3 TRADE, TRANSPORT, AND TERRITORIAL DEVELOPMENT These patterns suggest that while a decline in _external_ trade costs itself was associated with a redistribution of activity from primary to secondary regions, a decline in _internal_ trade costs was correlated with greater concentration. To explain this pattern of territorial development in India, we develop a model featuring two countries, a home country and the rest of the world (ROW), where the former has multiple regions. In particular, the home country is characterized by a region designated as a port, the primary region, and all international trade must pass through this region.

Our model shows that the impact of a decline in external trade cost (of importing) on regional activity depends on the internal trade cost (distance from the port). A decline in import cost potentially raises competition for domestic manufacturers. Nonetheless, regions farther from the ports, the non-primary regions, remain protected by high internal trade costs. This could stimulate a reallocation of manufacturing activity from the primary region to nonprimary regions. Similarly, a decline in internal trade costs has two opposing effects on the activity of the non-primary region: while it increases the demand for its products by other regions due to lower domestic cost of trade, it also reduces protection from imports, thereby depressing activity. The overall effect depends on the initial level of internal trade costs.

Using a difference-in-difference strategy on Indian organized manufacturing data, we find that the average growth rate of activity (output, employment and plant count) in the secondary region was higher relative to the primary region in the period immediately following the trade liberalization reforms that sharply reduced import tariffs. We also show that the relatively higher growth rate in the secondary region during this period was observed for industries experiencing larger tariff cuts. This result on spatial reallocation is consistent with our model that reallocation of activity away from primary regions is driven by high internal trade costs that insulates manufacturers in non-primary regions from trade competition. The pattern of spatial reallocation reversed during the period 2000-09, coinciding with the timing of construction and upgrade of the “Golden Quadrilateral” (GQ) highways that may possibly have altered the internal trade costs.<sup>2</sup> Manufacturing activity in secondary and interior regions grew slower on average than their counterparts in the primary region during this period. Within the secondary region, however, those along the GQ highway network grew faster. Although lower internal trade costs reduce attractiveness by inducing higher competition in districts that fall along the network, it also enhances market access by providing opportunities for greater expansion. The net outcome is an interplay of these two opposing forces. The activity in the interior region, even with the districts connected on the GQ highways, remained

> 2The GQ highway project sought to improve connectivity between the four major metropolitan areas of India – Delhi, Mumbai, Kolkata and Chennai.