The recent political and institutional developments have underlined the need to calibrate reforms by both the Union and state governments in a coordinated manner. In particular, the elevation of a chief minister of a state as the prime minister of the country is seen to bring about states’ perspective in policy calibration. Similarly, the replacement of the Planning Commission with the NITI Aayog, with a mandate to strengthen co-operative federalism and provide a platform for healthy intergovernmental competition brings the focus on coordination and governance between the Union and states.
It is not that the states’ policies and their governance were not important in the past. Surely, they played very important roles. However, brought up in the staple diet of centralised planning, the focus of discussion was on Delhi and even after the market-based reforms were initiated in 1991, the discussion on policy environment was Delhi-centric and the practice of the Planning Commission approving state plans only added to this. Indeed, after dismantling of the protectionist regime and licence-permit raj, the second generation reforms should have had a predominant state focus to ensure efficient public service provision, competitive levels of infrastructure and effective regulation to deal with predatory competition, information asymmetry and market imperfections.
Intergovernmental co-operation, both vertically between the levels of government and horizontally among the units within each of the levels is important in every federation to ensure harmonious calibration of policies and to ensure a common market. At the same time, co-operation can work only in an environment of mutual trust. When the parties in power at the Union and in the state are different, it is necessary to have systems and institutions for fostering co-operation. It is also important that these systems and institutions should have credibility and enjoy trust and confidence of both the Union and the states.
Although the Constitution specifies the functional domains of the Union and states, overlapping cannot be avoided and in such cases, co-operation among the participating governments is necessary. There are concurrent responsibilities and some of them, like energy and environment, have an important bearing on sustainable development. In the case of Union government functions too, the states can be co-opted as agencies for implementation. The Union government may have a role even in functions listed for the states to ensure desired minimum standards in respect of the services with significant externalities, merit goods and for redistributive reasons. Cooperation is necessary also in carrying out tax reforms like the introduction of the goods and services tax (GST) and to remove impediments to internal trade or even in the case of conduct of foreign policy if it affects the states.
However, there are limits to co-operation, for the relationship between governmental units is essentially competitive. Extreme form of co-operation could rob flexibility and autonomy to the states for catering to the diversified preferences. Once the Constitution ensures the division of powers between the Union and the states which are not extinguishable, it provides a ground for both vertical and horizontal competition. As Albert Breton and Pierre Salmon have argued, people and opposition parties benchmark the best performances of different levels of government and would pressurise their governments to perform according to the set benchmarks. The chances of being voted to power will depend on the confidence of the voters on the political party which conforms best to the benchmark.
Intergovernmental competition can be a source of dynamism as has well been demonstrated. In China, the competition among the state enterprises required the local governments to create enabling environment. However, unless certain preconditions are met, and effective regulation is put in place, competition can be predatory and rather than being a source of dynamism, it can turn out to be a source of exploitation of the weak states by the strong ones. The important preconditions are (i), there should be a measure of “competitive equality” in the sense that every state should have the capacity to provide comparable levels of public services at comparable tax rates; (ii) “cost-benefit appropriability”, that is no state should be able to pass on the burden of its expenditures on non-residents or indulge in acts of protectionism. These conditions imply that resource allocation will be guided by comparative advantage in terms of resource endowments. The states will be faced with hard budget constraints and while their dependence on transfers is inevitable, care should be taken to avoid perverse incentives while designing transfers. There should not be any bailouts. There should be free and unimpeded factor- and product-markets throughout the country.
Thus, imparting dynamism in a federation requires both fostering co-operation to calibrate policies in a coordinated manner and harnessing competition to enhance efficiency and productivity. This requires an institutional platform in which both the Union and the state governments come together to bargain, coordinate and resolve conflicts. As mentioned earlier, co-operation is possible when all the parties to the bargain gain and if there are gainers and losers, there is a mechanism for the losers to be adequately compensated. Often, the gains from a policy initiative may not be clear or if the extent of gains and losses are not transparent, there can be gaming by the competing parties. Therefore, there must be an independent platform for bargaining and conflict resolution and high quality research to quantify and demonstrate the implications of co-operation and competition.
One of the major shortcomings in Indian federation is the absence of such an institution. In the initial years after independence, bargaining and conflict resolution was conducted in an informal environment, thanks to the single-party rule and the confidence and trust enjoyed between the regional and central leaders due to the long years of the freedom struggle and sacrifices made by them. The end of single-party rule, the emergence of coalition governments with regional parties as pivotal members of the coalition and shortening time horizons of politicians have brought to the fore the imperativeness of having an independent institutional mechanism for intergovernmental bargaining and conflict resolution. The objective of creating Inter-State Council to undertake this task was defeated by placing it in the Union home ministry. It hardly provided a platform for resolving Union-state and inter-state issues. The National Development Council too did not fill the place as it became a forum for delivering speeches! The newly created NITI Aayog is supposed to fill this void. The relevance of NITI will critically depend on fulfilling this task and it remains to be seen how it evolves.
By M Govinda Rao
The author was a member of the Fourteenth Finance Commission and is currently Emeritus Professor, NIPFP. email: firstname.lastname@example.org