Laveesh Bhandari, director of economics research firm Indicus Analytics, is co-author of a report titled Economic freedom of the states of India 2012 that was released last week. Using indicators such as the level of interference by the government, legal structure and laws regulating labour and business, the report measures the economic freedom in different states. In an interview, Bhandari spoke on the performance of states and the importance of economic freedom to attract investments and fuel growth. Edited excerpts:

What is the central takeaway of the report?

The report measures economic freedom and its evolution among the states of India. It has been doing this for about 10-odd years. What we are finding is that there are all kinds of states that are making tremendous progress in improving economic freedom.

These states are not just those that are typically considered to be advanced states. Among the topmost states are states like Madhya Pradesh, which for many years in the past was considered to be part of the Bimaru (Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh) states, but is now progressing very rapidly.

Then there is a state like Gujarat, which has been attracting a lot of investments, in part because of the freedom-oriented policies of the government. And by freedom here I mean economic freedom.

So a first major takeaway is that all kinds of states are improving in India and that is contributing to overall economic growth in the country, which is being driven from the states rather than liberalization of Central government policies.

The report finds that although economic freedom has improved at the state level, it has slipped at the national level. What is the reason behind this difference?

The national average, at least in the last two years, has not grown much. But there are some states that are growing very rapidly. Gujarat is one, and Madhya Pradesh is another. Even a state like Bihar is improving tremendously. Increasingly, what we are finding is that some governments at the state level are centralizing power within the chief minister’s office. The chief ministers in some states are able to drive policies that are much more coherent and cohesive than typically what’s seen in the past. This is not happening in many other states and not at the centre.

There was this line of thought that if you draw a straight line from Kanpur to Kanyakumari in the south, the states to the right of it are not doing well economically. Does this still apply?

That is not true any more. There are many states in the north and east that are doing very well and those from the south and west that are not doing very well.

Among the states that are not doing well today is West Bengal. You would have expected things to have improved there but actually things are worsening there in terms of economic freedom. That’s something we need to be careful about. Economic freedom has an impact on investment and, therefore, on growth in the medium to long term, though immediately it may not show up.

Then there is a state such as Jharkhand, which is among the poorest performing states of India today. Essentially, a whole lot of political instability and inability of the coalition to work has actually led to its poor performance. But a state like Bihar, which is lagging in the index, is improving at a tremendous pace.

Does economic freedom necessarily ensure investments come into a state?

In the long term, if you are able to deliver economic freedom, not just international and out of state investments, even domestic investments tend to be greater in areas where there is more economic freedom. It also translates to greater employment and growth and so on.

Economic freedom is the most important thing in the long term for investments to flow in. But given that there is also the issue of law and order situation in any particular state. For instance, you may have a state like Jammu and Kashmir, which might be performing very well in many aspects. Or, for that matter, many of the eastern states where there is the Naxalite movement.

But, because of the conditions there, you may not get that kind of rapid growth or that rapid increase in investment. Insurgency is going to be an important factor. But it will have a short-term impact, and its impact can be overweighed by other factors. One example is that of Punjab, where, till 1992, there was growth in investments when insurgency was at its peak. So it’s not that insurgency completely eliminates investment and growth. Chhattisgarh is a classic example. And so is Orissa.

Law and order is an important thing. Related to that is governance. Governance is both delivery of services and efficiency of the government mechanism. It does impact investment.

Political stability or instability may not be that important as long as you can have good governance, good law and order, decent infrastructure, and, of course, overall free environment. Even if you have political instability, you can have growth. For example, Tamil Nadu is a state which is doing well in terms of economic growth and has been doing decently well in economic freedom; but every four years, the government there changes.

Why are states that have industrialized faster lagging behind other states in economic freedom now?

It has to do with the politics of it. There are many states which might have done well, but where the political forces tend to push towards impinging on economic freedom to try and deliver through the government. They have unnecessary rules and laws in the hope that those will do the job. But we know that doesn’t happen.

Essentially, what’s happening is that many states, once they start to do well, something happens in their political economy. To share the benefits of growth, states will deliver greater welfare services; and then there is this perception that we should have more labour laws, more land related laws and so on and so forth. So just by imposing greater laws and greater regulations, you don’t necessarily improve things. You tend to worsen them.

Does economic freedom have a greater impact on manufacturing or on agriculture?

Economic freedom has a lot of impact on manufacturing and an even greater impact on agriculture. Contrary to what most people might think, it is very critical for the farmer. If the farmer is unable to sell its produce wherever he wants to, then he will be dependent on the middleman. If he is dependent on middlemen, then the farmer will not earn enough surpluses to be able to invest. The freedom to sell, to buy at the price you want, or to lease, is very important for a farmer.