With a host of macroeconomic problems and paradoxes confronting the economy, some extremely dangerous trends in policymaking at the state level are going unnoticed. Even as India has increasingly turned into an open economy over the past 20 years, the economies of its constituent states are getting increasingly protectionist.
These restrictive fiscal measures apart, even physical controls are being enforced. Orissa has stipulated that 60% iron ore mined there must be used within the state. Karnataka has taken it upon itself to decide on the actual quantity each iron ore mine can produce and supervise its utilization.
All these new levies, be it in the form of a entry tax, or an extraction cess or a export duty are in addition to existing taxes/duties by the government and not in line with the overall direction of tax regime that the country is moving towards. There is little surprise then that consensus has eluded the imposition of a supra state tax such as the goods and services tax.
Underlying the creation of these fiscal barriers is essentially a restrictive policy of economic protection. These state governments are imputing and adding an economic element to the administrative and political boundaries of a state. The administrative boundary of a state is being slowly, but surely, converted into an economic border.
At the moment, these steps are being taken by a few resources-rich states to primarily prevent the outflow of scarce local raw material or the sale of non-locally produced goods within their areas. But there is nothing that prevents these steps from being extended to other areas or states. There is now an unmistakable trend of rising “regional protectionism” within India.
There are obvious reasons for rising protectionism at the sub-national level.
First, of course, is the serious economic disempowerment of state governments under the new economic regime. The economic liberalization from 1991 along with political decentralization has put state governments in a pincer: with the Union government squeezing them from the top and the panchayats pushing them from below.
As matters stands today, companies, and in some cases even individuals, have greater flexibility in managing their economic affairs than the state governments. Be it access to foreign borrowings or changing tax rates or bases or sheer allocative powers of public expenditure, the operational powers of states have been seriously curtailed.
Second, the fiscal experience of sub-national governments has been less than beneficial under the new economic dispensation. The brunt of fiscal contraction, whenever it has happened, has been borne by the states through a reduction in central transfers.
Their power to raise revenue and decision to allocate expenditure stands severely curtailed. For instance, the free and unencumbered central assistance to state plans is not more than 20% the total plan size. The remaining transfers are drafted and designed by the Union government. The states are mere executing agencies. Ideally, as globalization deepens and its impact gets stronger in the domestic politics of each country, the policies of sub-national governments take on an increasingly significant role in determining the future of open global markets.
No one seems to be thinking how these protectionist policies can affect macroeconomic liberalization. A deeper internal economic integration of sub-national economies is a must for further globalization. In fact, except in the financial sector, liberalization is just a policy at the national level; its real arena are markets in the states, be it product markets, the land market or the labour market.
It is not just a matter of one common market for globalization. The numerous barriers to inter-state and even intra-state trade and commerce, starting from regulatory to policy ones, prevents the realization of the gains from domestic internal trade.
To be sure, internal trade contributes nearly one-fourth of the gross domestic product (GDP) and provides employment to about 50 million people who are mostly self-employed and engaged in wholesale and retail trade. This is much more than the contribution of international exports-to-GDP growth and employment in India.
Finally, unless this protectionist trend is reversed, there is a serious possibility of some parts of the country becoming more closely integrated with the global economy than with their neighbouring states. This will be the beginning of the socio-political disarticulation of the idea of India which would in turn place unbearable strain on the unity and integrity of India.
Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at haseeb@livemint.com
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