Growing inter-state disparities
OUR nation, as a republic, has just passed the half-century mark. The first 50 years of the Indian state have been quite remarkable in several ways, with many ups and downs. On the one hand we have succeeded in building a modern nation with matching institutions and a vibrant democracy and society. Indians have established their excellence in almost all walks of life. Our education system has produced world-class professionals who occupy top positions even in developed countries. On the other hand, a sizeable section of Indian society remains illiterate, ill-fed and ill-clad. Very many divisive forces are at work undermining the vitals of the nation. The Indian economy has been characterized as a sleeping giant that is yet to recognize its potential strength.
This article highlights a disturbing trend that has become more apparent during the last decade: widening socio-economic disparities across the Indian states. No doubt, considerable disparities in the level of development across the regions existed even 50 years ago. Indeed, one of the principal justifications for introduction of five year plans and the establishment of the Planning Commission was to ensure a process of regionally balanced and socially equitable development. Through public and directed private investments, as well as various other interventions and public policies, balanced development across the regions was pursued during the first four decades of planning. Though such policies were not an unadulterated success, a measure of regional balance in development was maintained.
The role of government in general, and the central government in particular, in the economic activities of the nation changed substantially since the initiation of economic reforms in 1991. The private sector, which was controlled and contained in various ways, has since then been encouraged to play a more important role. Market forces, rather than government directions, would decide the investment decisions – where to invest, what to produce, whom to sell to, and so on. The locations and priorities were to be market-determined rather than government-determined. The government would have to be a facilitator for private initiatives rather than an arbiter and expected to restrict its economic activities to areas that were purely in the domain of the government.
Indeed, the past history of the governments at the Centre and states is such that they have entered into areas and activities that are best left in the hands of private sector and at the same time have left out or neglected activities that only governments can undertake. Various manufacturing activities carried out by public sector undertakings are examples of the former whereas primary education and basic health services are typical examples of the latter.
The experience of a decade of economic reforms clearly indicates that one of its major victims has been balanced regional growth. Private investments have increasingly gone to relatively developed regions that have better social, economic and physical infrastructure and better governance, especially in terms of speedy decision-making processes. Five major states, viz. Gujarat, Maharashtra, Tamil Nadu, Andhra Pradesh and Karnataka, that together account for less than one-third of our population, accounted for almost two-third of the private investment proposals over the last 10 years since August 1991. The same set of states benefited from over 60% of the commercial bank credit and financial flows from national level financial institutions like IDBI, IFCI etc. In contrast, another set of seven major states, viz. Uttar Pradesh, Bihar, West Bengal, Madhya Pradesh, Rajasthan, Orissa and Assam together accounting for 55% of the population received less than 30% of the private investment proposals and a similar share of bank credit and other institutional finances during the last decade.
An interesting aspect of the economic performance in the ’90s is its regional dichotomy. The better performing states are in the western and southern regions of the country and they are geographically contiguous. On the other hand, the non-performing or poorly performing states are in the northern and eastern regions of the country; they too are geographically contiguous. While all the states in the first group are coastal states, all but two, viz., West Bengal and Orissa in the second group have no coastlines. Indeed, this geographical dichotomy is not restricted to economic performance. More or less similar trends are also noticeable in other spheres of development.
The most striking dichotomy is in respect of socio-demographic trends. A recent ranking of all districts in the country1 by the National Population Commission (NCP) on the basis of a composite index of socio demographic progress clearly brings out the frighteningly wide socio-economic disparities among the major Indian states. Out of the 569 districts covered by the report, 190 belong to the forward group of states consisting of eight major ones which include the five economically better performing states plus2 Punjab, Haryana and Kerala. Another 299 districts belong to the group of backward states, which consist of the seven economically backward states.
However, while 180 out of 190 districts of the forward group of states had rankings among the first 300, just 76 out of the 299 districts from the backward group of states had rankings among the first 300. Indeed, while all the districts of Kerala and Tamil Nadu are among the first 100, all the districts of Bihar and Rajasthan are among those below 300 in ranking. It is clear that the two groups of states are world’s apart socio-demographically.
The indicators used to construct the composite index to measure socio- demographic development pertain to quality of life, which almost all modern societies take for granted. It is not that the value systems of the societies encompassing the seven states in the backward group are inimical to those simple pleasures of life. Indeed the better-off sections of these societies – the rich, the ruling class, the educated elite and other influential sections – ensure that they enjoy most of these facilities and characteristics. At the same time, they have miserably failed in ensuring universalization of such essentials.
Every country, every society, has its own share of marginals. This is true of even the most affluent modern nation, the U.S.A. There is, however, no major modern nation where such a large section of society is hopelessly at the margins as in the case of the major states in northern and eastern India.
A concomitant of poor economic and socio-demographic performance is poverty and deprivation. The latest estimates of poverty in the country and its spatial spread for 1999-2000 clearly indicates this. While the poverty ratio for the country as a whole is 26.1%, it is as high as 33.1% for the backward states as a group and as low as 17.9% for the forward states as a group. All the states in the first group with the singular exception of Rajasthan3 have a poverty ratio more than 25%. In contrast, all the states in the second group have a poverty ratio less than or equal to 25%. It is clear that India’s battle against poverty has to be fought in the northern and eastern states.
Again, in terms of per capita incomes, the gap between poorer and richer regions has grown in recent years. The per capita income in Maharashtra was 3.8 times that of Bihar in 1998-99 as against 2.8 times in 1990-91. Further, while all the seven states in the backward group have a per capita income below the national average, all but one out of the eight states in the forward group have a per capita income above the national average. The only exception is Andhra Pradesh where the per capita income was as much as 99.7% of the national average.
The growth of per capita income in each of the seven states in the backward group except West Bengal was below the national average during the ’90s. This was on account of two complementary factors. One, the incomes of these states grew at a lower rate than the national average. Second, the population growth was significantly higher in these states as compared to those in the forward region. Indeed, the per capita income growth in real terms was virtually negligible for Bihar and less than 2% in Uttar Pradesh during the last decade as against a little over 4% for the country as a whole.
It is abundantly clear from the foregoing discussion that in terms of various dimensions of development, the gap between the backward and forward regions of the country has widened during the last decade.4 Since the beginning of the ’90s private investment has become the principal engine of growth and private investment has primarily gone to states that have well developed infrastructure in terms of power, transport, communication, educational and health facilities, law and order and so on.
One logical solution is to provide infrastructure facilities in the backward states so that they may attract private investment. These are in the public domain, mostly to be provided by the state governments. They, however, have no resources to invest in these critical areas. Most of them are hard-pressed even to meet their committed current expenditure on salary, pension and interest payments. Since the states are poor, their revenue raising potential is also low. In short, these states find themselves in a vicious circle, unable to attract private investment because they are poor and poor because of an inability to attract private investment.
An alternative solution could be central assistance to these states to upgrade their infrastructural facilities. This could be either through central investments or increased central transfers to such states. Again, serious constraints exist. To begin with, the Centre’s ability to finance large investments either from its own resources or through borrowings has been constrained on account of decelerating growth in central revenues and its concern with fiscal deficit and debt sustainability. Another problem, perhaps even more serious, is the likely objection which may arise from better performing states to increased central fund flows to backward states.
On a couple of occasions in the past the so-called performing states expressed their displeasure to such favoured treatment to non-performing states. One was in the wake of the 11th Finance Commission Report which recommended higher share in fund flows to backward states. The other was in the context of a proposed revision of Gadgil Formula for allocation of central assistance for state plans.
While almost all forward states wanted higher weightage in the formula for better performance, most backward states wanted higher weightage for poverty and backwardness. While the forward states complained that they were punished for better performance, the backward states argued that since they are unable to attract private investment, they should be compensated by increased public fund flows.
Such polarized positions of the forward and backward states is certainly not a healthy trend in our federal set up. Of course, there is nothing unusual about such bickering in a federal framework. Indeed, in almost all the mature federal countries like Canada or Australia, richer provinces have objected to federal transfers to poorer provinces. However, federal transfers have been an intrinsic aspect of all federal countries involving more and less developed regions.
It is the responsibility of the Centre to ensure that more or less same level of public services are provided in all parts of a federal nation. The founding fathers of our Constitution were quite aware of this requirement. They ensured that the more buoyant sources of tax revenues such as personal income tax, corporation tax and excise were assigned to the Union Government. Further, the Constitution stipulated that Finance Commissions to be set up every five years should decide the quantum of shareable tax revenues to be assigned to the states and the horizontal distribution of the same across the states.
With the introduction of the planning process another window for transfer of central funds to states was opened up. While Finance Commission mediated transfers are essentially to ensure equitable public services across the nation, the fund flow mediated by the Planning Commission is intended to ensure more or less balanced economic and social development throughout the country. The formulae for horizontal allocation of funds across the states employed by the Finance Commission (FC) as well as the Planning Commission (PC) are, on the whole, highly progressive.
Amajor criticisms of the fiscal federal transfers through the two commissions is that they give insufficient weightage to fiscal discipline and performance. While the FC is criticized for its gap filling approach, the PC is accused of encouraging expansion of bureaucracy and increasing debt burden for the states. While there is an element of truth in these accusations, it is imperative to recognize that the issues involved are far too complex to be so caricatured.
The most important causative factor for the widening regional disparities in the country has been the retrogression of the central and state finances. The root cause of the fiscal crisis at the Centre as well as in the states has been the rise of powerful vested interests that appropriate a major share of public finances to the disadvantage of the rest of the society and economy at large. These powerful lobbies inflict great harm to the public exchequer by ensuring maximum gain from public expenditure with minimum payments.
The principal vested interests operating in the economy could be broadly characterized as the desi industrialists, the farm lobby, the bureaucracy and the trade unions. All of them, one way or another, receive patronage from the political class. Indeed, there is a strong and often unholy alliance between the ruling politicians and these vested interests to their mutual advantage.
Recent studies5 indicate that the total subsidies provided by the Centre and the states together account for about 15% of the gross domestic product (GDP). Further, about two-third of such subsidies are of a non-merit nature, i.e. they are on goods and services that are not in the nature of public goods or are not provided on egalitarian considerations. In other words, about 10% of the GDP, that is roughly equal to one-third of the government expenditure, is going as direct and indirect subsidies to the influential segments of society. Though subsidies are often introduced and maintained in the name of the poor, they mostly subserve the non-poor. Again, several subsidies originated in the name of economic efficiency and growth, but their continuance is at great cost to the same objectives.
The current mess associated with the reforms in the power sector has its genesis in subsidized power supply to certain categories of users, especially to the agricultural users. Originally, such subsidy was to encourage spread of groundwater based lift irrigation. Over the years competitive populism and powerful commercial farm lobbies have converted almost all the State Electricity Boards (SEBs) to sick units.
Attempts to cross-subsidise one class of customers by others led to rampant power theft and private power generation by industry. Even after cross subsidization, the annual loss of the 19 SEBs adds up to over Rs 30,000 crore. Since the SEBs are in huge overdues to several central public sector undertakings, their finances, in turn, are also in doldrums. Over the last five years serious efforts have been made to reform the power sector by the Centre and the states. The progress so far, however, is not worth reporting.
Asecond messy area involving considerable loss to the public exchequer and to the public is the current food security system. As of now, the public foodgrain stock is about 60 million tones against the required stock of about 15 million tones. As against an average price of Rs 550 per quintal paid to the farmer, the economic cost to the public agencies is over Rs 900 per quintal.6 There is only negligible off-take through the public distribution system (PDS). Even at the best of times, PDS only marginally benefits the poor households in the backward states.
Indeed, the huge foodgrain stock held at enormous public cost has done great harm to the cause of the poor by removing sizeable quantities of food supply from the market, thus driving up market prices. Purchase of foodgrains at prices well above the market-clearing levels may serve the short-term interests of farmers in surplus regions. However, such policies have hurt the long-term interests of the very same farmers and Indian agriculture in general. Along with globalisation, India has lost its comparative advantage in respect of several agricultural commodities.
Fertilizer subsidy places another heavy burden on the central exchequer. It is well known that a significant share of this subsidy benefits the fertilizer industry and not the farmers. Again the original purpose of the fertilizer subsidy was to encourage spread of green revolution technology to new areas and farmers. The spatial and seasonal distribution of fertilizer use clearly indicates that the lion’s share of the subsidized fertilizer was used by commercial farmers for a few crops in agriculturally developed regions. Since most of them get the benefit of support price operations, phasing out of fertilizer subsidy and the corresponding increase in cost of production can easily be handled. The political fallout of such a rational policy may, however, be difficult to handle.
The single-most powerful lobby in the country, no doubt, is organized labour and the bureaucracy. The power of the organized labour force that accounts for less than 10% of the workforce in the country, can be gauged from the fact that all the major political parties pamper them. None of these parties identify their destinies with the greater numbers of unorganized labour. A principal cause for the current crisis of public finance in the country was the salary revision of the government employees at the Centre and in the states following the report of the Fifth Pay Commission. The political bosses readily acceded to the employees demands irrespective of the paying capacity of the exchequers.
An immediate fallout of the pay revision for the bureaucracy was similar pay revision for the employees of the central and state public sector undertakings (PSUs) and the teaching community whose wages are paid through grants-in-aid by the state. A vast majority of the PSUs, numbering about 250 at the Centre and about 1000 in the states, incur losses. But their bloated staff, backed by powerful unions, received double the wage, often for half the work, in comparison to similar private sector firms. Also, there is little evidence of improvement in educational standards on account of government taking over responsibility of salary payments to school and college teachers. The available evidence, in fact, contradicts this expectation.
The fiscal strains experienced by the governments at the Centre and in the states as a result of the liberal handouts in the form of higher salaries and subsidies have been further accentuated by their decelerating revenue collections. The tax reforms at the Centre, contrary to expectations, resulted in a decline in the tax to GDP ratio. Unlike other countries that carried out similar tax reforms, we brought down tax rates without removing the plethora of exemptions and concessions.
At the state level, huge tax concessions and exemptions offered to private industry competitively to attract investments by different states resulted in loss of considerable tax revenues without any gains collectively to them. Indeed, the main losers were the developed states that succeeded in attracting considerable private investments. Several of them experienced a major reduction in tax to GDP ratios during the ’90s on account of this. Reduced own revenues along with reduced central transfers resulting from reduced central revenues caused a fiscal crisis in most of the forward states. This, indeed, has resulted in their hardened stance against central fiscal transfers to the backward states.
The acute fiscal crisis of the backward states was the creation of the ruling elite in those states themselves. They mindlessly implemented the revised central pay scales without looking at their paying capacity. While central pay scales in richer states may not be incompatible with their paying capacity, they are totally out of tune with the average incomes of the people in poor states. A number of such states currently find themselves in a situation where their entire revenues are not enough to meet their salary and pension obligations. These state governments have truly become ‘by the bureaucracy, for the bureaucracy and of the bureaucracy’.
What is the image and message such state governments have left for a new generation of job seekers? Any rational young person would seek employment in the government where pay is good and work is seemingly light. There will be tremendous pressure on expansion of government employment while the professed policy of the state governments is to down-size their bureaucracies.
The plight of the state governments in the developed states is not much better. Most of them fit into the Galbraithian description of ‘affluent societies’, i.e. private affluence co-existing with public poverty. While the economies of these states grew at high rates during the ’90s, their public exchequer became weaker and weaker. Further, a number of these states have serious intra-state regional disparities in economic and social developments. Just like the Centre that has the responsibility to address inter-state regional disparities, these state governments have the responsibility to address intra-state regional disparities. Strengthening central and state finances by way of raising revenues and cutting wasteful expenditure appear to be the ideal course. In any case, the state cannot abdicate its sovereign responsibility.
* The views expressed in this article are strictly personal. The author is grateful to Rohit Sarkar for helpful comments.
1. For details see ‘District-wise Social Economic Demographic Indicators’, National Commission on Population, Government of India.
2. Punjab and Haryana, though still high income states, suffered relative stagnation during the post-reform decade. Kerala, though socio-demographically at the top could not gain much economically during the post-reform period.
3. Rajasthan’s poverty ratio is 15.3%, which is a bit of a surprise even for the Rajasthan government.
4. Indeed, in respect of certain other indicators of economic activity/prosperity like telephone density, vehicle density, equity participation etc., the gaps have widened even further.
5. Several studies have been carried out by the National Institute of Public Finance and Policy relating to subsidies in the recent past. Based on one such study, the Ministry of Finance brought out a white paper on subsidies in 1997.
6. The longer the foodgrain is stored the higher the economic cost but the lower its market-ability.