- States’ growing importance in economic federalism
- Cooperative and Competitive Federalism is the secret to India’s success
- Trends that shifted the economic centre from the Centre to the states
India’s growth hinges on cooperative federalism
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In the World Bank’s Ease of Doing Business index released recently, India ranked 63, an impressive jump from its lowly rank of 142 in 2014. However, there is evidence of investors being frustrated by venality, indifference and corruption at the operating level.
States’ growing importance in economic federalism
- The reaction to central government’s dominance came in the early 1980s when strong regional leaders started agitating against the hegemony of the Centre.
- This resulted in center giving some autonomy to states but only in political domain. Much of the economic policy control stayed with the Centre which decided not just public but private investment as well.
- However, this arrangement started to change with the onset of 1991 reforms.
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.
Trends that shifted the economic centre from the Centre to the states
Change in the content of the reform agenda
- The Centre executed the 1990 economic reforms in India without even informing states. This is because all such reforms pertained to subjects such as industrial licencing, import permits etc. which were entirely within centre’s realm.
- However, the second-generation reforms (1996-2007) shift the economic agenda’s emphasis to land, labour and taxation, which need the consent of states.
- The GST deal was completed till the Centre guaranteed to fill the revenue gap of states according to an agreed formula. This shows the increased influence of states on center.
Changing dynamics of fiscal federalism
- As per one estimate, Centre collects about 60 % of the combined revenue but gets to spend only about 40 % of the combined expenditure. On the other side, all states together collect 40 % of the combined revenue, but spend as much as 60 % of the combined expenditure.
- This shows that the states now not only get a larger quantum of central transfers but also get to decide on how to spend that larger quantum.
- More importantly, states also enjoy greater autonomy in determining their expenditure.
Utilization of State finance matter much more that before
- How states manage their public finances matters much more than before. RBI in its latest annual report on state finances pointed out states’ increasing weakness in raising revenue, and their unsustainable debt burden. This shows the significance of states finance as it is overlooked by such an important body (RBI).
- As the RBI pointed out, the quality of expenditure at the state level has a multiplier effect on overall development outcomes.
Role of state in creating a conducive investment climate
- Much of the responsibility for improving the ease of doing business rests not with center but with the states.
India can only achieve its ambitious growth targets by enhancing competitiveness at all levels of government. However, While the coordination of policies across various levels of government requires cooperation, the role of fostering a sense of competition among sub-national governments cannot be ignored.
To know more, refer to IASTopper’s Mains article on Reforming India’s architecture of fiscal federalism: https://www.iastoppers.com/reforming-indias-architecture-fiscal-federalism-mains-article/