The impact of unbalanced productivity advance on Indian urbanization : some preliminary findings

DISCUSSIOQN PAPER Report No.: UDD-53 THE IMPACT OF UNBALANCED PRODUCTIVITY ADVANCE ON INDIAN URBANIZATION: SOME PRELIMINARY FINDINGS by Charles M. Becker Edwin S. Mills Jeffrey G. W-illiamson April 1984 Water Supply and Urban Development Departmnent Operations Policy Staff The World Bank the World Bank does not accept responsibility for the views expressed herein which are those of the authiors anid should not be attributed to the .World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designations employed, the presentation of material, and any maps used in this document aze solely for *the convenience of the reader and,do not imply the expressidn of any opiniion whatsoever on the part of the World Bank or its affiliates co-icerning the legal status of any country, territory, city, area, or its authorities, or concerning the delimitation of its boundaries, or national affiliation.  Research Prorect No.: 672-64 Analysis of Indian Urbanization  ABSTRACT This paper investigates the impact of changes in sectoral productivity on output and employment patterns in a simulation model of the Indian economy. Productivity gains in major urban sectors are found to have fairly strong urban growth effects both in the short and long run. Rural productivity advances initially stem urban growth, but have little long run effect. Sv.  TABLE OF CONTENTS INTRODUCTION STATIC AND DYNAMIC EFFECTS OF A ONE TIME PRODUCTIVITY SHOCK CONCLUDING REMARKS REFERENCES8  THE IMPACT OF UNBALANCED PRODUCTIVITY ADVANCE ON INDIAN URB.NIZATION: SOM PRELIMINARY FIN.DINGS Charles H. Becker* Edwin S. Mills*** Jeffrey G. Williamson** *Assistant Professor of Economics Vanderbilt University, Nasnville,TN,. 37235 **Professor of Economics, Har-vard University, Cambridge. NA. 02138 ***Professor of Economics, Princeton University, Princeton, N.J. 08544 ABSTRACT This paper investigates the impact of changes in sectoral productivity on output and employ- ment patterns in a simulation model of the Indian economy. Productivity gains in major urban sectors are found to have fairly strong urban growth effects both in the short and long run. Rural productivity advances initially stem urban growth, but have little long run effect. INTRODUCTION India's development trends differ in many critical respects from stylized growth patterns. Its urban population has grown at the moderate annual rate of 3.8%, Just less than twice the national population growth rate. Yet this persistent urbanization has not been a&companied by large structural shifts in employment and output composition. Furthermore, incremental capital/output ratios have experienced alarming growth, especially in, predominantly urban sectors. The unusual circumstances of India's growth indicate that a thorough analysis of Indian eco- comic growth and it.srelation to urbanization would be valuable. In order to provide such a Study, we have constructed a m=ti-sector model of Indian rural-urban migration, city growth and economic development (Becker, Mills and Williamson (2], hereafter "BMW"). Since many of th, critical forces of relevance to the city growth issue cannot be captured adequately by a single analytical model, we have designed a more complex model that is solved by numerical techniques. The model willx.serve eventually to forecast future urban growth under varying assumptions regarding exogenous variables' values. Counterfactual simulations can also be used to assess the contributions. to recent urban growth of productivity changes, world market conditions, capital accumulation, skilled labor formation, demand shifts and changes in fis- cal policy. This latter exercise requires us to derive a comprehensive understanding of the impacts of these forces, both in the short run and over time. This paper begins the analysis of the sources of Indian urbanization and output growth by ex- amining the impacts of sector-specific, disembodied technological change. Since sectoral factor productivity growth rates do appear to vary in India, it is important to determine the effects on urbanization of such differences. After presenting a brief description of the model, we report results from counterfactual simulations of the Indian economy for the 11 year period 1960-1970 that predict how the Indian economy would have responded at that time to chaages in productivity parametars from their estimated values. THE BMW MODEL OF INDIAN URBANIZATION BMW offers a dynamic general equilibrium simulation model of the Indian economy. It is oriented in particular to analyzing variables likely to influence urbanization that have been omitted in previous models. The framework is predominantly neoclassical, but migrants' mov- ing costs are recognized, as are segmented capital markets. A major difference between BMW and other computable general equilibrium ("CGE") models of LDCs involves the role of governmnt in a poor, mixed enterprise economy. In BMW, government has the option of consuming goods and services, providing transfers to households, delivering public services to households and industries, or investing in government enterprises. Most CGE models minimize government's role by assuming similar public and private investment behavior, and by ignoring differences in public and private enterprises. BMW explicitly con- fronts the effectx of non-competitive government investment allocation, and incorporates government relationships with public enterprises in its fiscal system. BMW also recognize. the critical role of public services as intermediate inputs, and thus provides a direct role  f or government in th.e producrioh' --oce~s * There pU.iai services the major compon- ents of infrastructure: rcad3, -7i'o ,e tran.sct.. 'anr, *ar,.r, and healt. servic2s. We creat these as private intermedicate products uzsec in the pro duot4on of final goods, and assuime that their provis`on is biased towards rl:rn induscrios and t eal:. household:i. BMWl's characterization of India 3'could oe cons.stent with major private seccor institucions as well. These characterist4cs include high'y fragmented capital markets and a p?rtially segmented labor market. Earr.ings differ bt skill classes in BMW, and since laborers of different skills are not close substitutes, akilled and unskilled labor markets are quite distinct. Yet unskilled and sklfled labor both are present in the traditional and rural as vell as the modern and urban sector3. Models :E-zen omiz cFnsidiration of skilled labor out- side the modern urban sectors. bUt a modei designed tr^ analyre Indian rural-urban migration cannot justifiably ignore the presence of a substa;.t-al body of educated, skilled labor in rural India. Indeed, our results find that the proportion of skilled workers in migrant streams tends to be higher than their share of the national labor'force. Flnally, neither profit nor rental income accrues exclusively to one class, as many modela assume. The model distinguishes between tradeable and non-tradeable goods, and consumption of some services and housing is therefore location-specfic. This specificity, along with different consumption' patterns and the presence of location-specific taxes, generates differences in urban and rural households' living costs. Two goods are internationally tradeable:nanu- factures and agricultural products. India is a producer,consumer, importer and exporter of both goods. Following Armington li), we assum.e ext'ort den.and functions with finite price elasticlties, and also assume that imported g,'ods are imperfect substitutes for do-mestically produced goods of the same type. In view of our desire to understand Indian growth while minimizing co#plexity, BMW includes ten sectors and four productive factors. The model includes agricultural and urban manu- facturing, which together absorb most of the labor force. As with the Kelley-Williamson i4,5) CGE model of a "representative developing countrv", EMN contains rural and urban "informal" service sectors as well as a skill- and caDital-intensive service sector that produces largely public administration.1 Again foll'owinf! Kelley-'illiamson, there are three housing sectorn--rural housing, urban "informal" housing of low quality, and urban "formal" housing of higher quality. Finally7, the irndel distinguishes separately u;ban public services (power, other utilities, some transport) ann rural public servizes (largely public irrigation and rural public adm.inistration). Although these public service sectors are not large employers in India, they do utilize large portions of the nation's capital stock and provide essential intermediate goods to other sectors. The four factors in BMW are capital, skilled labor, unskilled labor, and land. Numerical solutions to the BMW program require the derivation of a set of consistent para- meter values. Insofar as is possible, these values are based on available econometric results. For values not thereby restricted, we compel the model to exactly replicate obsery- edd1 national accounts and other data for a "benchmark equilibrium" year, chosen to be 1960. That is, we choose unknown parameter aad exogenous variable values to force the model's solu- tion to provide estimates of endogenous variable values identical to t;ose actually observed for 1960. Once base year exogenous variablea are known, they can be systematically 'revised for succeeding time peric-.s, 'Fo' example, 1961 camital stocks equal 1960 capital stocks plus endogenously determined 1960 net in-:estment levels. A small set of technological change parameters are not restricted by the static data con- sistency requirement. These parameters are derived bt assuming that India experienced an "equilibrium 'growth era" during the 1960s. Given static parameter values and initial exogenous variable values along with hi-torL:zl ser!qs for exogenous variables such as world prices, BMW is solved for ics endogenous variable vilues in the absence of any technological progress. We then compare actual and simulared vjaIues -f key endogenous variables and cal- culate residual productivity -ai.nr i;~ot Pxp'a nec by capital accuu=Lation and labor force skill acquisition. Once we hnve dcriv:: dynamic parameter values by an iterative process from our equilibrium growth era restrictions, th.. model can be run; forward, with its per- formance judged by its ability to rerli.-ate output an,' emplovr.:ent patterns from the 1970s and carlv 1980s. The dy-namic parameters are now in the process of being derit e.. Those values used in the sim- ulations reported here were derive- unt, r the x' mmlifying assump: ion that all productivity changes occurred as Hicks-neutral factor-disoarb,di2ad multiplicative shifts in the sectoral production functions. These parameter. ar;- jaliminary, as the Hicks-neutrality restriction enables the model to successfully track rectcral cutput - ths, but generates greater urban However, BMW's RS sector includes a large rural marnufacturing component in addition to rural private services. -9 -  employ-ent creation than that actuallv recorded. This r ndm- 'ndicates that a labor-saving bias has been present in urban manufacturitfg (anid pop6ibly i- orher jrzbJt sectors' techno- logical change). Given the rapid growth of registered manufacturing relative to unregistered manuracturing, the presence of s.cah a bias at an aggregate level is hardly surprising. The dynamic para=eter values employed here provide good measures of overall sectoral pro- ductivity advance (though urban technological progress may be slightly understated and rural gains overstated: see [ 3]) liowever, presence o' labor-saving bias in some urban sectors, along with needed demographic data refinements, force these figures to be preliminary. The productivity parameters chosen also differ eor the periods 1960-1964 and 1965-1970, reflect- *ing the latter periods' dramatic decline in the urban manufacturing and in public service sectorts growth. Simulations beyond 1970 will assume that long term producitivity growth is an average of the extremely successful early 1960s and unsuccessful late 19603.2 STATIC AND DYNAMIC EFFECTS OF A ONE TIME PRODU'CTIVITY SHOCK. Table 1 reports elasticity values for k,ely urbanizatior and macroeconomic variables with re- spect to productivity parameter changes. Each counterfactual simulation involves a sector- specific,.Ricks-neutral technological improvement. Specifically, the simulations increase the ith sector production function'smultiplicative constant term Ai for the entire period 1960-1970. The impact of this technology shock involves immediate reactions in labor, pro- duct, and foreign trade markets. Investment behavior responds as well, but stock adjustments occur with a one year gestation lag. Cost of living differential changes are a8so assumed to have a lagged effect on migration decisions, The figures presented in Table 1 reflect full general equilibrium influences, and will differ from the partial equilibrium multipliers commonly used, but the impact of the disembodied technological progress on output and relative price of the affected sector's good depends critically on this general price elasticity of demand. If output demand is relatively price elastic, then productivity growth will be reflected in large output supply responses in the affected sector. If output demand elasticities are low, then cost-reducing innovations will be passed on to users via falling prices. Resources will flow to the affected sector if the full general equilibrium rise in output is proportionately greater than the productivity gain itself. If demand elasticities for urban goods are high and urban sectors experience relatively large total factor productivity ("tfp") growth, then final demand will shift toward urban goods. GNP will become dominated increasingly by urban sectors, new urban em- ployment opportunities will appear, and city growth will take place. It will also take place if productivity advances in rural sectors occur, but are met instead by low price and income demand elasticities; In Table l,disembodied 1mprovements in all "modern" urbaii industries are met with sufficient- ly buoyant short run demand elasticities that the own sector equilibrium supply response elasticity exceeds unity. Since the output growth rate for urban manufacturing (N), public service (PSU) and modern services (KS) exceeds tfp growth, input use must grow. With capital fixed initially,labor use therefore increases. As in the Kelley-Williamson (KW) small, open economy,l% A. growth generates a strong supply response: 74.000 workers migrate to cities, of whom 29',000 find M sector employment. But the price of M sector value added also declines.0.89% in the partially closed Indian economy, resulting in a smaller urbanization impact than if the economy were fully open.3 Short run output, own sector employment and total urbanization effects are even greater in the case of KS tfp growth, although KS gross output is 45% smaller than M's. Moreover, the literature known as economic base theory tends to describe service sector output growth as responding to growth in manufacturing (see Mills and Becker 16 3, Ch, 6). A major reason for the greater KS urbanization elasticity is that M is capital intensive relative to KS, so that its short run supply curve will be steeper. KS also faces a highly elastic demand curve: government tax reveiiue rises by 0.16%, most of which is automatically spent on pur- chasing KS goods, In addition, an HKS housing investment spiral takes place. As KS value added price falls proportionately less than the technology gain, factor marginal value pro- duct schedules increase; labor then migrates to urban areas. In particular, a high skilled labor growth elasticity (0.49) is recorded in response to skilled labor intensive KS's tfp gain, driving up the demand for high quality urban housing (HKS), encouraging investment in 2Total non-houising productivity advance declined from 1.15% in 1960 to -0.3% in 1968. The productivity parameters calculated for the 1960s can also be compared with other residuals estimated in growth accounting exercises. It is interesting to note that BMW does not find a strong "green revolution" spurt in agricultural productivity during the late 1960s once out- put levels have been corrected for variations in rainfall, labor quality and intermediate input use. 3Relative price elasticities reported are deflated by a domestic production based Laspeyres price inidex. -3-  T.ASLE 1. STATIC AND !' ! 2F!ACTS I L: '*-T' AD,'.'CE: C:. UNE3AT;A X .:M .- -LA>T:0 *t; IN t:TA )t-f.t,45-L ; (The counterfactual sinbu.-aticncc::c-~.: ,produc;'-it.,Lv advance in sect.r i involves a 1% increase in Lt. :