India: States vs. Federalism

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World News /09 Jun 2018

India: States vs. Federalism

India is a federal country with 29 States and 7 Union Territories. These States are at asymmetric levels of economic and social development. In a federal setup, asymmetries can be vertical (between Centre and the States) and horizontal (among the States). Theoretically federations are seen as ‘indestructible union of indestructible states.’ However empirical evidences show that such federations are rare. In a federal system, fiscal asymmetries are a complex outcome of constitutional division of resources and responsibilities across levels of governments.

From a fiscal perspective, we try to analyze whether there is economic convergence across States in India over the years, controlling for asymmetries in fiscal and social outcomes. Economic convergence means that a state that starts off at low growth performance levels should see a “catching-up” growth process with the states that had better starting points. If the growth rate of low-income states and high-income states tend to converge over a period of time, then it is said to have convergence. If the level of income converges without any control factors, then there is unconditional convergence.

Empirical evidence is inconclusive about economic convergence and these mixed results depended on the sample of countries, methodology, time period and type of convergence (conditional or unconditional convergence) at country level. The unconditional convergence implies that poorer states will grow, on average, faster than richer ones; and the conditional convergence implies that this will only be true if account is taken of other factors such as human capital attainment.

Asymmetry can arise from unequal federal arrangements that are “discretionary” and “rule-based.” The former relates to the administrative and political discretion in decision-making and expediency. The differentials in the bargaining power of jurisdictions during the process of federation can be a source of political asymmetry.

Whether federalism per se leads to economic integration among the subnational units is a matter of debate. However, in India, federal transfer system played a critical role in reducing fiscal inequality among the States. Although the transfer system remained progressive, the large fiscal asymmetry among the States continues to remain a major challenge. The most important aggregate of the States accounts is the Net States Domestic Product (NSDP). According to per capita NSDP at constant prices (at 2004–05) price for the year 2014- 15, the highest per capita income state is Goa, with a per capita of Rs. 241,081. The state with lowest per capita income is Bihar, with a per capita income of Rs. 23,223.

The trend suggests divergence among Indian states, that is, states that had a higher level of per capita income were experiencing higher growth rates. The reason for no unconditional convergence is largely economic. Despite a progressive fiscal transfer system, where the poor States received much higher per capita transfers than richer regions, these transfers only partially offset fiscal disabilities, leading to lower investment in social and economic infrastructure in poorer regions in the country. The economic liberalization and reforms of 1991 contributed to larger private investment inflow to the richer regions of the country, resulting in further increase in inequality between the leading and lagging States.

The movement of various health and education related indicators and their relative position across States reveals convergence. These indicators are IMR and TFR for health, and literacy rates for education. Infant mortality rate (IMR) is defined as the number of infants dying before reaching one year of age, per 1,000 live births in a given year. Total fertility rate (TFR) is defined as the number of children that would be born to a woman if she were to live to the end of her childbearing years and bear children in accordance with age-specific fertility rates in a given year.

According to Economic Survey, 2016–17, the state with the highest IMR is Madhya Pradesh with an IMR of 69 per thousand births and the state with the lowest IMR is Goa and Manipur, both states having an IMR of 11 per thousand births. The Total Fertility Rate (TFR) is the highest in Bihar, while the TFR is the lowest in Goa. The highest literacy rate among the Indian States is Kerala (94%); the state with the lowest literacy rate is Bihar (62%).

Economic convergence can be examined taking into account federal asymmetries in terms of capital availability, social and demographic outcomes, and differentials in public capital budgeting among Indian States. The tests for unconditional convergence failed to show evidence of poorer states “catching up” with the richer states. Conditional convergence tests also show no evidence of strong economic convergence among Indian States.

Economic geography plays a crucial role in the development of a region. Literature on convergence in the context of China has also documented that a large part of economic growth in coastal provinces comes from their deeper implementation of industrial and foreign trade reforms. Public capital expenditure has positive and significant effect on growth, for both the coastal and inland regions. Health outcomes as measured by the Infant Mortality Rate shows that improvement in health outcome results in higher economic growth.

These results have two important policy implications. If the path to fiscal consolidation is achieved through curtailing public capital spending by the States, it would have negative consequences on economic growth in the long run. Secondly, the quality of human capital formation is a pre-requisite for economic growth. Health related variables matter for economic convergence among States in India, and therefore public investment in health can be growth-enhancing for economic convergence.

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