The Political Economy of Federalism in India

Volume 19, Number 1 Article by R Srinivasan March, 2007

The Political Economy of Federalism in India : By M Govinda Rao and Nirvikar Singh, 2005, Oxford University Press, New Delhi, pp ix + 422, Price: Rs 695 (Hardbound). :

The frequent use of Article 356 of the Constitution of India to dissolve an elected state government and place it under central rule highlighted the lopsided power structure in Indian federation until the early 1990s. This was balanced to some extent by the formation of coalition governments at the centre, changing power politics in New Delhi and influencing Indian fiscal federalism. While some of the regional parties have been successful in cornering a larger share of the centre’s financial transfers, the amendment to the Constitution of India to bring all the central taxes into the divisible pool is definitely a welcome change in the transfer mechanism. The union government’s economic policy shift from a controlled to a regulated market economy framework, the constitutional status conferred on the local governments through the 73rd and 74th Amendments and the increasing presence of the regional parties in both the union and the state governments have initiated fresh discussions on Indian federalism.

Academic discussions on Indian federalism have been, by and large, in watertight compartments of political science, economics and law. Rarely do interdisciplinary works on Indian federalism emerge, covering the entire gamut of political, economic, institutional, and legal issues. The book under review is one such. The authors have done an interesting analysis of the impact of the amalgamated economic and political forces on the evolution and working of federal institutions in India. The book deals with ‘the system, institutions and outcomes arising from the interplay of political and economic forces in Indian federalism’ in an attempt to broaden the conceptual framework for analysing Indian federalism ‘to include the political elements and institutions and their strategic interaction with fiscal elements’.

In the era of transition from a planned economy to a market economy, the authors have rightly identified the twin challenges before the policy makers – coordinated reform process by all levels of the government in the Indian federation to accelerate growth, reduce poverty and hasten human development; offsetting the disabilities of the disadvantaged states in the initial stages, and ensuring a level playing field in terms of access to market opportunities. The solutions to these challenges are economic in nature, but they must emanate from the political arena with some changes in the institutional setup and legal framework of the Indian federation.

The authors have presented a well-researched documentation of economic and political aspects of inter-governmental transfers, superimposed them on regional imbalances in growth and logically deduced suggestions for institutional changes to formulate simple and transparent intergovernmental transfers. Similarly they have presented a review of interstate water disputes in India, critically analysing their origin and the failure of the present institutional mechanism in resolving the disputes, and impartially suggesting solutions to solve them. This review comments on the inter-governmental transfer system and interstate water dispute settlement mechanism put forth by the authors of this book.

The authors have given a cogent analysis of inter-governmental financial transfers. The financial transfers from the union government to state and local governments have been through multiple channels. Financial tranfers can be classified as explicit (direct financial transfers through the Finance Commission, Planning Commission and discretionary transfers from individual union ministries) and implicit (flow of resources across states either from the union government or from one state to another due to the effects of planning and the regional economic policies of the union government, subsidised lending by the union government, priority sector lending by financial institutions, market forces and tax systems). The Constitution of India envisaged the Finance Commission as the only channel of financial transfer from the Union to the state governments. Over the years, however, because of political influences, transfers through other channels have increased in size, undermining the role of the Finance Commission. Politics has also influenced the constitution of the Finance Commission, specification of terms of reference, design of distribution formulas and grants-in-aid among the states by the Finance Commission. Based on an exhaustive review of the theory, the authors argue that inter-governmental transfers should aim at equity without creating adverse fiscal incentives for the state governments. The political influence on inter-governmental transfers has been so overwhelming that the transfers (both explicit and implicit) have not made any noticeable dent in bringing about equity between states. Rather there is evidence of persistent and possibly widening economic gaps between the states.

The authors suggest the following changes in the intergovernmental transfer system, which flow logically from their analyses:

• The Finance Commission transfers should replace all sorts of explicit transfers. That is, the Finance Commission should also decide transfers for State Plans and other discretionary transfers.
• The equalisation transfers should be unconditional.
• Transfers for capital projects should be a mix of block grants and market borrowings.
• The Finance Commission transfers should be formula based and should be simple and clear and amenable to changes in economic conditions.

While this suggested change in the institutional setup for intergovernmental transfers is indeed revolutionary and may be expected to solve many of the problems that the country faces at present, there is no guarantee that this new setup will be immune from political considerations. One missing link in the analysis is a discussion on the various formulas so far used by the various Finance commissions and the identification of a simple and clear formula among them. A thorough analysis is essential to take the discussion to its logical end. While it is possible to amend the Constitution to route all the transfers through the Finance Commission and even to fix the terms of references constitutionally for a given period of time, it is difficult to arrive at a simple and clear formula for distribution of financial resources among the states. Hence, if the authors had included a discussion on the formulas used so far in India and such experiments in other federations, the discussion on intergovernmental transfers would have been complete.

On the subject of inter-state water resources, the authors explain the existing institutional setup and point out that though the union government is empowered to issue directives on resolving inter-state water disputes, the state that perceives itself to be the loser usually vetoes the decision of the Union government even at the risk of precipitating a constitutional crisis. The authors underline a point that many researchers have missed, namely that inter-state water disputes encourage inefficient non-cooperative investments in dams, irrigation, etc. The failure, they believe, is due to the flawed design of settlement mechanisms, which are ambiguous and opaque. Further, much conflict over interstate river waters in India is ‘an attempt to influence or determine the initial allocation of property rights over water, by methods such as political lobbying’.

The authors suggest an entirely different institutional setup in order to remove political influence on the settlement mechanism, akin to the statutory regulatory authorities in a market economy (like SEBI) or the statutory authorities to decide inter-state financial transfers in a federal country (like the Finance Commission). This river water authority will have a federal structure – a National Commission for river water at the Union government level, consisting of a rotating membership of technocrats and administrators; and an individual River Board Authority for each river basin. The River Board Authority will include members from the federation of water users’ associations and similarly the National Commission will include some members of the river board authorities. This institutional setup is to be vested with the responsibility of assigning property rights of river water, designing a mechanism for dispute settlement and perspective planning for river water usage and related investments.

Though the suggested institutional setup is a novel idea, the attempt to remove the issue of river water disputes from the political arena is problematic. In the case of market regulatory authorities, they do not take over the authority of the politicians or bureaucrats in a big way; rather such an authority is a need arising out of the liberation of hitherto controlled market forces. In the case of the Finance Commission, the union government’s authority is divided between the union and state governments. While this is acceptable to the state politicians, the feeling among politicians at the union government that their prerogative is being usurped led to the politicisation of the functioning of the Finance Commission as well as the growth of transfers outside the Finance Commission setup. Given the highly fractured Indian political system, the authors’ proposal, which aims at taking away the political right of the respective state governments in deciding the allocation of interstate river water, which they believe is their historical right, is infeasible. It is possible to resolve this issue if the end users of river waters like water users’ associations are directly involved in the negotiation, because the issue more closely involves users’ right rather than property rights over inter-state river water. This is feasible if we look at the efforts of the Madras Institute of Development Studies (MIDS), Chennai, in bringing the agriculturists of Karnataka and Tamil Nadu together to discuss the issue of allocating Cauvery river water between the two states.

According to Dr S Janakarajan, Professor, MIDS, who has been facilitating the inter-state farmers’ dialogue as a means for breaking the Cauvery deadlock, the multi-stakeholders’ dialogue (MSD) is a platform for a sustained dialogue on sustainable use and development of inter-state river water for all those concerned in the inter-state water dispute. The MSD approach addresses one of the important issues that the authors of this volume are concerned with, namely, ineffective and non-cooperative investment in irrigation. It aims at strengthening, through amicable means, the existing mechanism and complementing it, rather than replacing it. In the case of the Cauvery River Water Dispute, the MSD has been going on over the last three years and has reached a crucial stage now, with the sixth meeting, in Tiruchi, being reported to ‘have removed suspicion over the irrigation practices, which have often caused heartburn among the farmers’1. While the existing institutional and legal mechanisms have not been able to come out with an acceptable distress formula to share water during deficit years, the farmers’ leaders of both the states hope to come out with such a formula. Irrigation and agriculture experts along with economists are drafting the distress formula; and the farmers will discuss the draft before submitting it to both the state governments and the union government.

It is important that any discussion on inter-state water dispute in a federal setup should include the MSD approach and such important non-governmental and independent initiatives by stakeholders, which have not so far been recognised either by the government machinery or by the academicians.

References

1. The Hindu, April 13, 2006.

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