Stuti Khemani, who works with the development research group of the World Bank, in her scholarly article published in the Journal of Development Economics, investigates if the fiscal transfers made by the Centre via planning commission are politically motivated. She studies such transfers for a period spanning 23 years, between 1972 and 1995. Such transfers are extremely critical to the states because in the period under study, central government transfers constituted nearly a third of state revenue. Transfers made through the Plan panel constitute 6% of the total revenues of the states and 51% of the state borrowings. The paper shows that affiliated states, i.e., states ruled by the same party that rules at the central level, receive a higher proportion of the resources that are directed through the Planning Commission. Interestingly, states where the ruling party at the Centre enjoys a thin margin get an even higher proportion of resources. The difference pointed out by the author is approximately 30%, which is both economically and statistically significant. Some politically-important states, where the ruling party at the Centre faces stiff fight, receive upto 50% higher grants and loans.
To attribute any political motive and claim any kind of causality, one must clearly understand the institutional set up in India and also the econometric framework used. In India, the central government collects the bulk of the taxes. A large part of the state government expenditure is funded by general purpose transfers made by the Union government. Two institutions play a crucial role in determining the amount to be transferred to each stateFinance commission, a Constitutional body, and the Planning Commission, which is populated by political appointees. It is important to note that transfers done through the Planning Commission pertain to central government schemes such as universal education schemes, employment schemes, etc, which are well-advertised by the central government. People associate these schemes with the central government. In short, the central government has political axe to grind in these schemes.
One may still argue that the above finding could just be a co-incidence and resource allocation might have been actually efficient. To counter this argument, the paper looks at the transfers made by the Finance Commission. The Finance Commission is a Constitutional body entrusted with the responsibility of determining the basis for transfer of general revenues from the Centre to the States. The author does not find any bias in the transfers made using Finance Commission formulae. In fact, such allocations counter the effect of partisanship described above. Politically-affiliated states receive 30% lower grants from the Finance Commission. It is important to note that this finding, apart from confirming the robustness of the findings above, also points at the fact that Constitutional bodies in India have, in general, been impartial. It is also important to note that the study covers 23 long years which saw different parties at the Centre as well as states and almost all states swung from being affiliated states to non-affiliated status and vice-versa. The rich econometric specifications employed by the author exploit these
variations and establish the main findings in a
These findings are very believable given the findings of a number of earlier independent studies. Shawan Cole, of the Harvard University, has shown that lending by public-sector banks in India tends to be politically-motivated. He shows that agricultural lending goes up during election years and the increase is higher in swing constituencies. He also shows that such politically-motivated lending fails to improve productivity. My colleagues, Shashwat Alok and Meghana Ayyagiri, from the George Washington University, have shown that even capital expenditure decisions of the public sector enterprises tend to be politically-motivated. Several other studies have found similar results for other countries.
However, it is prudent to be cautious before assuming that political intervention is going to end. The Prime Minister has not yet spelled out the details of the new super-advisory to be set up to replace the Planning Commission. It is understandable that the Independence Day speech is hardly the occasion to spell out the details, but it is important to unearth the devil hidden in the details. Suppose, if a new set up, with practically similar functions as the Planning Commission, replaces the latter, then the results will not be any different. It could become the proverbial old wine in a new bottle, a refuge to the political refugees, who are likely to sing to the tune of the government in power. In contrast, if the new set up turns out be an independent advisory group, then there is real hope of change.
Constitutional authorities in India such as the Election Commission, the Comptroller and Auditor General of India and the Supreme Court have established their credibility as neutral arbitrators in their respective domains, stray allegations notwithstanding. I recommend that the Finance Commission be given a larger role in determining the resource-allocation formula and the new body replacing the Planning Commission play a purely advisory role. If the governments intentions are clear, then this a great move towards strengthening federal structure of our country.
The author works for Center For Analytical Finance, Indian School of Business