M Govinda Rao: Inclusive growth & lagging regions

Although the transfer system has been equalising, it has not been adequate to offset the shortfall in the fiscal capacity of the lagging states.

Despite considerable research on the factors causing differences in the growth rates between regions and nations and why inequalities in the living standards between people, regions and nations have persisted and even accentuated, much remains to be understood. Endowment of resources and volume of investments can provide only a partial explanation. The impact of various policies and institutions is equally, if not more, important as they impact on the investment climate and structure of incentives and thereby, the volume of investment and its productivity.

Despite the importance given, history is replete with instances where people in the regions and countries with abundant natural resources suffer low levels of living. In India, for example, the 40 per cent of the population of the country living in the six states of Bihar, Chhattisgarh, Jharkhand, Madhya Pradesh, Orissa and Uttar Pradesh generate just about 20 per cent of incomes. Also, while the country has been registering high growth rates, the growth rates registered in these low-income states is much lower. Similar trends are seen in human development indicators. Thus, not only do these states have low incomes, they also have increasing disparities. Inclusive growth calls for identifying the constraints on growth in these states and reforms in policies and institutions to remedy the situation.

The six lagging states have more than a fair share of natural resources but are not able to harness them. Almost 78 per cent of the coal deposits (including proved, indicated and inferred deposits) in the country are concentrated in the six states. Bihar (including Jharkhand) has over 29 per cent of the coal deposits. Similarly, undivided Madhya Pradesh and Orissa each accounted for about a quarter of coal deposits in the country. Bihar, Madhya Pradesh and Orissa also have significant deposits of iron ore, copper and bauxite. Almost 25 per cent of the iron ore comes from Madhya Pradesh, 42 per cent of the copper ore is produced in Orissa and another 18 per cent in Bihar. Similarly, almost 42 per cent of the estimated deposit of bauxite is in Orissa, Bihar accounts for another 18 per cent and Madhya Pradesh 10 per cent. These states have an overwhelming proportion of estimated deposits of other major minerals such as lead, zinc and manganese as well.

Thus, in India generally there are significant and increasing inter-state disparities. Second, the states lagging in development are also those lagging in human development indicators. Third, these states have lagged behind others in development despite abundant natural resources. Fourth, these states have also borne the brunt of providing the country with significant mineral resources and forest cover.

Ironically, in some states, natural resources, instead of being a lifeline, have been a source of concern. Bihar has large river systems and rich alluvial soil, but large parts of the state are under floods year after year and despite much talk about the plans to mitigate the problem, the solution has not gone beyond the drawing board. The solution requires a regional approach involving both Nepal and India. Madhya Pradesh, Chhattisgarh and Orissa have large forest areas. Forest cover is an international public good, but the states providing it bear all the costs but never adequately compensated. The area under forests is not available for cultivation and the Supreme Court judgment restricting the felling of the trees has not only robbed them of an important source of non-tax revenue, but also has denied wood-based economic activities. Besides, state governments have to incur considerable expenditures in maintaining the forests and a higher unit cost of providing public services "" be it education, healthcare or even electricity distribution "" in these areas. Although the last Finance Commission recognised the need to provide compensation to these states in principle, the amount was insignificant. Similarly, the exploitation of major minerals falls within the domain of the central government, royalty payments are hardly enough to compensate them.

The role of resources in development is only part of the story. Besides resources, the development of a region depends on both policies and institutions and interactions between them. Policies determine the volume of investments and institutions determine the structure of incentives. Policies and institutions to create an enabling environment include providing competitive levels of infrastructure, proactive and responsive governance including enforcing property rights and protecting life and property. Creating comparable competitive levels of infrastructure in lagging states requires a system of equalising transfers to (i) offset fiscal disabilities arising from a lower revenue-raising capacity and a higher unit cost of providing public services to enable these states to provide comparable levels of physical and social infrastructure at comparable tax rates; (ii) ensure minimum standards of basic meritorious public services; (iii) compensate the states for the loss of economic activity due to banning logging and additional spending required for maintaining forests and a higher unit cost of providing public services due to scarcity of population in forest areas; (iv) compensate the states for the loss of economic opportunities due to the exploitation of mineral resources by the central government.

Institutional reforms relate to creating market institutions and a structure of incentives. Analysis of the intergovernmental transfer system in India shows that multiple agencies making transfers have blurred the objective of offsetting fiscal disabilities of these states. In addition, the methodology followed by the successive Finance Commissions has helped the states with higher base-year expenditures, and not surprisingly, per capita development expenditures including infrastructure expenditures in these states have all along been significantly lower than the all-state average. Although, on the whole, the transfer system has been equalising, it has not been adequate to offset the shortfall in the fiscal capacity of the lagging states. In addition, there are several sources of invisible transfers arising from controls on prices and outputs and origin based tax system, which, to a considerable extent, nullify the equalisation done by the explicit transfer system.

The problem of lagging regions is serious and it remains to be seen how the "inclusive growth" strategy of the 11th Plan deals with the problem.

The author is director, NIPFP. Comments at mgr@nipfp.org.in