Column: The state of capitalism

Written by Kunal Sen | Updated: Jul 17 2009, 05:59am hrs
Almost twenty years after India introduced its programme of far-reaching economic reform. were so accustomed to the oft-quoted statistics about Indias economic successstrong industrial growth at an annual rate of 9%, for examplethat its easy to overlook the more complex patterns of growth that lie behind the headlines.

In 1991, the Indian government dismantled the Licence Raj (the central controls that regulated market entry and production activity in the registered manufacturing sector) and introduced major trade reforms. The end of the Licence Raj was expected to lead to a more level playing field for Indian states, as decisions on industrial entry, location and expansion were no longer taken, or lobbied for, in the corridors of power in Delhi. Instead, regional decision-makers had a relatively free hand in devising state-level industrialisation strategies, with little or no intervention from the central government. However, it seemed that some Indian states have benefitted from the economic reforms more than others. Some experienced spectacular growthAndhra Pradesh and Gujarat, which grew at more than 10% for examplewhile others remained in the doldrums, such

as Assam, Orissa, Madhya Pradesh and West Bengal grew at 3% or less per annum.

Why did we see such differences in industrial growth across Indian states in the post-reform period Geography is often singled out as a major determinant of economic performance. For industrial growth, an important geographical factor is access to the sea. Almost all countries with macroeconomic success in labour-intensive manufacturing exports have populations almost entirely within 100 km of the coast. This is also true at sub-national level, so that coastal states in India would have expected to benefit more from the increased trade flows associated with the opening up of the economy than land-locked states. Economic geographers also stress the presence of a large domestic market close to the point of production as being important for manufacturing success. Industrial firms would tend to locate near large urban populations to economise on transport and production costs, and benefit from spillovers by locating near other firms. But geography does not do very well in explaining the variations in manufacturing performance that we see in Indian states. Some coastal states such as Gujarat have prospered while others, such as Kerala, have languished. Some land-locked states, such as Haryana, have done exceedingly well. West Bengal, a state with textbook advantagesa large metropolitan region, access to the sea and an extensive history of past industrialisationhas performed significantly below par.

I suggest that an alternative set of factors is in play here. Institutionsthe social and political arrangements that are seen as the rules of game in society, and their impact on desirable economic behaviouralso have a vital role to play in economic growth. It is likely that institutions hold the key to explaining regional manufacturing performance in India. Recent research shows the importance of labour institutions in explaining the unequal effects of liberalisation in India. Since 1991, states with more rigid or pro-worker labour institutions have witnessed slower growth in the registered manufacturing sector than states with flexible or pro-employer labour institutions. Other institutions, such as those that influence state-business relations may also have a decisive influence on regional industrial growth. Where effective state-business relations led to active co-operation between state governments and the business sector in order to increase investment and productivity, industrial growth was more likely to result. In a recent survey of more than 1,600 industrial firms conducted by the CII, firms were asked which states in their view had the best and worst business environments across India. They selected Andhra Pradesh and Gujarat as the best and Kerala and West Bengal as the worst. It is no coincidence that Andhra Pradesh and Gujarat have out-performed Kerala and West

Bengal in manufacturing performance by a wide margin since 1991.

If state-business relations are indeed the key to disparities in regional manufacturing performance, then a collaborative relationship between the state government and the business sector is far more crucial than innate advantages of geography or history. The good news for

policymakers in states such as Orissa (with no history of industrialisation) and land-locked Madhya Pradesh is that they can bring about a stronger performance in manufacturing if they provide a more conducive institutional environment in which business sector to expand. Greater infrastructure development and a credible investment climate will create incentives for industrial firms to locate in these states and perform well, even without a sea view.