A fiscal stimulus that comes from the poorest states of the country will enable them to raise capex spending, boost growth and catch up with the others
On many development parameters, India appears to be almost like a continent, with different states at vastly different stages of development. Underlying such stark differences are differences in the levels of per capita incomes, and such differences have risen sharply over the past two decades, a Mint analysis shows.
At the beginning of the millennium, the per capita income of the five richest states (based on per capita income) in India was 145% higher than that of the bottom states. That difference rose to 289% in 2010-11, and further to 338% in 2017-18.
Another way to gauge the inequality between states is to look at the coefficient of variation in per capita incomes, which provides a summary measure of the extent of differences between the states. This measure rose from 42.2% in 2000-01 to 57.8% in 2017-18, indicating growing divergence in the fortunes of states.
It is likely that changes in the Gross State Domestic Product (GSDP) figures after the introduction of the new series in 2015 has accentuated these differences, and to that extent part of the rise in inequality is a statistical artifact, as an earlier Plain Facts column had pointed out (see ‘How new GDP series has swung fortunes of states’, Mint, 15 May 2019).
But even if one accounts for such changes, the gap between the rich and the poor states is still quite large, and this gap has been growing over a long period of time.
This has meant that the poorer states are constrained in their ability to raise revenues, and are able to spend much less per capita on investments in human and physical capital compared to the richer states, thus perpetuating the cycle of inequality. The differences in spending on health and education are particularly stark, with poorer states spending far less per person compared to richer states.
Despite a plethora of centrally sponsored schemes which ostensibly aim to correct such imbalances, and despite attempts by successive Finance Commissions to equalize outcomes across states, development spending has not really converged across states. It is not so surprising then that development outcomes, measured in terms of multi-dimensional poverty have also not converged across states, as an earlier Plain Facts column had shown.
In a recent Economic and Political Weekly research paper, the economist and former Finance Commission member, M Govinda Rao argues that in designing central schemes, the Union government fails to take into account the per capita requirements of each state. As a result, richer states often tend to gain more from such schemes compared to poorer states. Rao uses the example of the Sarva Shiksha Abhiyan (SSA) to show how per capita spending on the scheme is higher for the prosperous states compared to poorer states. Given that the overwhelming majority of children are in the poorer states, this has grave implications for inter-generational equity and equality of opportunity in the country.
While Finance Commission allocation formulas tend to account for backwardness in general, they also take into account performance of states on various parameters, which tend to penalise states which have a legacy of poverty and bad governance.
“There is a history behind the inequalities between states and behind the kind of devolution that takes place," said Abhijit Sen, a former Finance Commission member. “Every Finance Commission tries to make sure that no state loses out in nominal terms while trying to make sure that the distribution of resources is more equal than before. It has been a gradual adjustment and hence it may not fully correct for historical inequities. After all, you have to give something to the richer states, and some of the richer states such as Maharashtra are large states."
Sen suggests that in some sectors such as health, the Finance Commission could calculate the minimum spend required on a per capita basis nationally, take into account the capacity of each state to fund that minimum spend, and then allocate grants based on the shortfall between the desired minimum and the states spending ability. Rao has suggested a similar mechanism for central sector schemes to correct imbalances in spending across states.
To add to the regressivity of Union government and Finance Commission transfers, poor states also have to operate under the same deficit norms as richer states, which crimps their borrowing ability and limits their capacity to correct a long legacy of under-development.
Although poorer states have a much greater developmental backlog compared to richer states, their share of total outstanding liabilities of states (as of fiscal 2018) was only marginally higher than that of the richest states.
If there are any deserving candidates for which borrowing limits should be relaxed, it is the poorer states of the country, which require a long-term fiscal stimulus to enable them to catch up with the rest of the country. The central government could cut its own borrowing and debt limits to facilitate more liberal borrowing limits for poor state governments since central government transfers (under various central schemes) tend to be even less progressive than Finance Commission transfers, according to Rao’s research. Such a move under a equity-sensitive fiscal regime, could enable poorer states to raise their capex spending, raising growth, and helping them catch up with other states.
The per capita spending on physical assets is less unequal compared to that on social infrastructure although it is worth noting that some of the poorest states are geographically larger, and hence their needs are higher.
While Rao and Sen argue in favour of greater resources for poorer states, not all economists agree.
One reason why some states are not able to raise developmental spending is the lack of state capacity and that problem can’t be fixed merely by allocating higher resources, said N.R. Bhanumurthy of the National Institute of Public Finance and Policy (NIPFP).
To some extent this is a chicken-and-egg problem: poorer states have poorer capacity to spend partly because they have fewer resources to invest (including in planning and collecting data to present their case for more funds). And till the time India’s policymakers are able to find a suitable and politically acceptable solution to this problem, the gap between the richer and poorer states may have widened even more.