The rise of rural manufacturing

There is growing evidence to suggest that the most conspicuous trend in the manufacturing sector in India has been a shift of manufacturing activity and employment from bigger cities to smaller towns and rural areas. This ‘urban-rural manufacturing shift’ has often been interpreted as a mixed bag, as it has its share of advantages that could transform the rural economy, as well as a set of constraints, which could hamper higher growth.

Given the size of the Indian economy and the need for balanced regional development, the dispersal of manufacturing activities is a welcome sign. However, the compulsions of global competition often extend beyond the considerations of low-wage production and depend on the virtues of ‘conducive ecosystems’ for firms to grow.

The movement of manufacturing away from urban locations was brought out by the Work Bank in a report a decade ago (Ghani, Ejaz et al (2012) “Is India’s Manufacturing Sector Moving Away from Cities? Policy Research Working Paper, World Bank). This study investigated the urbanisation of the Indian manufacturing sector by “combining enterprise data from formal and informal sectors and found that manufacturing plants in the formal sector are moving away from urban areas and into rural locations, while the informal sector is moving from rural to urban locations”. Their results suggested that higher urban-rural cost ratios caused this shift.

Recent data from the Annual Survey of Industries for 2019-20, shows that the rural segment is a significant contributor to the manufacturing sector’s output. While 42% of factories are in rural areas, 62% of fixed capital is in the rural side. This is the result of a steady stream of investments in rural locations over the last two decades. In terms of output and value addition, rural factories contributed to exactly half of the total sector. In terms of employment, it accounted for 44%, but had only a 41% share in the total wages of the sector.

Studies have documented several causes for the relatively steady rise and presence of rural manufacturing. Rural areas have generally been more attractive to manufacturing firms because wages, property, and land costs are all lower than in most metropolitan areas. Broadly there could be three explanations for this shift of manufacturing away from urban locations. First is the factory floorspace supply constraints. When locations get more urbanised and congested, the greater these space constraints are. However, the driving force behind such a shift is the continuing displacement of labour by machinery as a result of the continuous capital investments in new production technologies. In cities, factories just cannot be expanded as opposed to rural areas. Thus, increased capital intensity of production is one reason for this trend.

The second explanation hinges on the production cost differentials. Many firms experience substantially higher operating costs in cities than in rural areas, with inevitable consequences for the firm’s profitability and competitiveness.

The third is the possibility of capital restructuring — an approach advocated by radical and Marxist geographers. According to this view, there is a tendency for growing capital accumulation and centralisation by large multi-plant corporations. Big firms deliberately shift production from cities to take advantage of the availability of less skilled, less unionised and less costly rural labour.

The shift in manufacturing activities from urban to rural areas has helped maintain the importance of manufacturing as a source of livelihood diversification in rural India. In the aftermath of trade liberalisation, import competition intensified for many Indian manufacturers, forcing them to look for cheaper methods and locations of production. One way to cut costs was to move some operations from cities to smaller towns, where labour costs are cheaper. This trend helped to make up for the loss of employment in some traditional rural industries. The growth of rural manufacturing, by generating new jobs, thus provides an economic base for the transition out of agriculture.

Challenges ahead

The shift towards rural manufacturing faces two major challenges. First, though firms reap the benefits of lower costs via lower rents, the cost of capital seems to be higher for firms operating on the rural side. This is evident from the shares in rent and interest paid. The rural segment accounted for only 35% of the total rent paid, while it had 60% of the total interest payments. The benefits reaped from one source seem to be offset by the increased costs on the other front.

Second, there exists an issue of “skills shortage” in rural areas as manufacturing now needs higher skilled workers to compete in the highly technological global ‘new economy’. Manufacturers who depend only on low-wage workers simply cannot sustain their competitive edge for longer periods as this cost advantage vanishes over time. Manufacturers who need higher skilled labour find that rural areas cannot supply it in adequate quantities. This suggests the need for clear solutions to the problems of rural manufacturing and the most important is the provision of more education and skilling for rural workers. A more educated and skilled rural workforce will establish rural areas’ comparative advantage of low wages, higher reliability and productivity and hasten the process of the movement out of agriculture to higher-earning livelihoods.

A steady stream of investments in rural locations over the last two decades has ensured that 42% of factories and 62% of fixed capital is in the rural side