Industrial Productivity Growth and Agglomeration Economies

Abstract

Industries concentrate spatially because dense networks of firms and individuals generate benefits known as agglomeration economies. The literature has established that agglomeration economies have an impact on productivity growth. Three types of dynamic agglomeration externalities have been proposed for explaining this link– Marshall-Arrow-Romer (MAR) specialization externalities, Jacobs’ diversity externalities, and Porter’s competition externalities. The literature is inconclusive about the relative importance of these externalities for influencing industrial growth and productivity. Studies linking the dynamic externalities and regional growth are limited in the Indian context. The existing studies have focused more on static externalities. Further, the previous studies do not account for the possibility of different relative importance of these externalities in labour-intensive and capital-intensive industries. Using Annual Survey of Industries (ASI) data for selected two-digit industries at the state level, this study examines the role of these dynamic agglomeration externalities on industrial growth and productivity during 2001-02 to 2011-12. The first part provides an overview of the inter-state variations in the industrial performance in terms of growth of value added, employment and total factor productivity (TFP) during 2001-02 to 2011-12. The analysis finds that states with capital-intensive manufacturing show faster employment and productivity growth. The second part studies the pattern of regional concentration of two-digit industries during 2001-02 to 2011-12. It also examines the changes in this concentration over time and provides broad explanations for the observed phenomena. The study finds that regional concentration of an industry is a dynamic process and hence, static analysis may be inadequate. The third part tests the three theories of dynamic agglomeration externalities in context of the selected two-digit industries of the Indian manufacturing sector at the state level. This part focuses on the question: Whether own-industry concentration (specialization externalities) or the concentration of diverse industries (diversity externalities) has a greater impact on employment and productivity growth? The study also attempts to examine if the relative importance of these externalities differs in labour-intensive and capital-intensive industries. The results indicate that the impact of dynamic externalities on regional industrial growth should not be examined by pooling all the industries. The study finds that dynamic externalities have a positive impact on employment growth while the effects on TFP growth are unclear. MAR specialization externalities and Porter’s competition externalities positively affect employment growth in capital-intensive industries while Porter’s competition externalities and Jacobs’ diversity externalities positively affect employment growth in labour-intensive industries. To check stability of the findings, the analysis is replicated for a different dataset. These results highlight the unreliability of results obtained by pooling all industries. The findings imply that the policies of specialization and diversification should be formulated according to the nature of an industry. Policymakers should not view specialization and diversity as mutually exclusive; rather they should be treated complimentary depending on the nature and type of industry. These results can have a bearing on the formulation of ‘Make in India’ program that aims to boost the employment generation potential of the manufacturing industries. The results also highlight the crucial role of infrastructure in boosting the employment and productivity growth.