Is competitive federalism stifling economic progress in India?

Is competitive federalism stifling economic progress in India?

Given that the policy of competitive federalism is a mainstay of the Modi government’s engagement with the Indian states, it is important to look into the institutional and political considerations that will guide – or slow – economic progress in India.

India’s federal polity has followed a deeply contentious trajectory since the country gained independence in 1947. The volatile combination of regional, linguistic, religious, and economic contestations has created a political dynamic that far transcends the neutral developmental rhetoric that is presently seen in the centre-state relationship.

As evidenced not just in momentous breaking points – such as the demand for new states – but also in everyday interactions between the centre and states, it is local-level politics that becomes critical in determining the implementation of national macroeconomic policy. This makes economic policymaking crucially dependent on the underlying politics between the centre and the states.

In India, this relationship has followed a peculiar political development trajectory. The present foundation of centre-state relations is underpinned by a political dynamic whereby, within the broad rhetoric of welfarist development, the economic relationship between the centre and the states is influenced largely by implicit political bargaining.

The political context

The power equations among the states are influenced by various factors in Indian political life: political decentralization as a result of the emergence of powerful regional parties in several states, exacerbation of regional economic disparities among the states, and a tendency towards political centralization in economic relations.

Such a political context is completely divorced from the economic policy that the centre has followed so far vis-à-vis the states. With cities like Mumbai, Gujarat, Delhi, Bengaluru and others recognizing the growing importance of global cities as investment destinations, the importance of states in attracting domestic and foreign capital inflows has been recognized for a long time.

This has been the case since India became a market polity. However, in an atmosphere of political-economic centralization, the insufficient economic transfers to the states combined with historic regional disparities has hindered the states’ ability to attract investment. The current policy of cooperative and competitive federalism claims to rectify this.

Chasing investments

Through the creation of the NITI Aayog (National Institution for Transforming India) in place of the ‘socialist-era’ Planning Commission, and by acceding to the recommendations of the 14th Finance Commission, the government took the historic decision to substantially hike the share of states in tax revenue and put in place other safeguards to check the unbridled authority of the centre. This has come as a massive bonanza for the states.

On the face of it, patterns of competitive federalism are already evident in the relationship between states. Ever since the Modi government took over, the Vibrant Gujarat Summit for global investors is being emulated in leading states such as Tamil Nadu and Mumbai. Tamil Nadu is organizing a similar event to attract investments to the tune of 1 lakh crore rupees, with the UK, France and Japan confirming their participation in the summit.

Indore has already organized a global investors summit, and Mumbai has declared plans to compete with Gujarat to attract more investments. According to the latest data in the Economic Survey, Maharashtra currently attracts the highest number of investment proposals with employment potential, followed by Gujarat, Tamil Nadu, and Uttar Pradesh.

However, these are only a handful of well-off states, and even the patterns of inter-state competition in attracting investment are too preliminary to determine whether it will really institutionalize truly competitive patterns of investment. As of now, what is conveyed is simply a pro-investment policy environment.

Addressing local political risk

Whether the states are able to utilize the seemingly favorable policy environment unleashed by the reformist initiatives of the central government will depend on the changes they can bring about in the structures of their grassroots political economy. This will require a holistic approach to local political risk, with main considerations outlined below.

The problem of corruption in the widest sense, which adversely risks issues such as ease of doing business and speedy grant of project clearances, poses a major risk to the states’ economies. A recent instance of this is the deadlock in the Indian Parliament over the landmark Goods and Services Tax (GST), which proposes to ease the movement of goods and services between states.

The clear opposition of even some of the well-off states to the GST on the grounds of revenue loss clearly represents a political culture which balks at transiting to a more transparent and simplified rules-based regime.

The failure to address unequal development is one of the major hindrances to investment in certain states, despite a favorable policy environment. Indian states with high degrees of political mobilization are well-known for volatile protests against Special Economic Zones, especially those premised on land grab and, increasingly, adverse health and environmental risks. This is clearly seen in mobilization of Uttar Pradesh farmers against land acquisitions, as as well as protests against Koodankulum and Jaitapur nuclear power plants in Southern states.

Thus, In the Indian political economy, it is obvious that the political risk is two-fold. On the one hand, the risk regarding attracting potential investment inflows depends on the extent to which the states are able to effectively operationalize the policy incentives offered by the government.

On the other hand, this operationalization cannot be divorced from the social risks or externalities associated with developmental projects in a country fraught with inter- and intra-regional inequalities. Failure to holistically address the latter will likely hold the risk of crippling the former, in the long run.

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