Source: Financial Times

Expectations are high that India will finally realise its full economic potential through a combination of Modi magic, its abundant young labour force and a more liberal policy regime. A recent adjustment in the country’s accounting has led to claims that it may already have replaced China as the world’s fastest growing economy. Yet, if India is to achieve the same sustained success as China, it needs to take a hard look at why its urbanisation process has failed so miserably in comparison.

Four decades ago, these two most populous and poor countries faced similar economic prospects. With the bulk of their labour force stuck in subsistence farming and a relative scarcity of natural resources, the success or failure of their development efforts would be defined by their urbanisation process. In 1980, India was further ahead than China with an urbanisation ratio of 25 per cent ratio compared with the latter’s 20 per cent. Today, China has more than doubled its ratio to 53 per cent, while India’s has edged up only slightly to 32 per cent — and even at that level is marked by more pervasive pockets of slums. Some believe that China may have even reached saturation point.

China’s rapid industrialisation-driven urbanisation process led to a sustained double-digit surge in real wages, which uplifted some 600m rural people out of poverty and accounted for half the country’s 10 per cent annual gross domestic product growth rates from 1980-2010. In contrast, despite its impressive service-sector development, India has not managed to develop a vibrant manufacturing sector and most of its labour force is still mired in low-productivity rural activities.

Thus, it is not surprising that many see a revamped urbanisation process as being critical to India’s development agenda. Much of the current discussion has focused on the nuts and bolts of improving urban institutions, education and municipal financing to encourage larger and more productive cities. But most of it misses the point. China’s success occurred despite it having similarly weak institutions and, unlike India, it still has a restrictive residency system that discourages rural workers from relocating to urban commercial centres. However, in today’s India the basic incentives for a more dynamic and productivity-driven urbanisation process do not exist. If they are to be established, there needs to be a much better understanding of the nature of the problem.

The reason why India has failed and China succeeded can be illustrated by two simple indicators: their respective ratios of urban to rural incomes and the prices of urban property.

The ratio of incomes gives a sense of the relative differences in productivity between the cities and countryside. For China, this ratio is 3.2 – the highest in world. On average, urban workers are more than three times as productive as rural workers and are being compensated accordingly. No wonder some 270m migrant workers have flocked to the cities to secure better paying industrial jobs. For India, the same measure gives a ratio of 1.6, one of the lowest for emerging market economies, indicating that urban productivity is only moderately higher than in rural areas, and cities do not offer such a magnet of higher earnings.

The other key indicator is the relative difference in property prices in China versus India. China’s mega-cities have seen a five-fold increase in property prices in renminbi terms, or nearly seven-fold in US dollars over the past decade. No wonder concerns about a possible property bubble in China dominate global financial news. Yet despite these astounding increases, property prices in Beijing and Shanghai are still only half those of their Indian counterparts of New Delhi and Mumbai.

So because the productivity-related benefits are so much lower in India, the incentive for rural workers to migrate to the cities is much less than in China and this is accentuated by the relatively higher cost of living in Indian cities due to exorbitant property prices. These same inflated property prices coupled with other factors — notably logistical bottlenecks — put Indian manufacturers at a cost disadvantage in competing in global markets despite their lower wages. The net effect is to hobble India’s progress.

India’s lower urban-to-rural productivity ratio is partly the result of well-recognised distortions in its investment and pricing regime, as highlighted in studies done by the World Bank and IMF. But less widely understood is the negative impact of urban land-management policies.

India’s excessively high property prices reflect a combination of two archaic practices. One is the legacy of its colonial past in reserving large parcels of valuable urban land for government use, including sprawling and wasteful estates for civil servants and military cantonments. The other comes from outdated and overly rigid building codes that discourage concentrated development of commercial activity and housing in the core of its major cities. This pushes development to the outer suburbs, making it difficult to realise the agglomeration benefits that drive productivity gains.

Unless these issues are addressed, India cannot realise the growth benefits from a more rapid urbanisation-cum-industrialisation process which has characterised China and much of east Asia over the past four decades.

This article originally appeared in the Financal Times.