Reforms can bridge, is bridging, the two Indias

Regional disparities in India have been present for at least a century, if not more. Under normal circumstances, the processes of the market economy should generate ‘‘equalising differences,’’ whereby firms move to low-wage areas in the quest for reduced costs thus equalising differences in wages and land prices. Similarly, individuals migrate to high-wage areas, thus equalising wages, and increasing the land per capita in poor areas. These processes are expected to generate convergence of per capita GDP in the normal framework of growth theory…

(But) From the empirical evidence of the 1990s, there is some evidence of a lack of convergence. Some states, particularly the states of the West and the South, seem to have excelled in harnessing the opportunities of globalisation and the market economy. In other states, weaknesses in human capital and governance have generated reduced growth rates in the post-1990 period. This has been a source of much concern on the part of many observers, from two points of view. First, it is argued that if the economic reforms of the 1980s and 1990s failed to ignite growth in Bihar, then there is a need to find a new policy mix which can achieve high growth in Bihar.

Second, there are fears of mounting political stress that might come about if income disparities between rich and poor states widen further. There is a remarkable similarity between these problems in India and those that have been observed in China, where coastal provinces have progressed enormously compared with the interior.

While the above difficulties are real, there are also many forces at work which are steadily having an ameliorating effect.

• Flexibility of the labour market: As of today, roughly 90% of India’s labour force is in the unorganised sector, which is a classical labour market, undistorted by labour law. In addition, unlike China, India has no government restrictions on inter-state or rural-to-urban migration. This innate flexibility of the labour market will assist the process of convergence.

• Impact of new infrastructure on ‘‘equalising differences’’: Gains from internal trade are clearly an important mechanism through which poor states can obtain economic growth. This is critically related to costs of transportation. This suggests that the recent successes in infrastructure policy—particularly in roads, ports, airports, and telecom—are highly significant in thinking about regional disparities.

• Fiscal transfers: India has a well-developed system of fiscal transfers, through which taxes collected in rich states are transferred to poor states. This constitutes an important channel for convergence. While these rules have always been with us, the economic significance of these transfers improves in line with growth in GDP and in the tax/GDP ratio.

In the decade of the 1990s, India’s GDP was roughly $350 billion and the tax/GDP ratio was roughly 12%. GDP has already risen to $620 billion, giving a quantum leap in the expenditures of government. Looking forward, in a few years, if we envision GDP of $1 trillion and a tax/GDP ratio of 15%, then there will be enormously larger resource flows through existing fiscal institutions, which will generate much larger spending in poor states.

• Policy innovations: One important insight derived from the experience of economic growth in East Asia is the importance of ‘‘regional role models’’ where countries learned from each other. In the decade of the 1990s, a similar phenomenon has begun with the states. The political leadership of many states is increasingly conscious of the need to find policy innovations which would improve the quality and quantity of local public goods. Andhra Pradesh, Madhya Pradesh, West Bengal, and Kerala are all examples of states where there has been a distinct learning from the regional role models, and consequent changes in governance.

Parallel to this are two important policy innovations which are going to fully play out in the coming decade. The first is the move towards smaller states. It is widely conjectured that smaller states are more effective at catering to local variation in preferences and technology, and at ensuring greater accountability for public goods outcomes.

Uttaranchal, Bihar, Jharkhand and Chattisgarh are important experiments in this regard. It is, as yet, too early to tell whether the outcomes play out in line with the conjecture.

The second innovation is the devolution to local governments, as a consequence of the 73rd and 74th constitutional amendment. The underlying premise of Panchayati Raj is that when local citizens control public expenditures, there will be a greater likelihood of obtaining good outcomes in terms of producing public goods.

How are we faring? There is some evidence that these effects are already at work and are reshaping the nature of regional inequalities in India.

In a deliciously ironic development, the very phrase ‘BIMARU’, which symbolised backward states as of 1990, has become out of touch with the location of poverty traps! This symbolises the dynamism of regional economics in India.

Rajasthan and Madhya Pradesh have made significant progress in the 1990s. Chattisgarh, Uttaranchal and western parts of Uttar Pradesh have lower poverty. The most difficult areas are now no longer the BIMARU states, but the eastern region comprising Orissa, Jharkhand, Bihar, and eastern parts of Uttar Pradesh. This illustrates the mutability of poverty traps in India, and suggests that there are forces at work through which poor regions can obtain convergence.

(Kelkar, Economic Adviser to the Finance Minister, is a part of Team Budget 2004. This is an excerpt from his K R Narayanan lecture at the Australian National University, Canberra.)
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