Could job creation be a driver of poverty reduction in India?

While the Indian economy continues to grow, there is a consensus that creating more jobs is vital to reduce poverty. Ejaz Ghani shares trends which suggest that job creation is being driven by cities and small and young firms, but entrepreneurial growth in India has slowed down due to inadequate infrastructure and distorted factor markets. He suggests that the path to job creation and poverty reduction is scaling up local investments in education and infrastructure, and not chasing large firms.

India is now the most populous country in the world, and more than a million new workers join the labour force every month – this is equivalent to the entire population of Sweden joining the labour force every year (Bloom et al. 2011, Ghani 2018). As this is likely to continue for the next two decades, the pace at which jobs are created will determine the pace of poverty reduction in the future.

While the great giants of economic history recognised the link between job creation and poverty reduction, uncertainties remain. Do young and small establishments or large and established firms contribute more to job creation? Does the manufacturing or services sector contribute more to poverty reduction? Why do some cities create more jobs and reduce poverty faster?

Multiple studies have examined the role of entrepreneurship in job creation in advanced economies, but there is very little empirical evidence for India. In our paper (Ghani et al. 2011a) we examined the link between entrepreneurship and jobs in some 600 districts in India, in both manufacturing and services.

The economic geography of entrepreneurship in India

Although India’s economic geography for entrepreneurship and job creation is still evolving, evidence shows that jobs are largely being created by new start-ups, and not large and old firms. Unfortunately, the number of new start-ups, and entrepreneurship rates continue to remain low in India, given its stage of development (Ghani et al. 2011b). While the number of new enterprises, which are less than three years old, has shown a slight upward trend over time (Desmet et al. 2011), this has not been strong enough to create the requisite million jobs every year. There is also huge heterogeneity in the spatial distribution of start-ups across districts and states.

So which regional and spatial traits encourage new start-ups and local entrepreneurship in India? One possible explanation is the differential returns to investments and entrepreneurship. Another is that new entrepreneurs respond to differences in local infrastructure, education, population density, trade connectivity, and even demographics, although they have limited explanatory power. This list is by no means exhaustive, but it parallels the list of popular explanations for the agglomeration of economic activity and growth of new start-ups.

We found that the two most consistent factors that predict new start-ups and entrepreneurship are local education levels and the quality of local physical infrastructure. This holds true for both manufacturing and services. Factor markets and household banking quality also play a role in slowing the pace of entrepreneurship and job creation in India. Unfortunately, factor markets are highly distorted in India – land and financial markets in particular are more distorted compared to labour markets (Duranton et al. 2016). Poor land allocation discourages start-ups, as does poor household banking environment, especially for new and small enterprises.

What can be done to break the poverty cycle?

Policy makers need to recognise the strong link between job creation and poverty reduction. It is worrying that there are too few entrepreneurs in India for its stage of development. If India continues to undertake some basic policy steps to support entrepreneurs – including reducing factor market distortions, developing both physical and human infrastructure, and promoting networking and agglomeration economies – it has the potential to unleash business creation, job growth and poverty reduction.

There are well-defined limits to the pace at which countries can accumulate physical capital and physical infrastructure, but the limitations on the speed with which human infrastructure and education can be scaled up, and the gap in knowledge can be closed, are less clear. Because of the strong link between education, start-ups, and jobs, policymakers should remove any constraints that restrict the growth in the quality and quantity of local colleges and educational institutions.

Instead of being preoccupied with firm chasing (that is, attracting large mature firms from other locations) policy makers should focus more on encouraging entrepreneurship in their communities – small is beautiful – ‘young and small’ should be emphasised in job creation. India’s experience has shown that a strong link between initial levels of young and small firms and subsequent job growth and poverty reduction.

Cities play an important role in ensuring entrepreneurial potential in India, and contributing to the creation of more jobs and reduction of poverty. This is because cities have the potential to generate the majority of new jobs, and could drive a four-fold increase in per capita incomes (Ghani et al. 2014). Having more competitive cities that are livable, have good infrastructure, invest widely in knowledge generation and capacity building, are well governed, support sound national urban policy frameworks, and work through strengthened public and private partnerships at local, national, and international levels would also attract entrepreneurs.

Entrepreneurship is also vital to economic growth. While India has historically had low entrepreneurship rates, the situation is improving and overcoming this weakness will be an important stepping-stone to faster economic and job growth. India’s economic geography is still adjusting from the conditions that existed pre-deregulation, and much greater variation exists in spatial outcomes than is present in countries like the United States. This underscores the importance of effective policy design for local areas to benefit from agglomeration and urban economies.