M Govinda Rao: Regional disparities - Whom to blame?

The focus on reducing fiscal deficits as part of fiscal adjustment has not helped matters much in poorer states

There is considerable concern among the policy makers about growing regional disparities in the country. Although time series of comparable gross state domestic product (GSDP) estimates do not exist, the available evidence shows significant increase in regional disparities coinciding with economic liberalisation. Attempts to understand this phenomenon are few, despite its potential dangers to the long-term growth and stability of the country. The common perceptions are that, first, the disparities have increased after structural adjustment in 1991 and, second, productivity in the poorer regions in the country is low and it makes little sense to direct investments to these regions in the interest of accelerating economic growth.

An analysis of distribution of per capita GSDP among the non-special category states shows steadily increasing inequalities and this is attributed to the introduction of structural adjustment in 1991. However, the accentuation in inequalities actually started from the mid-1980s and not in the 1990s and the data from 1990-91 according to the base of 1993 essentially show continuation of the trend rather than any accentuation (see graph). Thus, economic liberalisation has benefited the states with stronger manufacturing and service sector bases and better access to markets than the states that are predominantly agricultural.

In a planned economy, the volume of investment and its regional spread are determined by the government and, therefore, given the endowment of natural resources and nature and quality of institutions, the pattern of regional growth is largely determined by the volume of investment. Investment may be made either directly by the central government or through transfers to states, besides by the private sector. In India, it is difficult to trace the incidence of direct spending by the central government. However, an analysis of investment in central enterprises shows that in 2003-04, despite repeated pronouncements on regional equity in successive five-year plans, the states with below average per capita incomes with a population share of 45 per cent accounted for only 29 per cent of the stock of capital and 41 per cent of the total employment in central enterprises in 2003-04. The story of Bihar is even more telling. The poorest state, with about 8.2 per cent of the country's population, received just 2 per cent of the capital stock and accounted for about 1 per cent of employment. Even the investment made in the poorer regions has not had the desired forward linkages because the freight equalisation policy denied any forward linkages, and, although this policy has been given up, it is not possible to reverse the past investment decisions.

If planning did not help to place the poorer states despite being well-endowed with natural resources, on a level playing field, the transfer system failed to enable them to harness them for development. The transfer system, particularly those by the Finance Commission, has had some equalisation, but it did not entirely offset the fiscal disabilities from low taxable capacities. This is because, in the very nature of their methodology of taking the base year numbers and making projections therefrom, they have imparted the bias. The "tyranny of the base year" was to condemn the poorer states for low expenditures assessment because they incurred low expenditures in the base year. At the same time, there have been several invisible sources of regressive transfers from inter-state tax exportation, output and pricing decisions and even from priority sector lending.

The focus on reducing fiscal deficits as part of fiscal adjustment has not helped matters much in poorer states. In fact, Uttar Pradesh and Bihar tried to contain revenue and fiscal deficits by drastically compressing expenditures. In Bihar, relative to GSDP the average revenue deficit for 2000-03 was less than 2 per cent and the average fiscal deficit was 4.6 per cent and in Uttar Pradesh the respective figures were 3 per cent and 5 per cent. The average revenue and fiscal deficits for major states were 3.2 per cent and 5 per cent, respectively.

Not surprisingly, average per capita aggregate as well as developmental expenditures in low-income states in 2003-04 were, respectively, Rs 2,577 and Rs 1,511, and these were almost 45 per cent and 42 per cent lower than those of above-average income states. In Bihar, development expenditure at Rs 1,076 was virtually one half of the average of major states by (Rs 2,034). This is indeed a precursor to increasing disparities. Thus, despite all policy interventions and impressions to the contrary, development spending in poorer states has continued to be significantly lower.

Often, it is contended that larger transfers of resources to these states or making public investment in them would be wasteful. As these states have failed to even protect property rights and the law and order situation is worrisome, even the private sector has shied away from these states in spite of bountiful natural resources. There is considerable evidence of low levels of governance. In the absence of effective governance, the rate of return on crime is high, and naturally, there is a strong nexus between politicians, bureaucrats, and criminals. The solution, however, does not lie in bypassing these states and the stability of Indian federalism lies in finding solution to these problems. Improving overall governance in these states is urgent and both the Centre and states will have to work towards this end.

The critical issue is that alongside improving governance, it is necessary to significantly augment spending on both physical infrastructure and human development in these states. Surely, there is no credible evidence to show that the capital-output ratio in these states is higher and, therefore, increased spending in these states may be desirable for both growth and equity. Infrastructure spending could improve overall productivity and help to accelerate growth and reduce poverty, which is concentrated in these states. Increase in human development, vocational training and improved access to markets could, in addition, increase mobility and which may improve the capital-labour ratio further. Thus, the strategy works both in augmenting scarce capital and providing the environment for excess labour to move into places where it can be productively employed. Indeed, adopting this strategy is imperative from the long-term perspective of the country.

The author is Director, National Institute of Public Finance and Policy. Comments at mgr@nipfp.org.in