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Redefining the Discourse on Fiscal Federalism

that has only begun to change recently following the 73rd and 74th constitutional Redefining the Discourse amendments. on Fiscal Federalism Transfers to States Political Economy of Federalism in India by M Govinda Rao and Nirvikar Singh; Oxford University Press, India, 2005;

Reviews

Redefining the Discourseon Fiscal Federalism

Political Economy of Federalism in India

by M Govinda Rao and Nirvikar Singh; Oxford University Press, India, 2005; pp 432, Rs 675.

SUDIPTO MUNDLE

T
his volume brings a breath of fresh air to research on fiscal federalism in India. Unlike much of the large literature on this theme, which repeat the same issues and cite the same facts on India’s strong centripetal tendencies, vertical and horizontal imbalances, etc, this volume attempts to frame the discussion in a new political economy framework. This enables the authors to address old issues from new perspectives, leading to new insights.

The authors Rao and Singh, as a team, have just the right credentials to attempt this difficult task. Govinda Rao, currently director of the National Institute of Public Finance and Policy and a member of the prime minister’s Economic Advisory Council, is one of India’s leading authorities on public finance, with a formidable track record of empirical and policy work on almost all aspects of the subject. Nirvikar Singh, currently professor of economics and director of the business management economics programme at University of California, Santa Cruz, belongs to a growing genre of economists of Indian origin in the US, who undertake research in the intersection of economic theory and empirical analysis with applications to India. Together they make an excellent team for adapting for application to India, the modern political economic theories of federalism due to Buchanan, Breton, Oates, Weingast and others. In keeping with the basic tenets of this theory, the authors proceed from a fundamental assumption that governments are run by self-interested decision-makers, as opposed to the traditional Musgravian assumption that government decision-makers are benevolent. They also assume that different governments in a federal structure compete with one another, driven by self-interest. This basic shift of premise leads to a fresh perspective on the issues under discussion and a very different interpretation of the data that is analysed.

The authors, appropriately, lay a great deal of emphasis on institutions. While the volume is primarily about fiscal federalism, they locate it within the larger context of federalism in general. The main thesis of the volume is along the following lines. Strong centripetal forces were at work in the formative years of independent India, resulting in a highly centralised federal structure – so much so that questions are asked about whether India is a federal or quasi-federal country. Making an important distinction between a federal assignment of constitutional powers and decentralisation, the delegation of central powers to lower level governments, the authors demonstrate the high level of centralisation that characterises the constitutional assignment of powers, the political system, the system of administration, and even the judiciary. The vertical structural imbalance between centralisation of revenue raising and borrowing powers, and the assignment of relatively greater expenditure responsibilities to lower level governments is seen as part and parcel of the centripetal features of Indian federalism. Given this vertical imbalance, transfers inevitably have a key role in achieving the goal of horizontal equity across states. Multiple transfer channels, and the political economic factors influencing these channels, have prevented the transfer system from ensuring horizontal equity across states. The same centripetal political economic forces also account for the overlapping jurisdiction of and limited assignment of powers to local governments, a feature that has only begun to change recently following the 73rd and 74th constitutional amendments.

Transfers to States

The most valuable contribution of this volume, covering several chapters, is the detailed discussion of transfers from the central to state governments. In addition to the formal transfer channels, i e, the Finance Commission, the Planning Commission and other central ministries, transfers also take place through informal channels. The authors present a very detailed assessment of each of these channels. The existence of invisible transfers, such as subsided interest on central loans to the states, makes it difficult to assess the true distributional impact of transfers. As far as visible transfers are concerned, the authors conclude that these have failed to ensure horizontal equity in the allocation of public resources across states. The authors are critical of the “gap filling” approach that has been adopted by successive Finance Commissions. However, their main critiques of the transfer system relates to the multiple channels of transfers and the manner in which political economic factors influence the transfer of resource by the Planning Commission and, especially, discretionary allocations by various central departments that run central or centrally sponsored schemes in the states.

The authors provide a detailed review of earlier research that confirm, despite methodological differences in specifications, the role of political factors in public resource allocation.1 This is also confirmed by the authors’ own empirical tests reported in this volume, though the results are not very robust. The authors contend that the constitutional validity of multiple channels of transfers is fragile, and make a bold reform prescription. They suggest that all grant transfers should be exclusively channelled through the Finance Commission, in cooperation with central ministries. The Planning Commission should focus on providing financing for the national infrastructure development programme, including concessional loans to the states, much like multilateral bank financing for countries.

Economic and Political Weekly March 18, 2006

Another major contribution of this volume is the discussion of local government. The analysis of institutional arrangements, assignment of revenue powers and expenditure responsibilities to local governments, and reform issues relating to local government are all conveniently collected together in chapter 13, entitled ‘Issues in Local Government Reforms’. It is pointed out that despite panchayati raj being a cherished concept in India, the assignment of powers to local governments in actual practice has been extremely limited. The main challenge here is overlapping jurisdiction between state governments and local governments, with the latter functioning mainly as a decentralised agent of the former in the past. The authors recognise that the 73rd and 74th constitutional amendments are key legislative landmarks in empowering local governments. But they contend that to give any real teeth to the legislation, several reforms are required in assignment of revenue and expenditure responsibilities and institutional arrangements, particularly the latter. The authors underline the importance of the State Finance Commissions in this context. However, the recommendation of the State Finance Commissions will remain on paper until they are notified and implemented by the state governments. Few state governments, if any, have as yet notified and implemented the recommendations of their own State Finance Commissions.

The policy and institutional reforms recommended by the authors on various aspects of federalism have been summarised in chapter 14, ‘Policy and Institutional Dimensions of Reform’. Apart from some of the key proposals relating to transfers and local governments cited above, the authors also make a number of proposals for reforms of both the fiscal and financial system to help establish a more efficient and equitable federal system. A particularly important recommendation in this context is the proposal to introduce a constitutional amendment to assign the power to tax services to the state governments, shifting it from the implicit jurisdiction of the central government under its residual powers of taxation.

In this reviewer’s view some topics included in the volume could have been excluded since they divert attention from the central theme of the volume. Perhaps these chapters were included because the volume purports to discuss not just fiscal federalism, but the larger field of federalism as a whole. However, it would have been better if the volume had remained more sharply focused, since it in any case does not do justice to this larger field. Thus chapter 10, which claims to discuss federalism with regard to national resources, is mainly a discussion of interstate disputes in sharing of river waters, with only a token discussion of interstate issues relating to hydrocarbon and other mineral resources, pollution, and biodiversity resources. It is not clear what value is added by this chapter to either the vast specialised literatures on these topics or to the volume under review. Similarly, chapter 15 seems a rather pointless discussion attempting to link Indian federalism to globalisation. It is again not clear what value is added by this chapter beyond the by now well known, and often repeated, point that

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Economic and Political Weekly March 18, 2006 important components of the reforms necessary to appropriately position India to engage with the process of globalisation have to be undertaken by state and local governments. It would have been better to drop this final chapter, and conclude the volume with the policy proposals summarised in chapter 14, which effectively pulls together the discussion in the rest of the volume.

Finally, there is an epistemological issue concerning the institutional and policy reform recommendations. Normatively, the proposals are generally well justified. However, if government decision-makers act in self- interest, which is a basic premise of the authors, and existing institutions and policies reflect the balance of political economic interests, then the reforms that are initiated will also reflect the balance of these interests; be they centripetal, centrifugal or otherwise. Hence, a positivist justification of these normative reform proposals will depend on whether the political economic interests at work are likely to lead to these outcomes. This has not been successfully demonstrated for the reform proposals. In their historical review of Indian federalism (chapter 3), the authors do refer to the rise of regional political parties, and their influence in central coalition governments. This development has profound implications for the balance of interests in a federal structure. It would have been interesting if the authors had systematically explored the linkage between these historic developments and the reform proposals.

However, this is by no means an easy task; and certainly this remark should in no way detract from the value of what the volume has accomplished. It is a landmark contribution that will have a significant influence not only on the discourse on fiscal federalism, but also future research in the larger field of public finance in India.

EPW

Email: smundle@adb.org

Note

1 An important and early contribution to this interesting debate that the authors missed in their review is a paper in this journal by Hiranya Mukhophdhyaya and K K Das, ‘Horizontal Imbalances in India: Issues and Determinants’, Economic and Political Weekly, April 5, 2003.

Economic and Political Weekly March 18, 2006

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