and 27% of services as of 2000—and it is likely that its share has since grown.

While it’s clear that the government can’t leave farmers in the lurch, Delhi has done comparatively little to encourage the growth of the manufacturing sector, whether through tax breaks or other economic incentives.

Myth 3: Rural-urban inequality is on the rise. India’s urban-rural income gap, the ratio of mean urban to rural incomes, diminished to 2.8 in 2000 from 3.3 in the early 1990s. Of course, absolute levels of spending are still dramatically skewed, because urban households are far richer than their rural counterparts. At the margin, however, that’s changing. Between 2000 and 2005, real rural household consumption expenditure grew by 8% against 4% in urban India.

Unfortunately, Delhi still focuses mainly on rural inequality— and is enacting policies that could only worsen the situation. Policies like the Rural Employment Guarantee Act (which provides 100 days of work in a year to any rural household)—leaving aside the shortfalls in implementation—move in a more interventionist direction in the face of strengthening market forces. At the same time, urban infrastructure investment needs a heavier policy push. The rural poor already receive almost twice as much housing assistance per capita as the urban poor. At 0.6% of GDP, total urban spending in India as a share of GDP has remained stagnant for the past 15 years.

If there’s a lesson to be learnt from all of this, it’s that urban growth and rural growth aren’t distinct and separate phenomena. Our study suggests that a Rs100 increase in urban consumption could lead to an increase in rural household incomes of up to Rs39—no small feedback, and a strong counter to the popular perception of “two Indias”. If India’s cities keep growing at their current pace, in aggregate 6.3 million non-farm jobs in rural areas (more than the total number of new professional services jobs projected over the next 10 years) and $91 billion in real rural household income could be created over the next decade.

Urban consumption also generates non-farm employment. A 10% increase in urban expenditure is associated with a 4.8% increase in rural non-farm employment.

Agricultural growth—even envisaging improved productivity—will not sustain the rural economy on its own. It’s the urban-rural linkages—if understood properly—that could provide a way to solve India’s semi-skilled employment crisis. It’s time to stop talking about “two Indias” and to start framing an economic policy for one country.

Edited excerpts from The Wall Street Journal.