Illustration: Jayachandran
Illustration: Jayachandran

The rise of the trillion-dollar state economies

However, most states do not have the economic management capabilities to deal with such size

Maharashtra has ambitiously set its eyes on becoming a trillion-dollar economy by 2025. This was stated by governor C. Vidyasagar Rao in a speech at the Vidhan Sabha in Mumbai last week, just before the state budget was presented.

Is this a case of tall talk? Take a look at the numbers. The Maharashtra economy is now around an estimated $400 billion, so the target is not beyond the realm of possibility as long as growth in nominal output stays on track over the next eight years.

There are currently only 16 countries whose value of annual economic output is more than $1 trillion. What this means is that Maharashtra could in effect have one of the largest economies in the world by the middle of the next decade. It is useful to remember that India as a whole entered the trillion-dollar club in 2007, according to data from the International Monetary Fund. Now one state is aspiring to be of that size. Further, the Indian economy was $274 billion at the time of the 1991 economic reforms. The fact that a state can now aim to become a trillion-dollar economy shows how the scale of economic activity has been transformed in India in recent decades.

But that is not all. There are another four states that have local economies in excess of $200 billion; that number would be five if Andhra Pradesh had not been bifurcated. It means four other states now individually have economies that match the size of the total Indian economy in 1991.

These states—Gujarat, Uttar Pradesh, Tamil Nadu and Karnataka —have a good chance of becoming $500 billion economies by 2025, or perhaps a couple of years later. To use the same comparison metrics as above, there are 25 national economies that are right now over $500 billion, while the Indian economy crossed that mark in 2002.

At the recent Uttar Pradesh Investors Summit in Lucknow, Prime Minister Narendra Modi said the northern state should compete with Maharashtra in the race for the $1 trillion mark. He added that such competition would strengthen competitive and cooperative federalism. Maharashtra currently has an economy that is twice the size of the Uttar Pradesh economy, so the result of such a race is pretty clear. However, the aspirational message of such a race is important as well. States are now looking at the trillion-dollar mark as an aspirational goal.

However, amid all these big numbers, the rise of these regional economic powerhouses will present challenges as well. There are two central challenges.

First, most states do not have the economic management capabilities to deal with such size. There is no doubt that the Union government will (and should) be in charge of macro policy in the broadest sense, but state governments are important stakeholders in terms of fiscal management, competitiveness, ease of doing business, infrastructure development and the provision of local public goods. It is not adequately understood that the collective size of state budgets is now larger than the national budget on which so much attention is lavished. States need to ramp up their policy capabilities if they are to deftly manage mega economies.

Second, many of the more successful states will have to satisfy the demands of citizens who have moved up the income ladder. Let us once again consider Maharashtra as an illustration. It will have an estimated 120 million residents collectively producing $1 trillion of goods and services. That would mean a per capita income of around $8,000—and even more if purchasing power parity is considered. These levels of average incomes would put Maharashtra at around where China is today. The type of government needed to meet the needs of a state at what the World Bank defines as higher middle income is radically different from the needs of a state still at the lower end of the middle-income category.

The rise of state powerhouses should change federal dynamics—both in terms of the distribution of responsibilities between New Delhi and state capitals, as well as in terms of the balance of political and economic power between states. These pressures make an effective and responsive central power in New Delhi even more important, to ensure that extreme forms of federalism do not create fault lines in the Indian union.

Do India’s states have the capability to handle trillion-dollar economies? Tell us at views@livemint.com

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