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The IT/ITES Sector and Economic Policy at the Sub-national Level in India

Information Technology and Information Technology Enabled Services firms in India are exploring greenfield sites in the country to mitigate rising wages, high staff turnover, and crumbling infrastructure in the established industrial clusters. This has opened a window of opportunity for secondary urban centres or second-tier cities. Eager to capitalise on the benefits that the IT/ITES sector can bring, sub-national governments are moving to position themselves to attract this investment. This article argues that effective policymaking must be based on an understanding of the locational drivers of the IT/ITES sector, the specific needs of different industry "clusters", as well as the policy options open to sub-national governments.

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The IT/ITES Sector and Economic Policy at the Sub-national Level in India

Francis Hutchinson, P Vigneswara Ilavarasan

Information Technology and Information Technology Enabled Services firms in India are exploring greenfield sites in the country to mitigate rising wages, high staff turnover, and crumbling infrastructure in the established industrial clusters. This has opened a window of opportunity for secondary urban centres or second-tier cities. Eager to capitalise on the benefits that the IT/ITES sector can bring, sub-national governments are moving to position themselves to attract this investment. This article argues that effective policymaking must be based on an understanding of the locational drivers of the IT/ITES sector, the specific needs of different industry “clusters”, as well as the policy options open to sub-national governments.

Francis Hutchinson (f.e.hutchinson@gmail.com) is an independent consultant on economic governance and is based in Singapore. P Vigneswara Ilavarasan (vignesh@hss.iitd.ac.in) is with the Department of Humanities and Social Sciences, IIT, Delhi.

W
hile Bangalore, New Delhi, and Hyderabad have e stablished themselves as international centres for the Information Technology and Information Technology Enabled Services (IT/ITES) sector, these cities are now no longer the default option for investors. Faced with rising real estate costs, crumbling infrastructure, and intense competition for skilled labour in major centres, IT/ITES firms are looking at s maller and hitherto untapped cities as sites for new operations.

Conscious of the benefits that hosting a vibrant, skill-intensive, and well-remunerated industry like the IT/ITES can bring, state and city governments across India are seeking to seize the m oment. Competition between states is fierce, as those that have yet to host these new industries are eager to join the club and those with established IT/ITES clusters are keen to spread the benefits of growth to other parts of their territories.

That said, the IT/ITES sector is rapidly changing, demanding, and often a ruthless customer – requiring constant efforts by g overnment and supporting industries to satisfy it. Needless to say, the virtual nature of these industries means they are m obile and liable to migrate to new areas in search of untapped capabilities or lower costs, requiring policymakers to strive to not just attract investment but also retain it.

In this context, the challenge for policymakers is to make their economies “sticky” – that is to offer locationally-rooted capabilities and attributes that are hard for competing regions to replicate. However, the nature and workings of IT/ITES firm clusters are not well known, and public administration literature has tended to ignore the importance and role of sub-national governments – which are arguably the best-placed to interact with firms and foster unique capabilities at the local level.

This article argues that in order for greenfield states and cities to successfully attract and retain IT/ITES firms, two things are necessary. First, the dynamics driving the geographic distribution of the industry and the attributes of different types of firm clusters must be fully understood. Second, policymakers in subnational governments need to be aware of the range and impact of policy options open to them.

To this end, this article is divided into five sections. The first looks at what is happening in the Indian IT/ITES sector, paying particular attention to structural changes in the industry and what they mean for its geographic distribution. The second looks at why this is happening by using an institutional economic geography approach to understand why industries establish themselves in a particular location, why they cluster, and why they move from one place to another. The third will discuss what can

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be done through analysing measures to foster locationally-rooted attributes that are available to policymakers at the sub-national level. The fourth section will set out potential trends in the s ector’s evolution. The fifth and final section will advance the a rticle’s main conclusions.

The Indian IT/ITES Sector

Undoubtedly, the growth of the Indian IT/ITES sector in dollar terms and as a share of the gross domestic product (GDP) has been impressive – jumping from $ 4.8 billion and 1.2 of GDP in the financial year (FY) of 1998 to $ 37.4 billion and 4.7 per cent of GDP in FY 2006. At present, some 1.3 million people are directly employed by the sector, with many more employed in supporting industries.

With regards to the sector’s breakdown, service exports constitute major part of the revenue, with 33.3 per cent in FY 2006. Within service exports, software products and engineering services accounted for 56 per cent, ITES/BPO for 27 per cent and IT services for 17 per cent. Export destinations are lopsided, predominantly oriented to the US (66.5 per cent) and UK (15.3 per cent). Among the industry segments, banking-related, high- technology, and telecom constituted 60 per cent of the exports [NASSCOM 2008].

The sector is largely driven by the larger firms and multinationals. For instance, in 2007-08, out of top 20 IT firms, 12 are multinationals, and among top 200 firms, 34 per cent are multinationals [Dataquest 2008]. The structure of the industry is p resented in Table 1.

Given the visible benefits the sector provides in terms of export revenues, rapid service sector growth, and employment generation, the Indian government has appropriated this sector as a tool for national development and is encouraging investment through higher expenditure on infrastructure, fiscal incentives, and tax exemptions [Department of Infor mation Technology 2008].

geographical distribution of the sector shows dominance of five clusters, namely: Bangalore; Chennai; Mumbai; Hyderabad; and Delhi [Singh 2004]. Earlier research [Kumar and Joseph 2005] notes that these “cities together account for 80.5 per cent of the top 600 companies” (p 97).

Existing clusters are not able to sustain the exploding growth with the limited infrastructure, rising labour and land costs. Nowhere is this more evident than in Bangalore, Karnataka’s erstwhile green and peaceful capital. Now, the city suffers from traffic congestion, power shortages and inadequate airport facilities [Rai 2005; Ribeiro 2005]; rising real estate prices [Business Standard 2008; Venkataraman 2008]; and high levels of poaching and staff turnover [Simhan 2004]. In order to overcome these problems, firms have started exploring second-tier cities as alternatives. This phenomenon harks back to the exodus of India’s nascent software industry from Mumbai to Bangalore, Chennai, New Delhi, and Hyderabad in the 1980s – cities that subsequently became the centres of software boom at Mumbai’s expense.

State governments are responding to this opportunity, as post1991 – India has entailed a new role for them. Liberalisation at the national level exposed the underlying regulatory structure at the state level, as state governments are charged with providing land, infrastructure, and monitoring environmental and labour standards. In addition to courting foreign investment from large multinationals, state governments are now negotiating loans and financing directly with international financial institutions such as the World Bank [ Rudolph and Rudolph 2001: 1542; Sinha 2004: 34]. In this context, some states are moving more proactively than others to implement reform, invest in infrastructure, and court foreign investment.

Thus, states that have yet to enjoy the benefits of these new industries are eager to attract investors, often offering additional incen-

The success of the Indian software s ector tives and individual attention1 [ Silicon India

Table 1: Distribution of Firms in Indian IT/ITES Industry

has led other developing countries to encour-Type of Firms Percentage of Market Share2008]. In addition, states such as Karnataka,

(Approximate)

age the development of their own industries Maharashtra, and Andra Pradesh that have

BPO IT & Engineering

[Carmel 2003; Heeks and Nicholson 2002]. Services e stablished industries are keen to decongest

However, this is not a foolproof recipe for Tier I firms 5-8 45-48 their cities and spread the benefits of growth

a ccelerated development. For one, researchers Tier II firms 4-5 2-25 to secondary centres [Business Line 2007].

are concerned about the depth and sustaina-Offshore global service providers 12-15 15 Policy developments at the central level bility of the industry. Despite the hype, some Pure play BPO providers 20 have been facilitating the growth of this MNC captive units 45-50 2-3

95 per cent of India’s exports consist of less sector [Balakrishnan 2006]. At the central

Emerging companies 8 15

sophisticated software services, rather than level, the agency that offers export-oriented

Adapted from NASSCOM Strategic Review 2007, 2008, p 83.

products or high-end consulting services and it is only recently that bigger firms have been able to win more s ophisticated and value added service provision contracts [Athreye 2005: 32]. Furthermore, very few companies successfully develop and market products [Dossani and Kenney 2002: 237]. The majority of local firms exports its services and thus has well-developed linkages overseas. However, these links are not with other local firms, making the diffusion of knowledge difficult and reducing them to virtual extensions of foreign operations [Balasubramanyam and Balasubramanyam 1997; Rasmus and Hesbjerg 2003; Vijayabaskar and Krishnaswamy 2004: 187].

The Indian IT/ITES sector generates economic and technological disparities at the national level as the benefits of growth are concentrated in a limited number of locations and groups [D’Costa 2003; Ilavarasan 2007; Kumar and Joseph 2007]. Extant

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firms dedicated infrastructure and facilities, Software Technology Parks of India, has begun to set up parks in many second-tier cities. Recent industrial policy measures, especially related to special economic zones, will also allow smaller IT parks more appropriate to smaller cities to be set up.

The move to spread the industry to new locations is being adopted by the larger firms. A research study among 123 IT/ITES firms [NASSCOM Foundation 2008] indicated growing importance of second-tier cities, with 73 per cent of participants having a presence in second-tier cities.

Recently, domestic industry majors such as MphasiS, Satyam, Wipro, Tata Consultancy Services, and Infosys have set up IT/ITES facilities in second- and third-tier cities throughout the country, such as Mangalore, Coimbatore, Nagpur, Surat, Visakhapatnam and L udhiana [Thanuja 2007]. Many of these investors are also setting

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up multiple facilities in smaller locations. Thus, Wipro, which has more than 50,000 employees, is setting up f acilities in Kochi and Thiruvananthapuram in Kerala, Coimbatore and Tiruchirapalli in Tamil Nadu, as well as others further north [OneIndia 2006].

This movement is not limited to local operations, as inter national investors are also setting up facilities outside Tier I locations. Honeywell set up operations in Madurai, in Tamil Nadu. GE has facilities in Jaipur in Rajasthan, and IBM and Dell have set up operations in Coimbatore in Tamil Nadu. The US retail giant Target is setting up a 3,000seat facility in Mysore, some 150 km from Bangalore.

Having looked at what is happening in the IT/ITES sector, the next section will set out a framework for analysing why economic activity clusters in specific locations and why it moves.

Institutions and Economic Activity

A cursory analysis of global economy reveals that industries are not evenly spread, but rather concentrated in specific locations. For example, in the United States, Chicago and Detroit used to be synonymous with manufacturing, Silicon Valley in California and Route 128 in Massachusetts are currently known for their IT industries, and New York and San Francisco host the country’s fi nancial sectors.

Economic geographers argue that economic activity agglomerates in “localised geographical clusters” for two reasons. These clusters can be “generalised”, meaning that they are the inevitable grouping of firms that occurs in large urban areas, or they can be “specialised”, meaning that they are comprised of groups of firms in the same or similar industries. The interaction between firms in both types of clusters generates externalities, or “spillover” effects, that benefit the group of firms as a whole [Dicken 2003:23].

A regional economic system’s externalities can be “traded” or “untraded” interdependencies. Regarding traded interdependencies, a gglomerations of firms are more likely to have a wider range of specialised supplier firms, which will, through better quality inputs, quicker delivery times, and more competitive prices, increase performance of all firms in the cluster. In addition, agglomerations of firms are also more likely to offer “thicker” l abour markets, with a wider variety of workers with required competencies. These benefits are well known, and were first a dvanced by Marshall’s work on “ industrial districts” [Scott 1996: 397; Storper 1999: 25].

In the Indian context, this explains why ITES firms are located along with IT service firms in the same clusters. Office infrastructure and supporting services (HR firms, training institutes, financial services, and consumer goods) are common and utilised by both IT and ITES firms. Also, the ITES sector absorbs university graduates that are not employed by the IT sector.

However, economic geographers also argue that clusters can benefit from “untraded” interdependencies, which include greater opportunities for the interchange of ideas, techniques, technology, and business opportunities that arise from proximity b etween firms. This also extends to include positive changes in the local institutional “environment”, including localised mores and norms regarding q uality, commercial cultures, and acceptable business practices. A positive institutional environment can mean that there is greater inter-firm trust regarding such matters as labour poaching, intellectual property, and collective reputation effects2 [Storper and Scott 1995: 512].

Thus, the local or regional institutional environment can have an effect on an industry’s geographic distribution, as areas with more conducive settings will contribute to their firm cluster’s long-term success. Storper and Scott argue that the geographical distribution of an industry goes through several stages (2003:590). They state that when an industry for a good or ser vice first develops, producer firms are often widely dispersed, as markets for specialised workers or supporting services are undeveloped and there are no agglomerations that generate positive externalities. This stage is thus termed “an open window of locational opportunity”.

However, during the second stage, the number of locations is reduced as the industry’s local institutional context becomes increasingly important for success. Locations with environments that are more able to provide specialised inputs, supporting services, specialised labour, and opportunities for collaborative learning will begin to pull ahead of others, as their firms become i ncreasingly competitive. After a period of time, this “process of cumulatively self-reinforcing development” will mean that only a few locations will be the sites of a specific industry – and the w indow of opportunity will have closed.

That said, all clusters are not created equal, and they differ significantly as to their structure, orientation, autonomy, and inter-firm dyna mics. In turn, these differences entail distinct benefits for the hosting region, as well as varying policy needs from government. Successful policymaking will depend as much on the adequacy of proposed measures to foster these clusters as it does on effective and e fficient delivery.

Based on the results of a study of high-technology clusters or “ industrial districts” in the United States, Japan, Korea, and Brazil, Markusen (1996) proposes a typology of clusters or “industrial districts” according to key attributes such as their: structure; d egree of inter-firm collaboration; local or international orientation; existence of supporting services; and role of local government.

Above and beyond the Marshallian industrial district, which enjoys the inevitable traded interdependencies that arise because of agglomeration, Markusen argues that industrial districts can be of the following variants: Italianate, “hub-and-spoke”, and “satellite”3 (Table 2, p 67).

The “Italian” type of industrial district is epitomised by the small, artisanal firm clusters found in northern Italy that, in addition to enjoying agglomeration economies, are characterised by high levels of innovation and dynamism, as well as very active local governments and trade associations that: provide shared amenities; attempt to solve collective action problems; and market the region. IT-oriented clusters, such as Silicon Valley, are a rgued to possess similar characteristics [Saxenian 1994]. The long-term prospects of these clusters are good if local firms can generate and sustain sufficient levels of i nnovation and dynamism. The extensive range and depth of traded and untraded interdependencies between firms make economic a ctivity highly localised and unlikely to relocate.

The “hub-and-spoke” industrial district is led by one or more lead firms which, in turn, sustain an array of supplier and supporting services locally and elsewhere. These clusters may be characterised by long-term and stable relationships between firms along the same v alue chain, but not between lead firms. These clusters do not tend to generate shared facilities or engage in collective learning, although lead firms may provide technical support and inputs to supplier firms. Local government activities will tend to focus on catering to the

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i nterests of lead firms, in terms of hard and soft infrastructure as well as lobbying the central government. Over time, a regionally-specific culture may develop as firms and workers come to identify with the local context, although workers will tend to identify with lead firms first rather than the district in question. In terms of longterm prospects, the cluster’s fortunes are dependent on the fate of the lead firm or firms. However, if these anchor firms generate enough externalities, they may attract other more dynamic and independent firms, thus helping diversify the r egion’s economy.

Satellite platforms are a group of branch plants of externally-located firms. The branches undertake tasks of varying sophistication, but f ollow key decisions made at firm headquarters. As a result, there is relatively little inter-firm collaboration within the district, and business and inter-personal links are almost all e xternal. Communication, technical inter-change, and labour mobility takes place between branches of the same firm, and as a result, there is very little development of a locally-rooted culture. Local governments supply infrastructure and tax incentives, but do not contribute to inter-firm exchanges or the fostering of untraded interdependencies. While satellite platforms do generate jobs and income, the lack of a unique institutional context or l ocally-rooted culture means that investment can easily be lured away by competitors.

It is important to state that the industrial districts discussed above are ideal types, and individual clusters may possess a combination of traits. However, it is equally important to point out that these characteristics are dynamic, as firm capabilities and the local institutional context evolve over time. Thus, while there is no guarantee that a satellite industrial district will become a hub-and-spoke cluster, it is clear that the latter offers a host region more in the way of stability and value added activities than the former. Thus, the challenge for policymakers is to develop policy frameworks that can improve their region’s economy to acquire and develop “sticky” capabilities.

Role of Sub-national Governments and Policy Options

Many of the changes associated with globalisation entail an i ncreasingly important role for sub-national levels of government. Liberalisation policies enacted at the central level have transferred considerable tributary and regulatory responsibilities to lower levels of government [Snyder 2001:94]. In addition, the

Table 2: Characteristics of Different Industrial Districts/Clusters

tendency of skill-intensive industries to “cluster” in specific regions to benefit from external economies requires greater attention to location-specific needs, something sub-national governments may be better placed to do [Gray and Dunning 2002: 413].

In many countries, the relationship between the central government and its sub-national counterparts is established in the constitution, which contains separate lists for unique responsibilities and a concurrent list for shared tasks. In many cases, e lections at the sub-national level are held much in the same mould as national ones. While the overall policy context is set by the central government, state governments have formal and i nformal responsibilities that permit them to play a pivotal role in their r egion’s economic development. As these government institutions are, in theory, closer to their constituents, they may also be better placed to deliver particular types of services [Abelson 2003].

While scope of the responsibilities of state or provincial g overnments may differ in each country and their actions may be constrained by national-level institutions and initiatives, the key attribute is the authority to tax and spend. Gray and Dunning a rgue that

economic policy can only be formulated by units which have the ability to tax (i e, to generate revenues) to fund financial incentives, and the legal authority to initiate and implement a variety of measures affecting the creation, utilisation, and geographical distribution of resources (2002: 410-11).

In terms of relative power, the dice are clearly loaded in the national state’s favour, as the resources under its control and, presumably, more territorially-extensive legitimacy put it in a unique position to provide certain public services and goods, particularly those associated with economic and political stability and sovereignty. However, sub-national governments are, in t heory, closer to their constituents and may be better placed to d eliver other types of services that rely heavily on contextual i nformation. Using this framework, Table 3 (p 68) sets out the appropriateness of different market complementing measures in relation to the level of governance.

Abelson argues that central governments are in a better position to carry out stabilisation tasks, such as managing aggregate employment and prices, as well as distribution tasks, such as f ostering equity and ensuring minimum living standards. In

Characteristics Types
Italian Hub-and-Spoke Satellite
Business structure Small, local firms One or more large firms plus suppliers Large firms owned and headquartered
elsewhere
Location of key business-decisions Locally Locally or non-locally Non-locally
Degree of inter-firm collaboration High collaboration and trust between High collaboration and trust between Low
and trust competitor firms buyers and suppliers, but not lead firm(s)
Labour-market Flexible, committed to industrial district Less flexible, committed to lead firm(s), Flexible within firms, not between them,
then small, local firms identification with firms not industrial district
Supporting services - training, Offered by local trade association Offered by lead firm(s) Offered by lead firm or purchased externally
marketing, technical support,
access to credit
Role of local government Active in regulating core activities and Active in promoting the interests of Active in offering inducements such as tax
promoting industrial district lead firm(s) breaks, export processing zones
Existence of a local industrial culture Development of a unique local culture Development of a unique local culture Limited development of a local culture
Long-term prospects Turbulent, but good Dependent on strategies of lead firm(s) Uncertain, locational advantage easily
replicable
Based on Markusen 1996:298-99.
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c ontrast, the provision of goods that provide localised benefits like health and education can be more efficiently performed by sub-national governments. Furthermore, due to their greater proximity to the local private sector, sub-national states may be better placed to deliver other types of services that provide localised benefits (2003: 346-47). This can include services that provide localised benefits such as health and education, as well as enabling policies for firms such as minimising information asymmetries, overcoming collective action failures, and maximising positive externalities.

As argued in the previous section, interdependencies that arise from firm clustering, particularly those that are untraded, have a strong public goods character. This is because they generate positive externalities for all firms in a given region, regardless of ownership. In a conventional market setting, firms will tend to under-invest in goods that provide generalisable benefits, and moral hazard may undermine collective efficiency. Thus, local government agencies can play a role in nurturing institutions that address these market failures.

If this is the case, different levels of bureaucratic capacity at the sub-national level may privilege the emergence and development of an industry in one location over another, as information tend to locate in the major centres of innovation and diversified economic activity where agglomeration economies can be realised” (1994: 293). In particular, due to their established reputations, first-tier cities will continue to be popular with first-time investors to India seeking to minimise risk.

That said, increasing negative externalities will drive out or deter certain types of firms. In particular, international firms that have a deep knowledge of India, a large appetite for risk, and larger workforces will be more likely to seek less congested roads, lower rates of poaching, and cheaper real estate. Similarly, large local firms, particularly those than can afford to maintain a representative office in an industry hub, as well as smaller niche players that have established domain expertise, will be more likely to seek more conducive environments for business.

In addition, second-tier cities offer considerable advantages as alternative locations for non-critical operations. The business a ssociation Assocham calculated that second-tier cities offer an average cost advantage of 15 per cent over first-tier cities [Live Mint 2007]. Relatively untapped real estate markets mean lower direct costs and less waiting time for permits. Many of these c ities have good local colleges, meaning that graduates are cheaper, easier to find, and – due to the proximity of their fami

flows between the local state and the Table 3: The Relative Importance of Policies by Level of Governance lies – easier to retain.
private sector contribute to a more sup- Market Complementing Interventions Relative Importance However, this does not mean that
portive policy environment. This is National State Sub-national State this process is without significant
borne out by a growing body of work that looks at the role of sub-national state institutions in fostering economic growth in China [Segal and Thun Access to finance R&D funding Foreign investment framework Encouraging discovery Reducing information asymmetries XXX XXX XXX XXX XXX XX XX XX XXX XXX drawbacks, as moving outside established centres implies some risk and inconvenience. Experiences of the firms located in second-tier cities
2001], India [Sinha 2005] and Malay- Reducing collective action failures XXX XXX offer some insights [NASSCOM 2006a,
sia [Hutchinson 2006]. Fostering inter-firm collaboration XX XXX 2006b]. Of concern are: the existence
However, it is also vital that policy Targeted skills provision XX XXX of a local airport; the frequency and
frameworks evolve in line with the in- Targeted infrastructure provision XX XXX timing of flights to major centres; ho
dustries that they seek to support. As Source: Partially based on Gray and Dunning (2002:426). tel capacity; the reliability of the pow

seen in the typology of industrial districts, infrastructure and tax incentives may be sufficient to attract branch plants of international firms. However, in order for more locally-rooted capabilities to develop, additional facilities and infrastructure need to be provided by either government or the private sector. The challenge for policymakers is to know how and when to effect these changes in line with evolving firm capacities. Recent evidence from Malaysia shows that sub-national governments that neglect local firm capabilities and concentrate on physical infrastructure and tax incentives will find it hard to move beyond hosting satellite firms and “virtual extensions” [Hutchinson 2008].

India’s Future Economic Landscape

What then does the future hold for India’s economic landscape, as the IT/ITES sectors revaluate their investment decisions in light of growing negative externalities in established clusters?

First-tier locations will continue to be the prime locations for IT/ITES operations in the years to come. This is due to factors such as their well-developed labour markets, established lobby groups, and developed supporting industries. As Markusen a rgues “Because high-tech industries are youthful, reliant on e xternal services, and subject to rapid rates of innovation, they er supply; and the existence of supporting services. Furthermore, while land is readily available, the availability of construction companies with the desired experience and expertise is far from certain. Time and cost over-runs in building the highly-specific facilities for IT/ITES operations can be frequent.

There are also issues regarding human resources [Sachdeva 2008]. The quality of the graduates in the second-tier cities is not encouraging, particularly with regards to spoken English. For instance, in Jaipur, leading second-tier city, “the employability was just 6 per cent of the total available pool of 27,000 people per year” [NASSCOM 2006b]. Also training facilities which IT/ITES firms share may not exist. Thus, the presence of one or two firms may be enough to dry up available labour. In addition, experienced managers may be reluctant to move to smaller cities with less vibrant career prospects. And, cultural factors can also affect operations, as traditional attitudes to women may prevent them from working at night or in the evenings [Patel 2006].

Smaller cities may also be far-removed from government officials and lack the critical mass of firms necessary to pressure state and local governments for necessary legislation and service quality. Thus, firms without branches in capital cities will find themselves isolated from policymakers. Also, the nature of the IT/ITES sectors will have a centralising effect.

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Therefore, with regard to second-tier cities, it would appear that that the IT/ITES industry is in the midst of the “open window of locational opportunity”. At present, firms are making investments based on labour arbitrage and the existence of cheaper i nputs. However, over time, the number of IT/ITES clusters in these cities will shrink. This is because firm clusters in the new locations have not had time to generate traded and untraded interdependencies such as specialised supplies of labour, more efficient inter-firm collaboration with the resulting productivity gains, or collective reputation effects.

However, this will change over time, as firms in these different locations start interacting with each other and their surrounding institutions. As this happens, some firm clusters will begin to outperform others as their regional economic commons develops and improves productivity. A key part of this story will be how state and local government officials react to and foresee firm needs. It is also likely that the distribution of IT/ITES firms across second-tier cities will be quite specialised, as different locations offer investors distinct advantages according to their specific attributes.

Large local and international investors seeking large numbers of skilled workers and good infrastructure and willing to pay mid-range prices will most likely cluster in state capitals with large industrial sectors. Potential candidates include K olkata, Ahmedabad, Chandigarh, and Lucknow as they have relatively well-developed infrastructure, good universities, and easier access to state government machinery. Over time, the cities with deeper stocks of skilled labour, more responsive state institutions, and better organised industry associations will b egin to pull ahead. Given their late entry into the sector, it is unlikely that these cities will become Italian-style industrial districts. However, a number of these second-tier cities could become durable hub-and-spoke clusters, as larger firms establish their o perations and generate a demand for supporting services. The challenge for policymakers will be to go beyond infrastructure provision to strengthening local business associations, seeking to attract and retain promising lead firms, and encouraging the broadening of the base of supplier firms.

Smaller local and international investors, particularly niche operators, seeking lower labour and real estate costs – as well as “lifestyle” factors such as less commuting time and a more familyfriendly environment – will target smaller cities close to prime industry centres. Mysore near Bangalore, Tiruchirapalli near Chennai, and Pune, a few hours away from Mumbai, belong to this group. In addition to their own attributes, these cities are able to piggy-back on their neighbours’ “hard” and “soft” infrastructure such as airports, training facilities, and industry associations. How ever, while labour may be more readily available, retention may be a problem as graduates move to the bigger city after getting experience. And, given their symbiotic relationship with their first-tier city, the future of these clusters is inextricably linked to them. That said, these cities could conceivably come to host a number of smaller, niche firms from their “mother” cities. Here the challenge for policymakers will be to preserve or i mprove the lifestyle factors that are attracting firms, as well as

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improving links to the first tier city they support. Attempts to foster greater inter-firm interaction and collective learning should also be undertaken, as competition will emerge from other nearby urban centres.

Local firms with an appetite for risk may chose to locate in c ities that do not have an industrial tradition, but that can offer a sufficient quantity of workers and adequate infrastructure. E xamples include Jaipur in Rajasthan, Coimbatore in Tamil Nadu, and Visakhapatnam in Andra Pradesh. These cities will

o ffer large cost reductions in terms of land and labour. However, due to their relative isolation and little exposure to industry needs, they may have high transaction costs, an unresponsive bureaucracy, and shallow pools of skilled labour. In addition, the non-existence of business associations may make collective action particularly difficult. These cities will be reduced to relying on one or two lead firms, more often than not headquartered e lsewhere. Given the hosting region’s limited resources, it is unlikely that lead firms will choose to locate high value added s ervices here. Thus, this activity will provide a number of whitecollar jobs for local residents, but little beyond this. At an early state, specialised infrastructure and tax incentives will be crucial to attract investment. However, long-term the challenge will be go to beyond this, and persuade lead firms to locate more sophisticated tasks in the given region as well as interact with local firms.

Conclusion

This article has looked at recent developments in the geographic distribution of India’s IT/ITES industries. Using an economic geography framework, it put forward an argument of why economic activity clusters and why it moves from one place to another. Key to economic success is the ability of a firm cluster to generate traded and untraded dependencies which boost firm performance through better inputs and services, greater opportunities for learning and interchange, and reducing information and c ollective action failures. While a new industry may initially be widely dispersed, over time interdependencies will affect firm performance and clusters that have more conducive environments will outperform others. Thus, over time, this “open window” of locational opportunity will close and a given industry will be restricted to a few sites.

Given increasing negative externalities in established industry centres, firms in the IT/ITES sectors are beginning to move operations to greenfield sites around the country. This has opened a w indow of opportunity among a range of smaller, less well known cities to attract initial investments. The challenge facing them is to subsequently foster the development of larger, sustainable clusters.

Government policy can play a role in helping create an e nabling environment and boosting a cluster’s “economic commons” through addressing collective action issues, providing shared amenities, and addressing certain market failures. Thus, despite constitutional and financial constraints, sub-national g overnments can, in fact, play key roles in fostering local economic activity.

The question is not whether sub-national governments can play a role, but how. Policymaking in a globalised world is

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i nfinitely more complex than it was a generation ago, requiring as well as the specific needs of the cluster in question. In addipolicymakers to strive to retain footloose investment while simul-tion, policy approaches, especially at the sub-national level, must taneously seeking to attract new operations. To be successful, evolve in line with firm capabilities, requiring constant communipolicy frameworks must be tailored to the nature of the industry cation with the private sector.

Notes

1 For instance, one of the most underdeveloped states, Bihar has devised IT policy in 2008 whose one of the seven objectives is “to create a favourable climate in the State for investments in the IT, ITES and knowledge-based industries with a view to generating employment, earning income through exports and encouraging e-Commerce, thereby significantly increasing the contribution of the IT sector to the State GDP.” (http://gov.bih. nic.in/Documents/Draft_IT_Policy_2008.pdf).

2 It is also important to note that agglomeration can also generate negative externalities such as pollution, increasing rent, labour poaching, or intellectual property theft. Furthermore, local institutional environments can also have negative characteristics, such as high levels of distrust, or a tendency to compete on price as opposed to quality.

3 Markusen also proposes a fourth variant, the socalled “state-anchored” district, which relies on the activities of one or more state-owned facilities. Given that the majority of activity in the IT/ ITES sectors is private sector-led, its attributes will not be reviewed in detail. That said, an argument can be made that the software clusters in Mumbai and Bangalore had these initial c haracteristics.

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