INDIA is, first, foremost, and wholly, a Union of states. Thanks to its Constitution and to its history, it has a powerful Centre; thanks to its political diversity and cultural variety, it has needed federalism to survive. Yet today Indian federalism, and thus the integrity of the Union itself, face unprecedented threats.

These threats can be categorized along three axes: economic, social, and political. The economic axis is perhaps the most obvious, and the easiest to describe. This Union of states has an economy that is seething with competition, rather than cooperation, and at several levels. The Union government and the state governments taken as a whole are in competition for tax resources; and the state governments themselves are additionally competing against each other for those same resources.

Meanwhile, India’s recent decades of growth and development have been geographically unbalanced. In other words, not just Indian state governments but also their economies are competing against each other, especially for investment, and there have been clear ‘winners’ in this race.

Essentially, Indian states are on different economic trajectories. In the development literature, it is usually argued that poorer areas grow faster than richer ones, a phenomenon known as ‘convergence’, since it means they will converge to an equal per capita income. But, if the areas in question have different economic fundamentals, then the end point of this convergence might well be different levels of income – which is known as ‘club convergence’. This is likely what is happening in the case of India.

Most economic research on the subject has suggested the presence of club convergence in India, rather than absolute convergence. For example, some research has suggested that two such ‘clubs’ of states have formed since 1965, in a process that picked up pace in the 1990s: one group of states converging to about 50 per cent of national per capita income, and another towards 125 per cent of national per capita income.¹ Other work has found three different clubs of states, at different relative levels of poverty.²

In fact, more basic studies of recent experience suggest that, rather than absolute convergence, India faces ‘unconditional divergence’; for example, in the 2000s the growth rate of the richest four regions was 1.6 times faster than that of the poorest four regions.³

 

Economists have confirmed the common sense observation that some parts of India are growing faster and in a distinct manner from other parts of India. The areas that appear to be converging to a lower equilibrium in terms of per capita income are, in particular, Uttar Pradesh, Bihar, Madhya Pradesh and other similar regions. Meanwhile the coastal states, particularly in the West and South, are racing ahead.

This pattern has become so established both in the data and in popular imagination that it may be hard to recall that till as recently as the 1990s, there was little difference in terms of poverty or income levels between (undivided) Andhra Pradesh and Uttar Pradesh. But, as pointed out by Mudit Kapoor and Rahul Ahluwalia,⁴ the difference since then has been striking. In 1993-94, AP’s per capita income was 1.5 times UP’s; in just over a decade, it was more than twice UP’s. If we believe the club convergence story, then it is likely that while both states have seen economic growth, AP has converged to the higher, coastal club, while UP is converging to the lower, inland agrarian club.

 

The human implications of this differential performance are worth stressing. While, in 1993-94, the ratio of people below the poverty line to the total population of the state was almost identical in both states, by 2011-12 the difference in the same ratio was 20 percentage points. About 30 per cent of UP was still below the poverty line by national standards, while less than 10 per cent of AP was.

Addressing this divergence is not easy. In a command economy, as India was prior to 1991, measures to reverse geographically unbalanced development could more easily be applied. But these policies are usually anti-competitive, costly, and sometimes counter-productive. Freight equalization, for example – a policy under which the government subsidized the movement of natural resources to less resource-rich areas – was meant to ensure the spread of industry to less served areas, but merely built up the industry of the western coast at the expense of the East.

Theories of club convergence argue that the formation of these clubs depends upon certain characteristics of each region. Economists who have detected clubs forming in the growth patterns of Indian states have tried to isolate various such characteristics – from the proportion of irrigated land and the density of infrastructure, to the literacy rate. What is of most concern, however, is that so many of the possible determinants relate to social indicators that are not quickly changed through government spending or transfers.

 

Yet the vast and apparently growing difference between states in terms of their economic performance has nevertheless lent an additional urgency to the political competition between the various states, and between them and the Union government, for tax revenue that funds spending and transfers.

Inter-regional transfers are a fact of life in democracies. Greater geographical differences in terms of income within a political unit naturally tend to be associated with greater transfers of tax revenue across regions. The question is whether the better-off states have much to complain about in the Indian case.

It is often argued, for example, particularly in Tamil Nadu, that it receives from the Centre only 30 paise or so for every rupee it contributes to the central kitty, while Bihar receives two rupees for each rupee that it puts in. That is certainly one possible way of looking at how much is being transferred. (As an indicator, the tax sourced from a particular territory overstates the actual ‘contribution’ of the residents of that area because it includes corporate taxes paid by companies that might operate and earn profits outside that territory.)

But, once normalized by population, the picture becomes a little more complicated. Consider, for example, the question of their share in net central tax revenue as seen in the Union Budget documents.⁵ In 2018-19, Tamil Nadu was allocated about Rs 4,700 per capita as its share; meanwhile, Bihar received Rs 7,600 or so. The average disbursal to states was Rs 5,900 per capita. Given the differential in terms of income between the two states, a difference of under Rs 3,000 per head might not be considered that vast.

 

But the amount that Tamil Nadu and Bihar receive per capita to spend from the pool of taxes is constrained in two crucial ways, both of which are open to political contestation. First, the actual amount is partly determined by the formula for division between Union and states, and between states, that is set every five years by the Finance Commission. And, second, a proportion of the total amount they receive is ‘tied’ to certain specific schemes and programmes, which reduces the political and budgetary choices of the elected state government.

Such tying of states’ resources has been common for decades but is, even so, a blatant violation of constitutional norms. Constitutionally, the Seventh Schedule lists the policy domains – ‘subjects’– that state governments are responsible for, those the Union is responsible for, and those that are shared between the two. The idea is that tax revenue will be shared between the Union and the state governments so that the states can spend on their subjects, and the Union on its subjects.

But the Union, with the connivance (if public disapproval) of finance commissions, has reduced the freedom of action for states by taking the lion’s share of funds and then passing it on to states not through regular channels but as grants under Article 282 of the Constitution, an afterthought of a clause that allows for ‘miscellaneous’ transfers. In other words, the Union might not have the Constitutional right to regulate, say, school education; but it can, through the use of conditional grants to states under Article 282, effectively amass regulatory power in that domain that was not granted to it by the Constitution.

All ‘centrally-sponsored schemes’ were and are an assault on Constitutional federal principles. Unsurprisingly, state governments resent the schemes, which are not designed in state capitals with their needs in mind – and, in some cases, are presented as ‘gifts’ from the political leadership at the Centre, even when the administrative resources used for their implementation belong to the state government. Over time, therefore, the Union’s arrogation to itself, through Article 282, powers granted to state governments has seriously weakened Indian federalism.

 

The Union government has also sought ways to augment the amount it takes from the tax pool at the expense of the states. For example, it frequently announces ‘cesses’ and surcharges, such as on fuel; such levies go straight to the Centre’s kitty, and do not have to be shared with the states.

But perhaps most worrying is its recent, last-minute, revision of the terms of reference for the Fifteenth Finance Commission. While the constitutionally mandated commission is supposed to be an impartial arbiter of how to divide the Indian state’s resources, its terms of reference are set by the Union government alone. In July this year, as the commission was already preparing its report, the Union government added to its terms of reference the requirement that the allocation for defence and internal security be set aside in advance, and only then the taxes be divided between the Centre and the states.

Currently, of course, the defence budget comes out of the Union government’s share. So this was seen as a blatant attempt to force the commission to give the Union government more fiscal space at the expense of the states – after the states had already submitted their requirements to the commission under the previous terms of reference. Again, the spending needs of state governments collectively – which are, in the end, responsible for a majority of the most vital services for Indian citizens – were being subordinated to the demands of the Union government, in a manner quite at odds with constitutional principles.

 

The original terms of reference⁶ for the Fifteenth Finance Commission were already controversial. They instructed the commission, in the words of its chairman, to find ‘monitorable performance criteria on things like progress made on ease of doing business, demography management and whether or not a state is deliberately pursuing a populist policy.’ In addition, it needs to consider the state’s ‘achievements in implementation of flagship schemes of Government of India.’ In other words, Union government schemes seem by definition to be non-‘populist’, and states that sign up to implement them will be rewarded with additional funds; while the finance commission must decide in advance which state policies are ‘populist’.

This is an obvious double standard. Like many actions of the Union government in the recent past, it serves to reduce the policy-setting room of state governments while expanding the fiscal resources of the Centre at their expense.

But perhaps the most controversial demand from the Union government related directly to the division of resources between states. In particular, all commissions are supposed to take states’ relative population sizes into account when calculating the division of funds between them; but the population shares had remained those found by the 1971 census. This is for an excellent reason: some states have entered a demographic transition, in which their fertility rates had fallen sharply and thus their population stagnated, while others were yet to enter that stage.

 

But the Fifteenth Finance Commission was told by the Union government to use the 2011 census instead. This would significantly increase the revenues allotted to states like Uttar Pradesh, Bihar, and Madhya Pradesh, and decrease those of the southern states and West Bengal. By some calculations, had the last finance commission used the 2011 census, those states would have received Rs 20,000 crore less to spend.⁷ This is not a small amount. Worse, it creates the impression that states which have worked harder on female empowerment and population control are being punished for their efforts.

The demographic difference is crucial to the story here. The states that have already gone through their demographic transition have total fertility rates (TFR, essentially the number of children born per woman) below 2.1, the rate at which populations are replaced. In other words, they have stopped growing. Tamil Nadu and West Bengal in 2016 already had European rates for TFR, at 1.6. Meanwhile, Bihar had a TFR of 3.3. In other words, there is a different demographic trajectory at work in these two groups of states, just as there are differing growth trajectories in most of the North and much of the coast.

The demographic difference reflects real differences in social policy, and perhaps the socio-cultural environment. Reporting on the fertility rate differences, The Economic Times pointed out that ‘Bihar, which recorded the highest fertility rate, had the highest percentage of illiterate women (26.8%) while Kerala recorded the lowest (0.7%).’ Other indicators of a more liberal social milieu, progressive policy and of female empowerment, such as the female labour force participation rate, might also be similarly correlated. The demographic divide is thus a social divide.

The Economic Survey for 2019 made some explicit predictions about what lay ahead for state populations. In spite of fairly aggressive assumptions about how swiftly TFR would decline in the North – down to 2.5 by 2021 in Bihar – the numbers underline how differing rates of population growth across regions might create a tinderbox.

 

In 2016, Tamil Nadu had about 75 million people, and West Bengal 91 million. In 2041, they might have, according to the survey, 77 million and 104 million people respectively. Meanwhile, Bihar and Uttar Pradesh today have just over 300 million people. But, in 2041 – even with the survey’s optimistic assumptions – they would have 423 million people. The ratios are turning ever more sharply against the coastal states. The unquestionable consequence of this will be demographic anxiety, and anti-‘outsider’ sentiment.

Thus a change in how shared resources are distributed is not an abstruse technical matter that interests only economists. It goes to the heart of a central political fault-line in India today, one that spans the social and economic spheres. The more prosperous and socially advanced states will feel they are increasingly called upon to finance spending in less advanced states that are not even showing signs of catching up in either social or economic indicators. What has, in the past, been a battle between the Union government and the state governments about resources is now a burgeoning divide between two groups of states – and, worse, a divide that both flows from and mirrors very real political and cultural divisions on the ground, which have taken on an increased urgency since 2014.

 

The general elections of 2014 were a turning point for Indian federalism. First, the age of coalitions had come to an end, after a quarter century that greatly empowered regional parties and state level leaders. This in itself took India back to an earlier paradigm, one that had vanished with the defeat of Rajiv Gandhi in 1984 – a paradigm in which a single party easily dominated at the Centre and thus naturally saw government in state capitals as being subservient to New Delhi instead of being forced to view them as difficult but necessary partners.

But there was an additional twist to this situation. For the first time in Indian history, a government had been formed at the Centre which had no real need of southern or eastern votes. During the previous single-party period, the Congress was the major presence in each state of the country, and big inter-regional political bargains could be made within the organization. This was no longer the case. Yes, the BJP aggressively seeks to expand into geographies in which it has no historic or cultural roots. But the plain fact is that its dominance in the North and West was sufficient to grant it a parliamentary majority, and the South and East has noted that.

The electoral faultlines of 2014 do not correspond perfectly with the demographic and economic divisions discussed above. Gujarat is growing fast, but is a BJP stronghold; Delhi, which the BJP swept in 2014, had a total fertility rate of 1.6 in 2016. But there is enough of an overlap to indicate the very real possibility that a culturally distinct, demographically stable, and economically dynamic swathe of India might be turned into a permanent political minority – and forced to finance, through transfers, growing and less productive populations elsewhere from which it is increasingly politically (and culturally?) alienated. This is a recipe for crisis.

The only way to rescue India’s constitutional structure and to restore health in federalism under these circumstances is through responsible politics, especially at the Centre. This is somewhat thin on the ground at the moment. But there are timeless principles that need to be applied. Writing in these pages in the September 1984 issue of Seminar, Nirmal Mukarji – a former Cabinet Secretary and also, less relevantly, this Seminarian’s grandfather – argued that for federalism to work it must be an ongoing political project, one in which political parties allow space for the ‘other’:

‘Learning to live with ‘other’ parties in practice means two things. One is abiding by the rules of the federal game; and the rules that really matter are (a) a fair and assured devolution of finances and (b) an end to destabilisation, whether by misuse of President’s rule or by defection… The other is evolving a consensus on essential policies and programmes… of course, "other" parties will have their respective ideologies and they must be allowed scope to innovate.’

These basic principles are increasingly ignored today, even though the crisis of federalism is considerably more urgent than it was four decades ago.

 

Footnotes:

1. This estimation of the relative incomes of the two clubs comes from S. Bandyopadhyay, ‘Rich States, Poor States: Convergence and Polarisation in India’, Scottish Journal of Political Economy 58(3), 2011, pp.414-436.

2. In M. Ghosh, et al., ‘Regional Divergence and Club Convergence in India’, Economic Modelling 30, 2013, pp. 733-742.

3. This calculation was performed in R. Cherodian and A.P. Thirlwall, ‘Regional Disparities in Per Capita Income in India: Convergence or Divergence?’ Journal of Post Keynesian Economics 37(3), 2013, pp. 384-407.

4. In Arvind Panagariya and M. Govinda Rao (ed.), The Making of Miracles in Indian States. Oxford University Press, Delhi, 2015.

5. https://www.indiabudget.gov.in/budget 2018-2019/ub2018-19/rec/annex4.pdf

6. Available at https://fincomindia.nic.in/writereaddata/html_en_files/fincom15/TermsofReference_XVFC.pdf

7. See V. Bhaskar, ‘Challenges Before the Fifteenth Finance Commission’, Economic and Political Weekly 53(10), 2018.