How focusing on startups can spur development in Tier II and III cities

India has about 65% plus population under the age of thirty-five. The demographic dividend which is expected to persist till the mid-2050s, will be an engine for economic growth if decent job opportunities are shaped up in all parts of India and not just the large cities.  

Till 1990 India’s economic development centered around on three type of cities: port cities such as Mumbai, Kolkata, or Chennai, political capitals such as Delhi, Hyderabad and cities where large, planned capital investments were made by Industrial giants such as Jamnagar, Jamshedpur, and Bhilai.

Post 1990s as the share of services industries in GDP rose, many cities developed because of the technology clusters such as Bengaluru, Pune, and Gurugram. Manufacturing investments too centered around areas where there was a proximity to a seaport or large airport. This was because of the fact that the trade and supply chains in any industry became extremely globalised and hence connectivity aspect was quite important.

This nature of evolution of trade meant that no large city-based economic clusters such as Jamshedpur or Bhilai emerged in the hinterlands of India post-1990. And many such city economies declined or at best they survived at the same level.

A classic case in this regard is the city of Ludhiana in Punjab, which was once the epicenter of cycle manufacturing. But as trade was difficult in a place that was not a seaport and did not have a large airport in the proximity, the city's industrial economy remained stagnant or could not experience the boom associated with other parts of India. 

As various state governments grapple with economic growth for regions beyond these existing clusters, a set of harsh realities are slowly sinking in. While there is a resurgence in manufacturing because of the China plus one strategy of global firms, there are not many companies like Tatas that would holistically focus on the economic development of Tier-II or Tier-III cities.

Manufacturing has become extremely mechanised such that the skill level (and hence compensation) of workers in many manufacturing clusters are very low. The mobile phone factories that have emerged across India typically employ factory workers who are 10th or 12th pass with not-so-high salaries. While this employment is important for a country like India, the spillover benefits happen in a city only when there is a strong consumption-led growth.

A key ingredient of economic growth is the presence of a domestic population with strong spending power. This either needs a set of anchor industries or several smaller startups or innovation-centric firms.

One after-effect of COVID-19 has been that there is a general acceptance in the technology industry that work could happen from anywhere. Companies are OK with people being in different-places and convening physically once in a while. Today, a number of startups and larger firms across India operate in that way. As long as there’s talent, connectivity and ecosystem support, startups can emerge from Tier-II or Tier-III city locations.

A case in point is the economic development happening in Thenkasi in Tamil Nadu, which is the base of Zoho. Due the high earning captive employee base, the associated segments such as retail, real estate, hospitals etc. are witnessing growth.

Wayanad in Kerala, which made its name over the last 20-30 years as a tourist center now has a fledgling startup ecosystem with firms such as Vonnue. Fintech platform Razorpay was first started in Jaipur. Though it has moved its base to Bengaluru, the local innovation in the Jaipur ecosystem gained a strong fillip due to it and multiple firms are emerging in the city.

The long-term return for such innovation ecosystem development investment is massive. Beyond the first level of indirect benefit of boosting consumption, success breeds more success. Early-stage employees of a successful startup often launch new startups themselves. Cities such as Pune have seen evolution of multiple other startups from an initial set of successful startups such as MindTickle, FirstCry, Elastic Run and Rebel Foods.

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While India had a three-level government structure (central, state, local self governments) for quite some time, barring a few powerful corporations such as Mumbai, Bengaluru etc., very few local self-governments had the sufficient resources to fund for economic growth. It is common in US for city corporations to lobby for companies to move in. They have more say in economic growth strategies. That situation is slowly coming to India as well with active participation from trade bodies.

Trade bodies such as the Malabar Chamber of Commerce have been at the forefront to market and develop the innovation ecosystem in Kozhikode area in Kerala. This region today has multinationals such as Tata Elxsi as well as niche ed-tech startups such was Interval, whose efforts were recently appreciated by the finance minister.

Innovation eco-system development initiatives are local. You need a trifecta of established companies, startups and the academic world to work together. Wherever necessary, Governments need to step in. For e.g., if a certain skillset is forecasted to be in demand to build a nascent industry cluster, it is essential for governments to step in and ensure that the required skills pipeline is built in the local ecosystem.

Similarly, if a nascent cluster of an innovative industry segment exists, it is the responsibility of Government to develop that cluster of innovation by appropriate market connects. If a venture capital ecosystem does not exist and startups have to move to other cities, the governments can step in and create that VC ecosystem by strategic investments.

There is a general misconception that innovation-based ecosystems are always technology industry based. That is not true. While technology is a great enabler, fundamental innovations can happen in any sector. For e.g., the port city of Cochin and surrounding areas had multiple MSME’s specialising in marine, spices and food processing.

A cluster of innovative firms such as Zaara Biotech – which specialise in algae-based food products have emerged in that cluster recently with the support of Kerala Startup Mission. As a testament to the city’s potential on food processing, Norway’s Orkla foods has recently bought out a majority stake in Eastern condiments. The fast-emerging innovative food and spices-based ecosystem in Cochin as well would have certainly attracted the Norwegian firm.

Traditionally when state governments plan economic growth, strategies have been focused on large infrastructure investments, industrial parks or getting some large industrial firm to set its base at best. These have large externalities. Most state governments are in a tight spot fiscally. And to get large firms, it is not just game of infrastructure, but also of subsidies and geopolitics.

These may not work for every state. Instead of that, states can focus on emerging tangents of innovation in different regions and make focused efforts to develop it. Such innovation ecosystem efforts along with strong governance mechanisms focused on ease of living and overall quality of life can attract talent and firms into such Tier-II or Tier-III cities.

Internationally, Catalonia region in Spain – other than the city of Barcelona - has a number of semi-urban or rural areas which has seen strong economic growth because of the innovation centric economic policies adopted by regional Governments. These include a set of initiatives such as developing the industry – academia collaboration, giving pilot projects to startups, developing circular economy initiatives, developing market connect for local firms etc.

The local governments in the region has been quite good at exploring synergies between local competencies, national government policies to get government grants and support for various projects. These initiatives are low-cost initiatives unlike large infrastructure development initiatives. These are focused work streams to develop the market and the region’s brand.

One cannot discount infrastructure investments, but the underlying point from these examples is that there exists a path for economic development by cultivating an innovation ecosystem through focused efforts.

Essentially, in this world of AI and technology impacting multiple sectors, the approach to economic development needs to be local. Governments need to keep an eye on what kind of innovation vectors are emerging in different regions and need to develop those into competitive advantages through strategic investments and ecosystem initiatives. The associated emergence of high-earning and high-spending professionals will give a strong boost to the local economy in the medium to long term.          

Prasad Unnikrishnan, Partner, Grant Thornton Bharat & Ajith Prasad Balakrishnan, Director

Grant Thornton Bharat