Indian Startups Will Flourish When Rents Fall In Cities

The Narendra Modi government recently announced its plans to ensure that India's startups find the regulatory framework conducive to their functioning. The government wants to simplify the process of starting a business venture. For example, startups will be exempted from income-tax for the first three years of their existence. They will also be exempted from the capital gains tax if capital gains are invested in funds recognized by the government. While these measures are important, this is by no means enough. Many argue that startups should be able to acquire land easily. Rents are higher in many Indian cities such as Bengaluru where startup firms cluster. Why is this so important?
Innovators are risk-takers. When risk is unreasonably high, innovation is less likely to happen. A film-maker, for instance, would find risk-taking costlier than a poet because the cost of making a firm is far greater than writing poetry. If a movie does not appeal to mainstream tastes, the film-maker may not break even. This is true of poets and novelists too, but as their operating costs are often lower, they do not find innovation too expensive. Many of the world's successful Internet startups originate in the United States because it is a society that tolerates innovators. But, cultural resistance to innovation is not the only barrier that startups face.
When rents are high, the risks involved in starting up a business are high too. When land acquisition is difficult, the cost of starting and expanding a venture becomes high too. (Easier land acquisition is a major reason why office space leasing has been rising steadily in Gurgaon and Noida.) Such costs are beyond startups that operate on a shoestring budget. Innovators with the best ideas are not necessarily the innovators with the deepest pockets. In large Indian cities, rents are unusually high. Connaught Place, for example, is the world's sixth most-expensive office space market. Rents in cities like Mumbai and Bengaluru too cut through the roof.
Rents in Bengaluru have risen in the past few decades because many successful technology companies have been driving up real estate rents in the city. But, at the same time, there are many regulations that constrain the supply of residential and office space. Rent control legislations, for example, leaves less incentive for landlords to let out property. Why would a landlord want to let out his property if rents are set artificially low, while evicting tenants is difficult?
Even though startups are free to operate out of satellite cities or smaller cities, rents are often the price companies pay for proximity in urban areas. The high degree of proximity between employees is more difficult to bring about in satellite cities or smaller cities. Governments, however, should do everything that can be done to lower the cost of proximity. If building supply goes up, the cost of proximity will decline too. There is, for example, great agreement among economists that a high-density building is important to generate greater interaction between firms. This is especially important among startup firms that require employees to be competent in many different aspects of a problem. For example, if the number of companies that a building houses is tenfold higher, the frequency of interaction between these companies would be much greater. Interactions are likely to be more diverse too.
Many believe that the Internet age has made proximity irrelevant, but evidence does not support this claim. The Internet does not seem to have replaced face-to-face interactions though it is definitely true that many tasks, today, can be done in any part of the world. Moreover, employees in startups are more likely to interact with each other on phone or through Internet applications if there is greater proximity. For this to happen, low rents are essential.
More importantly, many startups do fail. When startups fail, employees and entrepreneurs will find it much easier to land on their feet if startups are closer to each other. A startup may find it more difficult to attract employees if it operates out of a city where finding another job or starting up another business is difficult. Low rents allow talent to be more concentrated in a certain place. Low rents also allow firms that tap into complementary skills to operate closer to each other and learn from each other. Many innovations spread from financial firms to software companies and vice versa, when the computer industry was taking off in the 1970s and 1980s. The concentration of talent that low rent allows also allows firms in other countries to access talent at a lower cost. For example, a firm in the United States that outsources its operations to a firm in Bengaluru would benefit from the ease with which the firm in Bengaluru can hire talented employees. This is why it is important that rents decline in Bengaluru, Mumbai, Gurgaon or Noida though rentals are much lower in Ranchi or Cochin.