Economic Viability of Small States

For:

 

Should India be broken up into smaller states? Keeping in mind the vast population of majority of the states in India and their lack of effective development, it seems feasible to break up big states which are not doing well economically and socially. India has five states each with populations larger than Europe's largest nation, Germany, which has 80 million citizens. The western state of Maharashtra has almost twice as many people as Europe's second largest nation, France. Even the country's sixteenth largest state, Haryana, has more people than Australia. The large size of some of India's 28 states makes them difficult to manage and has prompted movements to divide them. There is no denying that India needs smaller states. Some states are simply too unwieldy, due to large populations spread over huge areas, to be effective administratively. Smaller states have proven to be more viable from a governance standpoint, and economically they have done very well if you look at the last 10 years.

 

And in the era of coalition governments, regional or state parties have become partners in central governance. The establishment of a market economy, too, has opened the floodgates to private capital that has led to increasing regional inequalities and, thus, contributed to the rising demands for smaller states.

 

History is evidence that smaller states have been advantageous for India’s growth. Comparatively smaller but compact geographical entities tend to ensure that there is better democratic governance, as there is greater awareness among the policy makers about the local needs. Homogenous smaller states would always be better poised to provide wider range of policies in response to local conditions. Smaller spatial units having linguistic compatibility and cultural homogeneity also allow for better management, implementation and allocation of public resources in provisioning basic social and economic infrastructure services. A relatively homogeneous smaller state allows for easy communicability, enabling marginal social groups to articulate and raise their voices.

 

Division of states would reduce distances between the state capital and peripheral areas and hence improve the quality of administrative responsiveness and accountability. Smaller states would also help India stay integrated.

 

Factual analysis shows the development and efficiency argument does work in favour of the new states when compared with the parent states. In the year 2000, Chattisgarh, Jharkhand and Uttrakhand emerged as separate entities from their parent states of Madhya Pradesh, Bihar and Uttar Pradesh, respectively. During the tenth five-year plan period, Chhattisgarh averaged 9.2 percent growth annually compared with 4.3 percent by Madhya Pradesh; Jharkhand averaged 11.1 per cent annually compared with 4.7 percent by Bihar; and Uttarakhand achieved 8.8 percent growth annually compared with 4.6 percent by Uttar Pradesh. Arguably, getting a territory of their own unleashes the untapped/suppressed growth potentials of the hitherto peripheral regions.

 

Against:

 

Size may matter; Big could be bold and beautiful too. Bigger states like Maharashtra, Gujarat and Tamil Nadu do better by leveraging the state’s output and budgets for intervention and investment. So let’s forget formulaic solutions and worry about formats. In a democracy, every vote is sacrosanct. Voters vote for change, not to be presented with fait accompli. And delivery of governance is dictated by devolution, not dialects. India turns 66 this year. Let not petty political cartography obfuscate the real reasons for failure. Let not India get lost in transmogrification.

 

India’s strength is in its unity. Today concept of small state is dividing India. Creating small states gives rise to regionalism and adds to the already existing adverse inter-state relations. Small or new states depend on central government, continue to get special grants and outright transfers for extended periods which increases the government expenditure. Small states like mineral rich Chhattisgarh and Jharkhand are often viewed as being much more vulnerable to the pressures of the corporations and multi-nationals due to their small scale of economies and the greed of the newly emergent regional elite.

 

Small states suffer from three major handicaps:

- Diseconomies of scale in production, marketing, distribution, and public administration;

- Exposure to high levels of risk because of small populations and limited physical space and

- Limited scope and capacity for negotiating with larger states and private sector entities.

 

 

Small states experience similar burdens linked to a combination of indivisible fixed costs and diseconomies of scale. In the public sector, this results in higher costs and reduced volumes of services provided; in the private sector, in concentrated market structure and a lack of diversification; and in trade, in high transport costs which are exacerbated for the most remote small states. Small size also influences the financial sector and how small states manage their exposure to natural disasters. These characteristics translate into a number of common macroeconomic features, such as high trade openness, high government wage bills, high levels of state intervention, a heavy reliance on trade tax revenues, and the frequent use of fixed exchange rates. A second broad challenge lies in small state financial sectors, which have not yet developed adequately to play their full role in managing volatility and fostering growth.

 

World over poverty reduction is an accepted indicator of growth and governance. Poverty in Andhra Pradesh dropped from 29.6% to 9.2% from 2004 to 2011.And in Tamil Nadu it decreased by 18.1%. But in small states like Chhattisgarh it decreased by only 9.4% and in Jharkhand by only 8.3%.According to the National Sample Survey Organization Jharkhand and Chhattisgarh is the worst performers when it comes to poverty levels and per capita expenditure. Greater economic freedom is positively associated with growth at the state level. If we see the economic freedom ratings 2011, we find that Gujarat has shown a remarkable increase from 0.46 to 0.64 and has moved from 5th position in 2005 to become India’s top state in economic freedom today. Among top ten states there are seven big states and the worst performer is Jharkhand which has come down from rank 8 to rank18. It shows the growth and governance of small states.

 

 

When India desperately needs her people to think globally, small states make them think regionally, even sub regionally. With 28 states alone India has so many regional parties that fractured verdicts and consequent instability have become an integral part of politics, both at the center and states. A dozen more going by the demands including those made by letterhead organization with no ground support, would mean scores of regional parties and there by more black mail, more fractured mandates and a more fragmented politics. It will ultimately lead to the balkanization of India.

The Good & Bad of Fiscal Stimulus Packages

The concept of Fiscal Stimulus Packages is essentially a Keynesian concept that states that governments, if need be can help revive the economy out of a recessionary phase. The responsibility of steering the economy need not necessarily be on the private businesses. The advantage in a slowdown that the government has over the private businesses is money: unlimited amounts of it. So does it mean that the government can keep pumping in money whenever the economy needs it? The answer to that is invariably no. We can only attempt to trace the effects that a stimulus package will have on the economy but can never be sure about it.

Stimulus packages are thought to have multiplier effects on the economy. More investment by the government means job creation. When employment rises, it means that the income of the people in the economy is rising. A rise in income leads to a rise in consumption which instigates the producers to bring more to the market. And this cycle continues. If this process works well, it instills the confidence needed to restore economic growth. But it all comes down to where this money is being spent. The economy will take the aforementioned path only if the government invests in productive activities. Spending on social welfare programs provides temporary relief to the citizens but doesn’t create any multiplier effects for the economy.

It would seem that during a recession all the government has to do is invest in employment generating activities which have inter linkages with other economic activities. So where lays the problem? The biggest concern is the cost to the exchequer. Spending on a stimulus package would be funded by additional government borrowing. The burden of that borrowing would fall on future taxpayers.

Stimulus packages are thus only a temporary adjustment procedure. The timing of the withdrawal of the stimulus is very critical. Another concern with the short term measures is that they tend to delay the reform process. If an economy needs institutional restructuring, stimulus packages revive the economy in the short run, thus postponing that essential process. Government’s action to fix short term problems often creates long term damage.

If the businesses know that they will be bailed out whenever in trouble, they will be more likely to make irresponsible choices that produce another fiscal crunch. Thus, today’s fiscal challenges can be taken by policymakers as an opportunity to restructure.

Nevertheless, in times of recession, private businesses also need to restore their faith in the economic institutions of the country. To revive faith, it becomes necessary that the government invests. When that happens, government is in a way sending the signal that it’s not all bad and if these investments help stir the economy, private corporations would also catch the hint and look at expansion plans.

 

Contributed by:

Prerna Banga

Section A, Economics

Batch of 2013-15

Sen versus Bhagwati

SEN:

If you want to go fast, go alone. If you want to go far, go together! 

The idea of inclusive development is the one advocated by the Argumentative Indian, none other

than Mr. Amartya Kumar Sen, an Indian Economist and a Nobel Laureate. Mr. Sen says, "I was

born in a University campus and seem to have lived all my life in one campus or another; born in

Santiniketan, on the campus of Rabindranath Tagore's Visva-Bharati." A highly educated and

revered economist and a philosopher, we advocate his views for a prosperous economy and its

unhindered continual growth. 

No nation has grown out of poverty to prosperity without taking care of the basic needs of its

people. Sen argues that growth of an economy is sustainable only if the grass-root level issues

are addressed. He emphasizes on public provision of subsidized food, education and health for

the masses from the very beginning, instead of waiting for the high growth phase to ensue. Sen

believes that public investment in education and health for the masses, apart from their

immediate redistributive effects, would help broad-based sustained economic growth in the

longer run by producing a better quality work force. Not just focusing on the GDP but also on

the social indicators is imperative. The impact that an individual’s contribution has, on the

economy, is formidable.

Presenting the facts, Kerala following the Sen Model has a literacy rate of 95.5%, sex ratio of

1084, greater life expectancy and 16.2 per thousand infant mortality rate as compared to the

statistics from the state of Gujarat which is widely accepted to be predicated upon the Bhagwati

Model which has a literacy rate of 82.2%, sex ratio of 918, lesser life expectancy as compared to

Kerala and 60.9% infant mortality rate. 

The way ahead is the Sen way, one of inclusiveness, rather than focusing on making the rich

richer and proclaiming that there will be prosperity, without paying attention to that section of

the society that needs these propellants of economic growth. The narrow-sightedness that has

made home in the political wills of the Governments need to change. An eye on the horizon, a

vision for sustainable growth is what can make the future of India look promising in the days to

come.

BHAGWATI:

Jagdish Bhagwati is an Indian American Economist and Professor of Economics and law at

Columbia University and an advocate of free trade and Growth. Recently over past two-three

months, there is an ideological debate between Amartya Sen, the Noble Indian Economist and

Jagdish Bhagwati on redistribution and State intervention versus Growth in a free market

economy to resolve all economic problems. This debate is popularly known as Sen vs Bhagwati.

Prof. Jayati Ghosh from Centre for Economic Studies and Planning, Jawaharlal Nehru University

said for this debate, "Media has tended to make it into a gladiator fight between two celebrity

economists."

Amartya Sen believes that growth depends on creating a dynamic workforce capable of learning

on the job which needs health and education whereas we (Jagdish Bhagwati supporters) believe

on laizzez faire that growth will raise incomes sufficiently for the workforce to be able to invest in

their own health and education which we feel that it is capable of creating faster and effective

growth rates. Hence we support Jagdish Bhagwati that it is growth which is vital for the Indian

Economy to develop and Growth should precede redistribution and not the other way round.

History is the proof of this. Indira Gandhi became the Prime Minister of India after Lal Bahadur

Shastri’s death for two reasons – Firstly, the electoral benefits which she had achieved because of

her being Nehru’s daughter. Secondly, they felt that her lack of political base would allow the

Syndicate to rule by proxy. They all were proved wrong when Indira Gandhi joined hands with

the Leftist group, gained control of the party and showed how shrewed a politician she could be.

The 1971 elections were fought with a slogan of "Garibi Hatao", but at the end the actions led to

"garibi badao" that even led to emergency in 1975 suspending fundamental rights from its

citizens. Our Indian Industry was under "lisence Raj" during this epoch where even to produce

more, add machines required Government permission. By the late 80s India was caught under a

great fiscal trap and mounting Current Account Deficits which led the Government to open the

stop gates and liberalize its Economy in 1991. With this it created new jobs, new industries, new

aspirations, new careers, new salaries and packages, emancipation of various classes of our Indian

Society. So we behold that it is Growth that has always been the engine of living-standards of

households plus the development of an economy.

Further we have also found that rapidly growing economies such as South Korea, Taiwan,

Singapore and Hong Kong in the 1960s and 1970s shows that growth pulls the poor into gainful

employment and automatically reduces sustained poverty reduction. Even our superpower US has

also grown into giant because of growth which has made them a developed nation. US poverty

reduced from 50% in 1900 to 30% in 1950 to 12.1% in 1969. It was economic growth that

eliminated child labor possibly well in US. The living standards of the poor in America today are

equivalent to the living standards of the middle class 35 years ago (Source : Stephen Moore and

Julian L. Simon , "It’s all Getting Better All the time : 100 Greatest Trends of the last 100
Years."). Redistribution alone claims that it is effective and a sure shot policy. But one should

even scrutinize the redistributive programmes that were implemented. Public distribution system

shows that 10 % of the food subsidy actually reaches the poor, ineffective NREGA Programme

because of corruption and funds getting transferred to multiple layers of bureaucracy, failure of

"Sarva Siksha Abhiyan". 

 

Hence we believe that India or any developing countries needs high economic growth rates which

would generate requisite revenues to deal with poverty. We feel that growth is the only way to

increase the overall income of a community. If the treasury is empty, all promises are slogans and

there will be no redistribution of resources. Hence that to happen it is very important that there

should be growth first and redistribution will follow. And we would end up with a quote said by

Chanakya , "Economic Growth is the backbone of a nation’s strength".

India versus China

INDIA:

The race between India and China is an amazing race between China’s hare and India’s tortoise.

Clearly India has many advantages—
1.      More Balanced Growth—India is a domestic consumption driven economy which is very less susceptible to shocks from international economy. Domestic consumption in India is 57% of the GDP.
2.      More Rational Companies—India’s companies are more focused on profitability. There are more than 6000 companies listed on the stock exchange and only 100 of them are state owned. India’s return of investment on various companies is almost double as compared to China.
3.      Democracy- India has proved the world that dictators are not needed for rapid development and the same can be achieved by democracy. It has shown incredible economic growth for decades.
4.      Property Rights—In India, article 31A protects the right to property as a fundamental right. The government is working day and night for the improvement of land and labour laws.
5.       Rule of law—India’s legal system has been in place for more than 100 years. The legal system is internationally respected. There are more than 150 top global multinational companies have established R&D base in India. According to US Food and Drug administration, India has more certified companies in the world after US.
6.      Banking Sector—India’s banking sector has always had a sustainable growth. Various policies like credit giving, interest rates, etc have always been regulated in accordance with the welfare of the economy. This sector did not face any crisis during the 2007-08 financial crisis which had gobbled up the US financial sector.
7.      Inclusive Growth—Owing to democracy and historical traditions, India’s growth has always been in consideration with the people. The overall growth of the country is at an average rate but inclusive.
Winston Churchill said, “Democracy is the worst form of government except for all those other forms that have been tried from time to time"

CHINA:
The rest of the world looked on in disbelief, and then awe, as the Chinese economy began to take off in the 1980’s at what seemed like lightning speed and the country positioned itself as a global economic power. China, a socialist market economy, is the world’s second largest economy with the GDP of $8.6 trillion. It is the world’s fastest growing economy with growth rates averaging 10% over past 30 years.

China is the largest exporter and the second largest importer in the world. It is also the second largest manufacturing economy in the world outpacing its world rival in this category, USA.China has implemented reforms in a gradual fashion. It has achieved what it has because of structural strength of its institutions. It is following a developmental path.
For nearly 30 years China has indeed been growing thrusting citizens into prosperity and its goods across the world. Between 1978 and 2013, China’s per capita income had grown from $153 to $9100. Its current account surplus had also increased over twelve fold between 1982 and 2004, from $5.7 billion to $71 billion.
It transitioned from being an agrarian economy to a manufacturing one, and is now concentrating on the development of service sector. China in year 2003 fed 20% world’s population with only 7% of world’s arable land. In 2011, china was largest producer of steel in the world producing 45% of the world’s steel. Even in current slowdown the Chinese economy is being able to manage a decent growth rate. It is also predicted that by 2016, China became the largest economy of the world overtaking USA.

Even though India and China occupy the same continent, they do not inhibit the same strategic realities. Geography, governance, culture, economy and diplomacy all play a huge role in making a big difference in strategic outcomes of the two countries. China’s geopolitical advantage can be summed up like this: (i) first mover advantage- China borders 14 nations more than any country in the entire world. (ii) It has settled borders with all of its neighbours. (iii) China has also built up very deep infrastructural linkages, commercial ties with its neighbours exporting goods while importing raw materials. So, in a way it has built a trans-national empire of resources already.

China is two decades ahead of India in terms of its economic size, infrastructural base and social indicators ,which probably indicates that Dragon has already reached the 21^st century whereas the Elephant is still lurching towards it.  

De-Jargonize

1. Liquidity trap
Liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand.

From household’s side

A situation in which prevailing interest rates are low and savings rates are high that is consumers choose to avoid bonds and keep their funds in savings. Bonds have an inverse relationship to interest rates; many consumers do not want to hold an asset with a price that is expected to decline.

From firms’ side

It usually arises when expected returns from investments in securities or real plant and equipment are low, investment falls, a recession begins, and cash holdings in banks rise. Businesses continue to hold cash because they expect spending and investment to be low. This is a self-fulfilling trap.

2. Seigniorage

Seigniorage is defined as revenue for a government when the money that is created is worth more than it costs to produce it. This revenue is often used by government to finance a portion of their expenditures without having to collect taxes. It is the value the government generates by adding its stamp to an ordinary piece of paper, piece of metal or nowadays an electronic bank entry.
Seigniorage =the face value of the money - the cost of printing/ minting it.
For example, it costs the Indian government Rs 2 to produce a note of Rs 10, the seigniorage is Rs.8

3. Repo rate 

Whenever a bank has a shortage of funds they can typically borrow it from the central bank based on the monetary policy of the country. Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks for meeting shortfalls in their reserve requirements against securities. Repo rate is used by monetary authorities to control inflation.

How repo rate affects the economy?

In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in controlling inflation.

4. Reverse repo rate

Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. It is mostly done when there is surplus liquidity in the market. It is a monetary policy instrument which can be used to control the money supply in the country.

How reverse repo rate affects the economy?

An increase in reverse repo rate means that commercial banks will get more incentives to park their funds with the RBI, thereby decreasing the supply of money in the market.

5. Statutory Liquidity Ratio (SLR)

SLR is the amount a commercial bank needs to maintain in the form of cash, gold, or government approved securities before providing credit to its customers. SLR is determined and maintained by RBI in order to control the expansion of bank credit. In simple words, it is the percentage of total deposits banks have to invest in government bonds and other approved securities. A SLR bond also qualifies for the portfolio maintained by banks to meet the liquidity requirement.

Contributed by:

Shreya Jain
Economics, Section A
Batch 2013-15