Business Environment, Clustering, and Industry Location : Evidence from Indian Cities

How do differences in the local business environment influence location of industry within countries? How do the benefits of a good business environment compare to those from good market access and agglomeration economies from industry clustering? We examine these questions by analyzing location decisions of individual firms. Using data from a recently completed survey of manufacturing firms in India, we find that both the local business environment and agglomeration economies significantly influence business location choices across cities. In particular, excessive regulation of labor and of other industrial activities reduces the probability of a business locating in a city. Our findings imply that in order to attract industrial activity, smaller or remoter cities need to offer even more attractive policy concessions or reforms in order to offset the effects of their relatively adverse (economic) geography. Our methodology pays special attention to the identification of agglomeration economies in the presence of unobserved sources of natural advantage