Land rezoning and structural transformation in rural India

Reducing regional inequality by moving jobs to people remains a primary policy objective all over the world. This has led to the increased use of place-based policies, with governments providing generous financial incentives to firms to locate to a specific area (often an economically marginalized area) to stimulate localized economic activity (in contrast to a policy of moving  people to jobs by incentivizing out-migration from an economically marginalized area to one with job opportunities). The economic rationale for such policies is that absent such intervention, coordination and market failures would lead to low levels of industrial agglomeration1. The evidence on the effectiveness of such policies is mixed and is especially scarce for developing countries.

Past obstacles to industrial rezoning in India

In a recent paper2, we study the effects of the Industrial Areas (IA) program in the state of Karnataka, India. Under this program, the local government acquires and consolidates contiguous parcels of privately held agricultural land and rezones them for non-agricultural activities, thereby making them available to private firms for sale or lease at market rates3. In contrast to more common place-based policies, no financial incentives are offered to firms to locate within these IAs. Policymakers therefore describe the program in a technical manual as “essentially a piece of real estate promotion”4. The majority of land-use laws in India generally reserve rural land for agricultural production and impose extensive bureaucratic obstacles to its conversion for industrial production. Such regulations are thought to constrain firm creation, productivity and growth in many developing countries5, and the difficulty of procuring large parcels of land for industrial use, especially in India, has been frequently cited as a crucial bottleneck6. The IA program, under which the government primarily acts as the facilitator of rezoning to enable non-agricultural production, therefore has the potential to promote industrialization. 

Observing industrial areas in Karnataka

We focus on two issues: first, we examine whether the land rezoning programme has succeeded in drawing large manufacturing firms to the IAs. This is not obvious a priori. In the absence of financial benefits, it is unclear whether the availability of land in and by itself suffices to attract firms to rural locations with their many disadvantages. Second, we test whether the IAs generate economic spillovers to neighbouring villages. Even if firms locate within IAs, there is no guarantee that they will recruit workers from the surrounding rural areas with their low levels of human capital. Similarly, the effect on firm activity in areas adjacent to the IAs is also unclear. Previous literature on experiences from the U.S. suggests that agglomeration economies generated by the arrival of firms increases industrial activity in surrounding areas7. However, the local entrepreneurs in the rural areas our study focuses on might lack the necessary skills and resources to establish firms. In addition, given that land regulations outside IAs remain stringent, the establishment of large, non-agricultural firms will continue to face major regulatory obstacles.

Specifically, we study the effects of close to 50 IAs established in Karnataka between 1991 and 2011. Our data is particularly well suited for analysing the effects of IAs, as we can identify their precise location, and can observe the key outcomes and explanatory variables at village level. The Karnataka Industrial Areas Development Board (KIADB) provided us details on the year of establishment and location of each IA. We matched the information on these IAs with economic and demographic censuses at the village level. The Economic Census of India, a complete list of all economic firms engaged in non-agricultural activities, provided us with village-level data on the number of firms by industrial classification and size, the number of workers in these firms, and the social caste and gender of firm owners. We used the economic censuses of the years 1990, 1998, 2005 and 2013. The demographic census includes village-level data on the population shares working in various sectors, their literacy rates and the presence of various public goods (paved roads, banking facilities, etc.). We used the demographic censuses of the years 1991, 2001 and 2011. Finally, we also made use of night-time lights data at the village level between 1992–2013. These data are collected by the National Aeronautics and Space Administration’s (NASA) Defense Meteorological Satellite Programs Operational Linescan System (DMSP-OLS).

Linking agglomeration economies to industrial activity 

We used a difference-in-differences identification strategy to analyse the effects of IAs. Essentially, we compared the development of economic activity in IAs over time with a comparable area without an IA (control group). We first conducted a semi-parametric analysis of the impacts of the establishment of an IA in the surrounding villages (see figure below), extending the radius by 30 km in a flexible and spatially precise manner. We found that spillovers occurred up to a radius of 5 km from the IA. We therefore designated villages located more than 5 km from an IA as the control group. We then estimated the treatment effects both within the IA and in villages located within a radius of 5 km from the IA.

We arrive at two main conclusions about the effects of IAs on economic activity. First, we find that the IA programme has been highly successful in promoting economic development within the IA zone. The establishment of IAs between 1991 and 2011 led to a two-fold increase in night-light density and the creation of roughly 40 new firms and 940 new jobs within each IA. Second, we find evidence of substantial economic spillovers. The number of firms and workers in areas within a radius of 5 km from the IA increased as well. A rise in the share of male workers engaged in non-agricultural activities was also noted. These changes are largest in villages bordering the IA, but also extend farther out, falling monotonically within a radius of up to 5 km from the IA’s boundary. We find that for each IA, nearly 500 local workers moved from the agriculture to the manufacturing and service sectors. This suggests that jobs created in new firms established within and around IAs are filled by both commuters and by local village residents. While we are unable to observe village-level output or incomes, the large increase in night-lights within IAs and their surrounding areas suggests this change was accompanied by substantial boosts to local income growth.

Conclusions

Two revealing disparities between the pattern of impacts within IAs and in their vicinity are worth mentioning. While new firms within IAs are mostly large manufacturing firms, newly created firms outside IAs mainly engage in the agricultural and service sectors. Nearly all of these firms employ fewer than 10, and usually only 1 or 2 employees. We hypothesize that firm creation outside IAs is mostly driven by increases in demand for goods and services from workers employed in large, IA-based manufacturing firms, as well as by the easing of credit constraints for agricultural producers. We also find that employment growth is higher in IAs located closer to major highways and cities, reflecting the importance of market access. Second, the impacts on firm growth and labour-force composition amongst the villages located in close proximity to IAs are lower where the baseline levels of agricultural productivity are higher, perhaps due to the higher opportunity cost of exiting agriculture in such locations.

The IA programme has also had an impact on the socio-economic dynamics in the villages. We find important heterogeneities according to the socio-economic composition of both village populations and firm ownership. First, the impacts are larger in villages with higher baseline fractions of scheduled castes (SCs), a particularly disadvantaged group in Indian society. In addition, we find that the IAs are associated with slightly greater firm creation amongst SCs and women, suggesting that such groups have disproportionately benefited from the new economic opportunities created by IAs.

The effects of IAs seem to be driven primarily by the provision of contiguous plots for non-agricultural economic activity, which has relaxed the land constraint firms in rural areas usually face. Overall, the success of the IA program suggests that the extensive agricultural zoning found throughout India represents a major obstacle to local economic development. Given the continuing prevalence of extreme poverty in rural areas, the IA program represents an attractive alternative to traditional policies that promote development through the movement of workers to urban areas8.