How to build inclusive cities and sustain economic growth

India’s Urban Awakening: Building Inclusive Cities, Sustaining Economic Growth, a report released by the McKinsey Global Institute on Thursday, describes the findings of a research that was launched 21 months ago in collaboration with the India office of McKinsey & Company.
The purpose of the research project was to understand how India’s urbanisation might evolve, explore the many problems facing India’s fast-growing cities and what policymakers can do to mitigate the strains of urban life in India and maximise the opportunities offered by cities.
McKinsey Global developed an econometric model to study the implications of urbanisation at the local, state and national levels, and the economic and demographic impact on the 70 largest cities in India.
The modelling was supplemented with more than 100 Indian and international urban experts and economists, and with officials in state and local governments.
There were workshops held with political and administrative leaders of five international cities — Johannesburg, London, New York, Shanghai and Singapore.

India is on the move. Economic reform has already unleashed investment and growth offering its citizens rich opportunities. Although the Indian economy has been resilient so far, the key issue now is how to sustain this momentum. Turning around its cities and releasing their dynamism will be critical to India’s future economic growth.

Unlike many countries that are grappling with ageing populations and rising dependency ratios, India has a young and rapidly growing population — a potential demographic dividend. But India needs thriving cities if that dividend is to pay out.

New research by the McKinsey Global Institute, the economics and business research arm of McKinsey & Company, estimates that cities could generate 70% of net new jobs created up to 2030, produce more than 70% of Indian GDP, and drive a near-fourfold increase in per capital income across the nation.

Surging growth and employment in cities will prove a powerful magnet. India’s urban population grew from the 290 million reported in the 2001 Census to an estimated 340 million in 2008, and McKinsey Global projects that it could soar further to 590 million by 2030.

This urban expansion will happen at a speed quite unlike anything India has seen before. It took nearly 40 years (between 1971 and 2008) for India’s urban population to rise by 230 million. It could take only half that time to add the next 250 million.

The speed of urbanisation poses an unprecedented managerial and policy challenge — yet India has barely engaged in a national discussion about how to handle this seismic shift in the makeup of the nation.

Indeed, India is still debating whether urbanisation is positive or negative and whether the future lies in its villages or cities. This is a false dichotomy — villages and cities are interdependent and symbiotic.

In fact, the urban economy will provide 85% of total tax revenue, which will finance development nationwide.

And some 200 million rural Indians who live in proximity of India’s largest 70 cities will directly benefit. But cities themselves are not just home to the prosperous. Far from it. Some 75% of urban citizens live in the bottom income segments earning an average of Rs80 a day.

Addressing life in India’s cities is clearly not an elitist endeavour but rather a central pillar of inclusive growth.

The cost of not paying attention to India’s cities is enormous. Today’s policy vacuum risks worsening urban decay and gridlock, a declining quality of life for cities, and reluctance among investors to commit resources to India’s urban centres.

We believe that the lack of serious policies to manage urbanisation could jeopardise even the 7.4% growth rate we assume in our base case, risking high unemployment.

McKinsey Global conduced a 21-month-long study to understand India’s urbanisation, to identify what was holding back India’s cities and what policy changes could transform the situation on the ground.

To create a fact based around which to analyse India’s urbanisation. McKinsey Global developed an econometric model and nine sector models that use baseline forecasts of economic growth to understand the implications of urbanisation at the national, state and city levels.

We supplemented our modelling with in-depth analyses of 15 Indian cities and 6 global cities and engaged in discussions with more than 100 Indian and international experts, urban economists and state and local governments.
This process has produced a set of recommendations, the vast majority of which India could implement within 5-10 years as long as it musters the required political will.

If India were to implement these recommendations, it could not only transform the prospects of its cities but also boost nationwide economic growth.
Estimating the impact is not straightforward, but we believe that carrying out the reforms described in this report has the potential to add as much as 1% to 1.5% to national annual GDP growth.

This additional growth would bring the nation close to meeting the aspiration voiced recently by the Prime Minister of achieving double-digit growth.

Cities will be central to India's economic future
Cities already matter to India. By 2008, an estimated 340 million people already lived in urban India, representing nearly 30% of the total population. Over the next 20 years, urban India will create 70% of all new jobs in India and these urban jobs will be twice as productive as equivalent jobs in the rural sector.

As a consequence, McKinsey Global projects that the population of India’s cities will increase from 340 million in 2008 to 590 million by 2030 —40% of India’s total population. In short, we will witness over the next 20 years an urban transformation the scale and speed of which has not happened anywhere in the world except in China.

Urbanisation will spread across India, impacting almost every state. For the first time in India’s history, the nation will have five large states (Tamil Nadu, Gujarat, Maharashtra, Karnataka and Punjab) that will have more of their population living in cities than villages.

In the global context, the scale of India’s urbanisation will be immense. India will have 68 cities with populations of more than 1 million, 13 cities with more than 4 million people, and 6 mega cities with populations of 10 million or more, at least two of which (Mumbai and Delhi) will be among the five largest cities in the world by 2030.

In terms of both population and GDP, many Indian cities will become larger than many countries today. For instance, the Mumbai Metropolitan Region’s GDP is projected to reach $265 billion by 2030, larger than the GDP of many countries today, including Portugal, Colombia and Malaysia.

As India’s cities expand, India’s economic makeup will also change. In 1995, India’s GDP split almost evenly between its urban and rural economies. In 2008, urban GDP accounted for 58% of overall GDP.

By 2030, under our base-case economic projections, McKinsey Global estimates that urban India will generate nearly 70% of India’s GDP.

India’s fast-growing and relatively productive cities will drive a near-fourfold increase in India’s per capital income between 2008 and 2030.

The number of households nationwide earning less than Rs90,000 per year is projected to fall below 20% for the first time in India’s history, while the number of middle-class households (earning between Rs2 lakh and Rs10 lakh a year) will increase more than fourfold from 32 million to 147 million.

These economic trends will unlock many new growth markets, many of them not traditionally associated with India, including infrastructure, transportation, healthcare, education and recreation.

There will be eye-popping numbers in the infrastructure sector. For instance, we project that the economy will have to build between 700 million and 900 million square metres of residential and commercial space a year — equivalent to adding more than two Mumbais or one Chicago every year.

In transportation, McKinsey Global projects that to meet urban demand, India needs to build 350 to 400 kilometres of metros and subways every year, more than 20 times the capacity built of this type by India in the past decade.

In addition, between 19,000 to 25,0000 kilometres of road lanes would need to be built every year (including lanes for bus-based rapid transit systems), nearly equivalent to the amount of road lanes that have been constructed over the past decade.

Cities will also be critical for inclusive growth
Cities are about more than just higher incomes — they also offer the promise of a higher quality of life for a larger number of Indians. This is because the scale benefits provided by cities — in India and around the world—offer the opportunity to significantly lower the cost of delivering services such as water and sanitation. Research indicates that the cost of delivering basic services is 30% to 50% cheaper in concentrated population centres than in sparsely populated areas. Given finite public resources, any potential savings could be vital if the government is to meet its aspiration for inclusive growth at affordable prices.

Cities are also vital for the funding of development because they generate the lion’s share of India’s tax revenues — between 80% and 85%.

Moreover, cities have benefits beyond their own boundaries. Our research finds that some 200 million people who live close to cities will benefit because they will enjoy improved access to jobs, markets and the urban infrastructure. Rural populations adjoining large urban centres today have an estimated 10% to 20% higher monthly incomes than the rural average.

India's current approach to cities could lead to urban gridlock and decline
Good cities offer a certain quality of life for their citizens and an attractive proposition for companies. Urban India has attracted investment on the back of strong growth, but is failing many of its citizens. Across all major quality-of-life indicators, India’s cities fall well short of delivering even a basic standard of living for their residents.

Combine this fact with India’s large-scale urbanisation and the task is going to become far more onerous. As the urban population and its incomes increase, demand for every key service will increase 5- to 7-fold in cities of every size and type. And if India continues to invest in urban infrastructure in its current rate — very low by international comparison — in 20 years’ time the urban infrastructure will fall woefully short of what is necessary to sustain prosperous cities.

Life for the average city dweller in India would become a lot tougher. Water supply for the average citizen could drop from an average of 105 litres to only 65 litres a day with a large section of the population having no access to potable water at all. India’s cities could leave between 70% and 80% of sewage untreated.

While private car ownership would increase, shortcomings in the transportation infrastructure have the potential to create urban gridlock - similar to the acute congestion that cripple some Latin American cities.

Indian cities need $1.2 trillion of additional capital investment by 2030
Unless it dramatically steps up construction of urban infrastructure needed, India will not be able to bridge the gap between demand for services and their provision. In per capita terms, India’s annual capital spending of $17 is only 14% of China’s $116 and 4% of United Kingdom’s $391.

McKinsey Global estimates that India needs to invest $1.2 trillion  (`53.1 lakh crore) just in capital expenditures in its cities over the next 20 years. That’s almost eight times the level of spending today in per capital terms.
Capital requirements, of course, vary according to the size of city. Tier I and Tier II cities would need capital spending of more than $200 per capita per annum.

International experience suggests it's possible to turn cities around in one decade
India of course has to chart its own journey. But there are nuts-and-bolts lessons that it can learn from other countries and cities around the world that have faced similar challenges. Many countries, including the United Kingdom, South Africa and China have turned around their cities in as little as ten years. The McKinsey Global study shows that five dimensions are important. These are funding, governance, planning, sectoral policies and shape.

Funding: Developing countries have used land monetisation and debt quite extensively to fund its urban infrastructure. China, for example, has given its cities the freedom to raise substantial investment resources by monetising land assets and also retaining a 25% share of value-added taxes. China has also converted many of its big projects into special purpose vehicles to access the debt market.

As for shape, most countries in the world have had the luxury of urbanising organically through history and have ended up with different portfolios and distribution of cities. In Germany, for instance, a large number of small- and medium-sized cities have grown up in parallel, reflecting Germany’s federal structure. We have seen the same in India. China is exceptional in that it consciously fostered a concentrated pattern of urban expansion initially with the development of its dynamic coastal cities.

India needs to create its own city transformation model across these five areas
On all five dimensions of urban management, India’s record thus far is weak. At root, India’s policy makers simply have not acknowledged the importance of an engaged and activist approach to its cities — and the neglect shows. The report also makes concrete suggestions in all five areas, most of which we would argue that India can implement within the next 5 to 10 years and thereby transform the prospects of its cities.