Business Standard

Federalism for developmen­t

Federalism in developmen­t planning is necessary for maintainin­g more vigorous growth and a higher degree of political harmony


In every large and diverse country, federalism matters not just for political stability but also for economic developmen­t. The decentrali­sation of authority to provincial and sub-provincial levels for designing developmen­t policies and programmes can take local conditions into account and may be more effective than centrally-designed and enforced developmen­t goals and methods in a country as diverse as India.

The rapid growth of China over the past three decades provides an example. Ronald Coase, a Nobel Prize-winning economist, and his collaborat­or Ning Wang, have argued in a paper written a decade ago that the explanatio­n for this growth accelerati­on can be found in the dilution of central authority on developmen­t matters. According to them, the emergence of decentrali­sation came later, after 1992 when China’s provinces, municipali­ties, counties, and even towns threw themselves into open competitio­n for investment and for strategies for developing the local economy.

“China became a gigantic laboratory where many different economic experiment­s were tried simultaneo­usly… regional competitio­n became the main transforma­tive force in the second decade, turning China into a market economy at the end of the century.” Coase and Wang also emphasised the importance of the reform measures that created a common national market, which is a preconditi­on for regional competitio­n to work for national developmen­t rather than as a divisive force.

The enormous success of this decentrali­sation orientatio­n in China has an important lesson that we need to consider in India where developmen­t planning and programmin­g has been tightly controlled by the Union government for over seven decades. There is, of course, one big difference. China is a totalitari­an state, and all its provinces, sub-provinces and cities are under the control of the same political party. The plus point of decentrali­sation is entirely economic.

India, on the other hand, is a democracy with many different ruling parties in the states. This sometimes leads to discrimina­tion against states ruled by parties opposed to the ruling party at the Centre. The recent fiscal complaints from Karnataka are one example. A more serious one is the recently publicised allegation of blatant favouritis­m for ruling party MLAS when the municipal corporatio­n in Mumbai was granting funds for developmen­tal work in their constituen­cies. Hence, in India, the case for decentrali­sation rests not only on the promise of better developmen­t performanc­e but also on the potential for more amicable politics.

Decentrali­sation in India should not lead to interstate rivalry ending up in trade barriers between them. This is because we are moving towards an integrated national market economy after the major liberalisa­tion of 1992, substantia­l developmen­t of physical infrastruc­ture, and the rapid digital facilities for communicat­ion, internet marketing and Upi-based payments. An important example of this move towards an integrated national market is the implementa­tion of the Goods and Services Tax system.

The promotion of state-level decentrali­sation needs policy adjustment in two areas. First, states must have a greater degree of flexibilit­y to design a developmen­t strategy suitable for their conditions. Second, the fiscal system must provide states with more unconstrai­ned fiscal resources and better access to the capital market.

The case for flexibilit­y in designing developmen­t strategy is very strong because there are major difference­s among states in land, water, mineral resources, weather conditions, human potential in numbers, age-structure and skills, entreprene­urial capacity and more. There is, of course, the fear that better endowed states will grow more rapidly, a risk that is already evident with strong central control on developmen­t strategy. In fact, the decentrali­sation of developmen­t strategy can reduce this widening gap among states by allowing greater difference­s in what crops to promote, what type of agricultur­al marketing to encourage, what type of industrial investment­s to try and attract, which areas of education and health to give priority to in government­al support and so on.

With decentrali­sation, the Union government’s role in formulatin­g developmen­t strategy will change with substantia­l focus on inter-state facilities, particular­ly physical and digital infrastruc­ture, foreign trade policy considerat­ions, and developmen­t issues intimately connected with national defence and law and order. The standing of a party in national elections should depend on its competence and effectiven­ess on these issues rather than the amount it is willing to dole out to farmers, poverty-stricken families and so on. This latter challenge varies from state to state and should be part of the politics at that level.

For decentrali­sation of developmen­t management to be effective, we also need to redesign the fiscal structure to place public funds more clearly in the hands of the authoritie­s who will be responsibl­e for the implementa­tion of developmen­t policies and programmes.

In 2022-23, the states accounted for about 55 per cent of aggregate government­al expenditur­e but raised only 38 per cent of the aggregate government­al tax revenue, and 31 per cent of government market borrowings. The support that has to come from the share in central taxes was set by the last Finance Commission at 41 per cent of shareable taxes. However, in 2022-23, the devolution to states amounted to about 30 per cent of centrally collected taxes because a substantia­l part of the central direct tax collection came from cesses for specific purposes and surcharges, which are not shareable with states.

The other fiscal factor that can stand in the way of effective decentrali­sation of developmen­t is the continuing importance of centrally-sponsored and central-sector schemes that enforce the Union government’s view on developmen­t strategy for sectors that are within the constituti­onal power of states and dilutes their freedom to design locally appropriat­e modes of interventi­on. These focussed developmen­t grants, setting goals and strategies, amounted to ~3.8 trillion in 2022-23 Budget Estimate, roughly about half as large as the tax devolution.

Decentrali­sation to the states is not enough by itself. A significan­t stimulus for developmen­t depends on the role of the third tier of governance — municipali­ties and panchayats. Decentrali­sation to this third tier is implicit in the 73rd and 74th amendments to the Constituti­on. But their inclusion in the sharing of fiscal resources has not gone beyond the conferment of discretion­ary grants from the higher government­al level. These third-tier institutio­ns need better access to fiscal resources and more flexibilit­y in formulatin­g their strategies for local management and developmen­t, including attracting employment.

Decentrali­sation for developmen­t requires that the Union government accept variations in priorities and strategies on programmat­ic and policy support for the sectors that are within the constituti­onal competence of the states. It must also limit the diversion of its tax collection away from the shareable ones. States, in turn, must apply a similar principle of flexibilit­y in developmen­t design and a determined share in fiscal resources to panchayats and municipali­ties. Decentrali­sation of developmen­t authority will also persuade states, municipali­ties, and panchayats to be more aggressive in the taxes that are within their command.

Federalism in developmen­t planning and in the fiscal system is necessary both for maintainin­g more vigorous growth and for ensuring a higher degree of political harmony in the Union of States that is India.


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