Monday, May 30, 2005

Growth amid stagnation

R Ravimohan: Growth amid stagnation

Business Standard

Small towns will now have to play a major role in the growth of the services industry

The composition of the Indian economy has rapidly changed in favour of the services sector, with the shares of manufacturing and agriculture declining over the past two decades. This is beneficial for the economic growth of the country for three good reasons.

First, it reduces the exposure to the most volatile component, which is agriculture. Second, the manufacturing sector is more capital-intensive than services, and for a capital-deficient country, this makes our economic progress less dependent on capital.

Third, the services sector by and large is more employment-intensive, which is again good for a country where 20 million people will knock at the doors of the job market for the next 20 years. So are we heading straight to Utopia, with no care in the world? The short answer is no and the long answer is the rest of this commentary.

Our economy faces three constraints, viz. core infrastructure, urban facilitation, and skilled labour. This is not good for any of the sectors of the economy. Everybody knows the constraints of power, roads, and ports affect manufacturing. A lot of focus has been on improving the supply of infrastructure services in the past decade.

The only additional point I would make is that power, roads, and ports also affect the services sector as much is they do the manufacturing sector. Indeed, a number of demand studies, e.g. relating to electricity, have concentrated on the needs of manufacturing and barely recognised the massive needs of the services sector. Telecommunication services have improved and have yielded tremendous productivity gains to the services sector.

However, the use of telecommunications and electronic equipment is now getting constrained by a lack of reliable power. There is a serious danger that the gains may be lost because other countries that are behind us in the services sector, especially with export potential, would become more competitive as we struggle with inadequate infrastructure. The same constraints that have been highlighted with regard to electricity are true for roads and ports as well.

The services sector essentially grows out of urban conglomerates. Given the tremendous growth exhibited by this sector, urban facilities and services are now becoming wretched constraints across the country. Nowhere is this more apparent than in Bangalore.

While other cities are also fast deteriorating, Bangalore is a stunning case study of how a city can get run down as its enterprises in the service s sector expand, with the city facilities not expanding simultaneously. The country has not yet faced the real crunch as the enterprises involved in services have moved to other cities like Pune, Mysore, Hyderabad, Kolkata, Chennai, and Indore.

However, each of these cities is getting into the same difficulties that Bangalore has gone through, namely inadequate investment in urban services. Traffic is a mess in most cities. Housing prices are going up and we may be now in the middle of a bubble that will burst when mortgage rates rise in the coming months.

Hotel rooms and air tickets are becoming increasingly scarce. Getting children admitted to good schools is a serious problem for professionals in the services sector. Pollution is rapidly worsening. Squatters and irregular dwellings make it worse. The green cover is rapidly disappearing and therefore the state of hygiene and health in cities is likely to only deteriorate.

The pressure of population is also taking its toll on law and order, which is also showing signs of fraying at the edges. The larger issue of undesirable migration to existing cities speaks of the inadequate efforts made by the smaller towns in providing opportunities to its citizens in upgrading its attractiveness to the services sector.

Lastly, we have not woken upto the nightmare of insufficient skilled labour, especially to man the burgeoning services industry. There is a mad rush to find and retain talent across the services sector. Indeed, it is beginning to affect the rest of the economy as well, as one can witness the upward pressure on wages.

India has sold itself as a world-class services provider at Indian costs. It is critical to hold those wage costs within reasonable levels for a few decades more till we achieve critical mass and have a more manageable portion of people living below poverty line. Else, we have a serious threat of becoming less competitive, especially as our core infrastructure is more expensive than in countries like Malaysia, Australia and the Philippines.

Is this doomsday? No. The situation can be easily salvaged. It requires some policy support and great deal of entrepreneurship. Let us take the example of skilled labour and the spread of urban centres together. Can the respective state governments encourage the private sector to set up educational-cum- services institutions across various smaller towns?

This will help the local citizens get relevant to be employed in the services sector and at the same time provide greater choices to the services industry and enterprises to locate their facilities, without being constrained by the confines of the larger cities.

Given the spread the telecommunication network has achieved and the rapid improvement in the road network, it is time for the policy makers and the entrepreneurs to think of smaller towns as centres of services industry growth in the next decade. This will also hopefully force the larger cities to buck up and reinvest in themselves to stay in the game.

Lastly, this will channel investments into a wider spread of cities, which will hopefully lead to a more balanced urban development. The incentives that policy makers could offer are concessions on land for office and staff residences, uninterrupted quality power and water, and access to educational institutions or concessions to set them up.

The second initiative that small town administrators can take is to improve their cities, like Surat did, to present a clean and attractive environment. Already most of these cities are bringing up malls, cineplexes, etc.

However, one of the essential ingredients to succeed in the global services is international air connectivity. These smaller cities should therefore quickly develop international airports and hotels. Lastly, some element of competitive local taxes could greatly enhance the attraction of living for young professionals and therefore tilt the decision of the enterprises to locate in tax-friendly regimes.

This will also engender competition at the city level and have a powerful positive impact on city maintenance, as we have seen the competition between states devolving much-needed progress in state-level reforms.

If these priority investments are made, India can sustain its leadership in the global services industry. The growth of the services industry will continue to drive economic growth in the country and offer a viable long-term solution to the employment issues as well.

Ravimohan is the Chairman and CEO of CRISIL.


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