Decoding state growth: Stronger attributes, specialised cities

This paper is authored by Shishir Gupta, senior fellow and Rishita Sachdeva, associate fellow, economic growth and development, CSEP, New Delhi.

India today is a transformed country, with businesses free to establish and expand, having almost unencumbered access to foreign investments, and operating in a largely competitive export/import environment compared to the early 1990s. This transformation is the result of economic reforms initiated in 1991 by the Government of India (GoI) and carried forward over time. Consequently, the real per capita Gross Domestic Product (GDP) has almost quadrupled from $561 in 1994 to nearly US$1,944 by 2020. Prime Minister Modi has now set out an ambitious plan for the future—India becoming a developed country by 2047, when it celebrates 100 years of Independence. In income terms, this translates into real per capita GDP growth of around 7.3% from 2024 to 2047, significantly higher than the 4.9% per capita growth achieved between 1994 and 2020.

GDP (Shutterstock)

The growth target is not only more aspirational but also set against a backdrop of a fragmented and increasingly complex global environment, coupled with the fact that the next phase of reforms required to meet the target will have to be led by India’s myriad states. The next generation of reforms will require a continuous build-out of human and physical infrastructure while adhering to fiscal discipline. Additionally, governments need to initiate the process of reforming factor markets such as land and labour earnestly. The finance minister, in her financial year (FY) 2025 Union Budget speech, emphasised, “The government will establish a comprehensive Economic Policy Framework to guide the nation’s development, focusing on increasing productivity and market efficiency. The framework will address all factors of production, including land, labour, capital, and entrepreneurship, with technology playing a critical role in improving total factor productivity and reducing inequality.” (Ministry of Finance, Government of India, 2024). The majority of these factors of production fall under the responsibilities of the state governments in India. This notion was emphasised by Prime Minister Modi when he “urged state governments to establish clear policies to attract investors” in his Independence Day speech of 2024. He emphasised that State governments play a key role and that reforms cannot be implemented solely by the Central government since implementation is done at a State level (Modi, 2024).

States of India rival mid-to-large-sized nations, especially in terms of GDP and population and wield considerable autonomy under the Constitution. This autonomy has played a key role in their diverse evolution over time, resulting in heterogeneity in crucial socio-economic attributes such as per capita GDP, the share of manufacturing, educational attainment, and life expectancy. For example, India’s manufacturing share of GDP has remained between 15 and 17% over the last couple of decades (MoSPI, 2024), whereas some states, such as Uttarakhand, Gujarat, and Himachal Pradesh (HP), already have more than 30% of their GDP derived from manufacturing. This is higher than any major country globally, including China. Furthermore, the wealthier states, such as Gujarat and Haryana, have a per capita income of approximately $4,000 as of 2023 and are on the verge of entering the upper middle-income band. In contrast, states like Bihar and Uttar Pradesh (UP), with a per capita income of around $1,000, are at the lower end of the middle-income category. In addition to higher per capita income, these wealthier states have also generally managed to grow their per capita GDP by more than 5.5% annually over the last couple of decades, almost 1.5- 2 times that of slower-growing states.

States are categorised as Fast, Average, and Slow, based on their per capita growth between 1994 and 2020. Eight states are classified as fast-growing, and six each as average- and slow growing states. Achieving developed country status by 2047 necessitates slower-growing states learning from faster-growing ones, and the latter from global peers, such as provinces in China. Two fundamental axes define state growth: (a) state-level growth attributes or determinants, including physical infrastructure—road density, transmission and distribution losses (T&D), Pradhan Mantri Gram Sadak Yojana (PMGSY) habitat coverage, and land affordability; social infrastructure—gross enrolment ratio in tertiary education and stunting ratio; and the quality of governance— violent crime rate, fiscal deficit to GDP ratio, and flexibility in labour markets; and (b) performance of key economic centres (KECs)—districts comprising million-plus urban agglomerations (UAs) and capital cities, plus districts that have increased their share in state GDP by more than 5%.

Strong growth attributes enhance the business environment and productivity, thereby driving investment and growth. A state is said to perform better on a growth-inducing attribute if its long-term average score is at or above state average levels. The correlation between the state per capita GDP growth rate (1994–2020) and the count of attributes on which a state performs better during this period is 0.69. While the relationship is robust, careful observation reveals some gaps. For instance, although both Gujarat and Tamil Nadu score similarly regarding these growth attributes, their long-term growth performance differs significantly. Gujarat’s real per capita GDP grew at 6.7% per annum compared to 5.9% for Tamil Nadu. Conversely, while both Maharashtra and Punjab have attributes similar to fast-growing states, their economic growth was insufficient to be classified as fast-growing. A significant explanation for this gap is the role of KECs in state growth. The fundamental difference between Gujarat and Tamil Nadu is the performance of their KECs, with the former growing at 10 per cent per annum compared to 7.7 per cent for the latter. Similarly, although Maharashtra and Punjab have attributes akin to fast-growing states, they did not grow fast enough because their KECs did not outperform sufficiently. The correlation between per capita state growth and KEC growth is 0.58. KECs are hubs of economic activity and typically grow faster than their respective states. One key reason for their outperformance is their specialisation in particular sectors (defined as a disproportionate share of any sector(s) in a KEC’s GDP, relative to the national share). This specialisation leads to an agglomeration effect, which boosts their growth and creates a virtuous cycle. The fastest-growing states, such as Gujarat, Uttarakhand, and Karnataka, have KECs that are growing significantly faster than the rest of the states. Across the 18 states for which we have district-level data, there are 58 KECs comprising 77 districts (in some cases, a UA comprises multiple districts). The GDP share of KECs in India’s GDP was about 29% in 2000, which increased to 34% by 2020, reflecting their faster growth trajectory compared to the overall state growth.

Performance of states on the two fundamental growth axes

A few key messages emerge from the analysis of state growth along two fundamental axes.

There are no shortcuts to fast growth in the long-term. Strong growth attributes and the performance of KECs are both critical for accelerated state growth. States that grow fast tend to be strong in both aspects, whereas slow-growing states are generally weak in these areas. We find no evidence of fast-growing states being strong only on a few growth attributes or islands of growth transforming a state into the fast-growing category in an environment of weak attributes.

Strong attributes help develop and deepen growth-enhancing KECs; the two usually complement each other. The group of states that meet both criteria—Gujarat, Andhra Pradesh (AP) (including Telangana), Uttarakhand, Karnataka, and HP—perform the best, with an average per capita GDP growth of around 6 per cent between 1994 and 2020. Conversely, states that are weak on both axes have typically grown significantly slower. When a state improves its performance of a growth attribute from below average to average or above average, its long-term per capita real GDP growth increases by 0.3%, ceteris paribus. Additionally, for a 10% increase in KEC GDP growth rate, the long-term per capita annual GDP CAGR increases by 0.2% (based on ordinary least squares regression, the regression provides a directional estimate of the potential magnitude of growth if a state enhances its attributes and/or KECs).

States have a pivotal role in improving both growth axes, as most of the growth attributes and KECs fall squarely within the remit of state governments.

· Of the nine identified growth attributes, six are in the State List—crime, fiscal deficit, health care, transmission and distribution (T&D) losses, labour reforms, and land policies—and hence, states have complete control over them. The responsibility, thus, lies with state governments to improve these growth determinants. For example, stunting is 22% in Kerala and 46% in Madhya Pradesh (MP), and while the former spends 8% of its budget on healthcare, the latter spends close to 6% (National Health System Resource Centre, 2020). The same applies to housing affordability; Gujarat is more than twice as affordable as Maharashtra, as reflected in the land pooling practice of acquiring land in Gujarat (Mahadevia, Pai, & Mahendra, 2018), which has kept prices in check compared to Maharashtra, which has some of the costliest real estate in the world.

· KECs are large urban centres generally governed by urban local bodies (ULBs). A better-managed urban centre enhances the productivity of its businesses, thereby fostering growth. Since ULBs are accountable to State governments, the latter assume primacy again. There has not been sufficient devolution of finances and functions from state governments to local governments as enshrined in the 73rd and 74th Constitutional Amendments, and this remains a significant reform agenda. Municipal revenue as a percentage of GDP has remained constant at 1% since 2007–2008, much lower than other developing nations such as Brazil and South Africa, whose ratios stood at 7.4% and 6%, respectively (Ahluwalia et al., 2019). Furthermore, the average tenure of a municipal commissioner is 10 months, leaving them with no incentive or ability to make a meaningful difference to their functioning (Annual Survey of India’s City System (ASIC), 2017).

Specialisation is key for faster KEC growth and occurs for three primary reasons: the concentration of factors of production, incentive-driven investment, and natural endowments. One key reason KECs grow faster than their respective states is sector specialisation, which yields economies of agglomeration. The top 20 fastest-growing KECs account for 50% of all instances of specialisation. Specialisation occurs when businesses within a particular sector find it optimal to invest in a specific location, transforming it into a significant hub for that economic activity. Bangalore emerged as a computer services hub due to Karnataka’s inherent strength in having a pool of trained labour. The auto hub in Uttarakhand and the pharmaceutical industry in HP developed as a result of the special package scheme announced by the Central government in 2003, which aimed to industrialise these states by offering significant tax benefits to industries establishing operations there. KECs specialising in mining are, by definition, driven by natural endowments. It is noteworthy that natural endowments and Central government incentive packages fall outside the jurisdiction of state governments. In other words, specialisation in a KEC occurs, more often than not, organically because of the above-mentioned reasons, rather than being orchestrated. This is because all parts of the ecosystem must align in a way that companies find it optimal to agglomerate in a particular KEC, around a set of anchor industries. Achieving this through planning and design is extremely challenging, especially in a federal and democratic country like India, where there is constant competition among state governments to attract more private investment and free movement of people. State governments should focus on strong determinants and well-managed urban centres to help develop and deepen specialisation in their KECs.

There is a strong association between capital-intensive specialisation and growth, while there is a weaker association with labour-intensive specialisation. KECs specialising in capital-intensive manufacturing have typically experienced the fastest growth. In contrast, KECs with specialisation in labour-intensive manufacturing do not exhibit the same pace of economic growth. The most recognisable KECs specialising in labour-intensive industries, such as Ludhiana (textile) in Punjab, Coimbatore (textile) in Tamil Nadu, and Agra (leather) in UP, do not achieve double- digit growth. Conversely, capital-intensive centres such as Udham Singh Nagar and Haridwar (automobile) in Uttarakhand, Solan (chemicals and machinery) in HP, and Jamnagar (petroleum) in Gujarat all experienced double-digit growth between 2000 and 2020. These observations from KEC-level specialisation and growth are consistent with the well-known narrative that labour-intensive industries have not performed well in India over the past few decades, as India is losing its comparative advantage in these products. The Revealed Comparative Advantage (RCA) of the textile industry declined from 4.62 to 2.79 between 2000 and 2018 (Ahmed, 2022). This is reflected in the textile industry’s share decreasing from 2.2% to 1.9% between 2000 and 2020, compared to an increase in the transport equipment industry’s share from 1.3% to 1.7% in India’s Gross Value Added (GVA) (Capital, Labour, Energy, Materials, and Services [KLEMS], 2020) during the same period. The lacklustre performance of labour-intensive manufacturing poses a constraint for States specialising in it to grow faster. This remains a big policy puzzle that needs resolution at the highest level.

KECs are relatively well distributed; pursuing a more distributed model may imply slower growth. Governments in India have consistently aimed to maximise growth while addressing regional inequity. The current government also seeks to achieve “balanced regional development across all districts” (Government of India, 2022). Since KECs are present in all states, compared to some other countries like China where its growth hubs are concentrated in the east, India is relatively better off. If we pursue the strategy of a significantly more distributed model, it may imply slower growth since it runs the risk of diluting the agglomeration benefits by spreading resources thin. Therefore, state governments should focus on continuously improving growth attributes and nurturing specialisation where it exists or begins to develop, rather than force-fitting niche products or services in a geographically disaggregated manner in the hope that these niches become the growth axis for those districts, leading to faster and more balanced growth. The government should prioritise improving existing Centres and nurturing them rather than creating new greenfield cities, as they can take a long time to yield results. For example, Gurgaon took 20 years to become the central business district of North India, despite having favourable conditions such as proximity to the airport, adjacency to Delhi, and availability of land. Resources such as capital and labour should migrate to areas that are, and emerge as, growth engines, driving faster growth. This fundamental trade-off needs to be internalised by everyone, from policymakers to the general public, to ensure informed decision-making.

States must determine their growth strategy based on their position on these two fundamental axes. Focusing only on state attributes may miss the binding constraint regarding KECs, while singularly focusing on KECs is not desirable since we find little evidence of isolated pockets of growth working strongly enough in an environment of weak fundamentals. There is, thus, no one size-fits-all strategy that will work for all states, given the heterogeneity in terms of growth attributes and the performance of KECs. State growth strategies should be a function of performance on growth attributes and KEC growth. In an ideal world, each state should focus on improving its attributes and KECs’ growth. However, since in reality there is a resource constraint, it is helpful to know which priority is likely to yield better outcomes. For example, if a state is lacking in both axes, it should first focus on improving growth attributes; it is the non-KEC parts that are dragging growth for such states. Improving them will enhance growth in general and also help KECs perform better. Alternatively, if a state is strong on both axes, it should focus on unlocking the growth potential of its KECs by making them globally competitive while continuing to improve its attributes. Such states have demonstrated that they can excel in both dimensions, and they should continue their good work. Even our best-performing KECs pale in comparison to their Chinese counterparts, whose growth centres like Shanghai and Beijing grew more than 10 per cent annually for four decades, compared to our best-performing KECs growing between 7 and 10% for nearly 20 years. Consequently, Shanghai and Beijing today have a GDP exceeding $500 billion compared to our biggest KEC, Mumbai, at around $150 billion.

The paper can be accessed here. 

This paper is authored by Shishir Gupta, senior fellow and Rishita Sachdeva, associate fellow, economic growth and development, CSEP, New Delhi.