India decoupled?

Amidst all the gloom surrounding India's fading economic growth, we risk glossing over the large variance in economic growth rates and quality of governance across Indian states. The fact that many of these states are comparable to large national economies, should alone be enough for us to be more nuanced in analyzing India's economic prospects.

As the recent Economic Survey points out, states like Bihar, Madhya Pradesh, and Maharashtra, have grown in excess or close to double-digit rates. In fact, even as national GDP growth rate slumped to 6.5% in 2011-12, half the states grew at double-digit rates for the 2010-12 period. One of the surprisingly less discussed stories is the remarkable success of state governments in reining in their fiscal deficits, reducing them from 4.1% for 1998-2004 to an estimated 2.1% for 2012-13, and even running a revenue surplus. This stands out in sharp contrast to the fiscal mess that has characterized the federal government. Some of the traditional laggard states have become trendsetters with progressive reforms. A recent article in Forbes summed up the successes,

Gujarat has emerged as arguably the best destination for investors... Bihar and Orissa have pioneered legislation to stamp out corruption. Karnataka is putting gender equality and women’s empowerment at the heart of planning. Kerala, as mentioned earlier, wants to be on par with Nordic nations. West Bengal now allows free movement of goods, having removed checkposts and trusting businesses to be honest. Punjab has introduced a Right to Services Act. The idea is to reduce citizens’ interaction with government officials and subsequently reduce the opportunity for corruption. 

A few observations in this context

1. Many of these successes are not built on any of the structural reforms that have been the staple of debates surrounding what needs to be done to get the Indian economy back on track. In fact, all these states have done well on the back of plain simple good governance.

Sure, there are benefits from some of these macro-level structural reforms. But, given the low level of inefficiency equilibrium, there are substantial low-hanging fruits to be plucked by good governance and effective implementation of the existing programs and schemes. It is a pointer to the federal government itself that simple governance reforms can itself dramatically improve outcomes.

2. It is well past time to reform the one-size-fits-all centrally sponsored schemes. Given the varying growth trajectories and requirements of states, such uniform programs are an extremely inefficient use of scarce resources. But instead of reforming or phasing them out, the federal government has in recent years, in deference to populist political considerations, dramatically increased the spending on such programs.

Consider this. The high-profile centrally designed programs NRHM, SSA, NREGA, NRLM, NSAP, IAY, and JNNURM form overwhelming share of financing in critical sectors like health, education, employment guarantee, livelihoods, social safety, housing, and urban development respectively. In other words, the agenda for addressing almost all the major development problems of a state is being framed in New Delhi, leaving the state as a passive recipient of central dole.

Many state governments have even scaled back their local need-based sectoral initiatives to accommodate these central programs. Apart from regular establishment expenditures, state government's own spending in these sectors is now mostly confined to meeting its share of the central allocation or in the complementarities to the national program. The rigid program guidelines, with norms and components, ostensibly aimed at facilitating the achievement of objectives, end up distorting incentives and distracting from addressing the real local problems.

3. Redesigning these programs require reforming the mandate of the Planning Commission itself. It is widely acknowledged that the current process of plan consultations are merely an exercise to annually re-validate the ongoing central schemes. Instead of planning top-down (sic), the Planning Commission should collaborate with the state governments and help prepare need-based state plans. It should provide state governments with the necessary professional expertise in the preparation of such plans.

This would mean dispensing with many of the central schemes and replacing it with sectoral bulk transfers. Such allocations should be made as part of comprehensive sectoral plan with clearly defined outcomes and accountability measures.  

4. We need to be careful with the promulgation of nation-wide regulations on economic issues. As the economy diversifies, private sector expands, the role of government changes, and India integrates more with the world economy, there will be the natural technocratic temptation to harmonize regulations to lower transaction costs. We need to be cautious about rushing with hasty legislations.

The need for harmonization, with its attendant benefits, has to be balanced against both political economy considerations and also economic issues arising from asymmetric economic cycles. In this context, TV Somanathan has forcefully argued in this article that proponents of a national Goods and Services Tax (GST) have overlooked important political economy considerations and its impact on the fiscal space available for state governments.

The Eurozone crisis has show that excessive harmonization carries with it considerable economic risks. Harmonization often leaves regions exposed to asymmetric economic shocks without the traditional cushions against the vagaries of the economic cycle. We need to be aware of the need to leave sufficient fiscal and regulatory flexibility that is necessary to effectively manage a continental size economy.