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Insights into Editorial: India’s growth hinges on cooperative federalism


Insights into Editorial: India’s growth hinges on cooperative federalism


   

Introduction:

In the World Bank’s Ease of Doing Business index released last month, India ranked 63, an impressive jump from its lowly rank of 142 in 2014.

Yet, there is anecdotal evidence of investors being frustrated by venality, indifference and corruption at the operating level.

 

Centralisation at time of Independence:

In the early years of our republic, the Centre dominated across all domains political, economic and administrative and states, even those led by leaders with political heft, acquiesced to this unequal arrangement.

The reaction to central dominance came in the early 1980s when strong regional leaders started agitating against “the hegemony of the Centre”.

 

However, Now, Growing importance of states in India’s Economic Management:

When the government amended the terms of reference of the 15th Finance Commission asking that allocations for defence and internal security be carved out upfront, before determining the pool of resources to be shared with the states, the states baulked at the highhandedness of the Centre.

Central government attempted to reform the land acquisition law by tweaking the balance in favour of investors, but quickly buckled down as many states took umbrage.

This, even though land is on the concurrent list in the Constitution, and a central law would have prevailed notwithstanding states’ opposition.

 

Cooperative and Competitive Federalism is the secret to India’s success:

  • Competitiveness is an idea that has stood the test of time. From early macroeconomic ideas of comparative advantage and competitive advantage, our understanding of the determinants of competitiveness has evolved considerably.
  • More recently, the concept of national competitiveness and regional competitiveness has come into the mainstream.
  • As the literature on competitiveness notes, there exists a powerful connection between economic and social development improving competitiveness requires investment in both.
  • This, in turn, requires coordination of our economic and social policies across various levels of government.
  • As a consequence, the Centre yielded to the states, but largely in the political space.
  • Much of the economic policy control stayed with the Centre which decided not just public investment but even private investment through its industrial and import licensing policies, leaving the states on the margins of economic management.

 

Three trends, in particular, have shifted the economic centre of gravity from the Centre to the states:

The first is the change in the content of the reform agenda:

  • The Centre could push through the reforms of the 1990s without even informing, much less consulting, the states because they all pertained to subjects such as industrial licencing, import permits, exchange rate and the financial sector, which were entirely within its domain.
  • In contrast, the second-generation reforms on the agenda now shift the emphasis, to use economic jargon, from product to factor markets like land, labour and taxation, which need, not just acquiescence, but often the consent of states.
  • Nothing illustrates the increased clout of the states in driving reforms more than the GST negotiations.
  • There was a clash of interests not just between the Centre and states but also between producer and consumer states, large and small states and coastal and inland states.
  • The grand bargain that culminated in the GST, admittedly imperfect, involved all parties making compromises.
  • But the deal could not be clinched until the Centre guaranteed to fill the revenue gap, if any, of states according to an agreed formula.

 

The second factor driving the economic centre of gravity towards states is the changing dynamics of our fiscal federalism:

  • Ballpark estimates suggest that the Centre collects about 60 per cent of the combined revenue (Centre and states), but gets to spend only about 40 per cent of the combined expenditure.
  • This asymmetry is mirrored on the states side. Together, they collect 40 per cent of the combined revenue, but spend as much as 60 per cent of the combined expenditure.
  • More important than the aggregates are the greater autonomy that states now enjoy in determining their expenditure.
  • The states now not only get a larger quantum of central transfers but also get to decide on how to spend that larger quantum.
  • The RBI in its latest annual report on state finances, raised several red flags states’ increasing weakness in raising revenue, their unsustainable debt burden and their tendency to retrench capital expenditures in order to accommodate fiscal shocks such as farm loan waivers, power sector loans under UDAY and a host of income transfer schemes.
  • As the RBI pointed out, the quality of expenditure at the state level has a multiplier effect on overall development outcomes.

 

The third major trend is states critical role in creating a conducive investment climate in the country:

  • Much of the responsibility for improving the ease of doing business rests not with Delhi but with the states. This highlights the need for coordinated action.
  • India’s prospects, including our aspiration for a $5 trillion economy, depend on the Centre and the states working together.
  • If ever there was an opportune moment for a big push on cooperative federalism, it is now.

 

Conclusion:

India can only achieve its ambitious growth targets by enhancing competitiveness at all levels of government.

Instituting a system of cooperative and competitive federalism has been a hallmark of India’s policy-making in the past five years and has achieved considerable results.

Cooperative and competitive federalism are complementary ideas that will drive India’s growth story in the coming decades.

Robust monitoring and evaluation systems are needed so that blockages can be identified, potential solutions deliberated and the results monitored.

India’s success stories in fostering competitive federalism have been backed by a robust data collection, validation, monitoring and evaluation framework.