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Photo: AP
Photo: AP

The economics of carving out new states

What we have learnt from the reorganization of 2000 is that the new states did as well, or no worse, than their parent states

The reorganization of states has for long been a contentious issue in India. Last year’s creation of Telangana as the 29th Indian state was also preceded by intense street protests. But that is not the only type of disagreement when it comes to the creation of new states. There are also intellectual debates between those who see smaller states as a boon for development, while others say that dividing existing states can breed animosity to an extent that national political stability comes under threat.

The first round of reorganization of states was often driven by linguistic politics—from the creation of Andhra Pradesh in 1952 to the decision to carve Haryana out of Punjab in 1966. Economic reasons have become more important since then. The decision to split large states such as Uttar Pradesh, Madhya Pradesh and Bihar in 2000 was taken despite the fact that the same language was spoken in the newly created states as well.

A new paper by economists Sam Asher of the University of Oxford and Paul Novosad of Dartmouth College provides the first systematic evidence of the impact of redrawing boundaries of these states.

Asher and Novosad write: “Examining outcomes 12 years after the formation of the new states, we find a marked increase in economic activity immediately across the border in the new states. School enrolment also increases, suggesting greater investment in human capital. Durable goods remain comparable across the two sides of the state border, suggesting that free movement of labour and capital can mitigate differences in economic opportunities across proximate geographies. The results provide new evidence that institutions matter for development, and local control of institutions can have large economic impacts."

Elsewhere, Pramit Bhattacharya and I wrote a few months ago in an article we published on the regional divide in Uttar Pradesh that there could be gains from state reorganization. “When governments distribute resources on partisan lines and some regions are neglected for a long period of time, there can be gains from dividing the state into smaller ones. While there may be an economic case for Uttar Pradesh’s break-up, its ultimate fate will depend on whether politicians foresee any gains from such a move."

Asher and Novosad employ a large array of data sets to present evidence that breaking up the largest and the poorest of Indian states brought gains to the new states. Since the formation of the new states, using night-time lights data (a novel way of measuring economic activity), the authors find that the gap between the new and the parent states has been narrowing over time.

They write, “Beginning rapidly after the formation of the new states, we see a level increase in light, and a convergence trend: the new states are growing faster than the old states; by 2008 the difference between economic activity in old and new states is no longer statistically significant, and the gap continues to close until the end of the data in 2013."

In addition to comparing the new states’ pre- and post-breakaway periods, the duo picked the border areas of each of the states and found “the new state side of the border has approximately 25% more economic activity, 10 years after state separation".

Economists have long focused on the need for greater local autonomy. In a 1972 paper, economist Williams Oates proposed that greater devolution of power works because the local bodies know best the interests of citizens. In addition, Oates’s theoretical prediction was that the greater the social heterogeneity, the higher the number of states should be.

In a similar spirit, economist Pranab Bardhan of the University of California, Berkeley, in a recent essay contends that local expertise and technology can be harnessed better through local government.

Meanwhile, economists also show there is a need to balance two factors when thinking about the viability of smaller states: economies of scale and social heterogeneity.

A larger state, by virtue of having a larger market, can generate financial resources more efficiently to supply public goods to its citizens. However, when there are too many diverse groups in a sprawling state, conflict emerges. And instead of public-goods provisioning, redistribution of resources among regions becomes the central political issue. In other words, when the diversity effect becomes greater than the scale effect, there is an economic case for a smaller state.

In a 2003 book titled The Size of Nations, Alberto Alesina of Harvard University and Enrico Spolaore of Tufts University showed that the size of a country is irrelevant to economic success when there is free trade. So, smaller states can make up for the costs of size effects by being more market-friendly.

In 1970, economist Albert Hirschman wrote a thin volume called Exit, Voice, and Loyalty. In it, he talks about two important levers of expressing discontent—exit and voice. As an example of exit, if the quality of the food sold by the public distribution system (PDS) is bad, people switch to other available markets. Voice simply means people fighting to get better quality of food through PDS.

While Hirschman focused on market organizations in his earliest use of these concepts, the broader argument applies to states in India. If the state doesn’t address the issues of regional imbalance, the regions should have the option of exit.

New states in the country are often seen more as the outcome of political compulsion and less as drivers of institutional change. If there are lessons to be learnt from the reorganization of 2000, it is that the new states, as the preliminary evidence suggests, did as well or no worse than their parent states.

It also remains to be seen how each of these states stack up against their parent states individually. It is only then that we will be fully able to comprehend the lessons learnt from redrawing political maps.

Economics Express runs weekly, and features interesting reads from the world of economics and finance.

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