Economic Reforms and Center-States Relations

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ECONOMIC REFORMS AND CENTERSTATES RELATIONS

ECONOMIC REFORMS AND CENTERSTATES RELATIONS The founders of modern India set themselves the task of devising a Constitution that would suit India's "unity in diversity," adopting a federal Constitution with some unitary features. The states of the Indian Union have been vested with jurisdiction over important areas and assigned independent sources of tax and other revenues and are fairly autonomous within their spheres. However, the states' powers are circumscribed by: a list of concurrent powers; powers given to Parliament to legislate with respect to any matter in the state list under certain conditions (Article 250); a requirement to obtain the president's approval of proposals for state legislation in areas of concurrency before they can be enacted; and the placing in Entry 52 of the Union list "Industries, the control of which by the Union, is declared by Parliament by law to be expedient in the public interest." With respect to a subject in the concurrent list, supremacy is given to the law passed by Parliament. Furthermore, the president can supersede a state government if he or she determines that there is a breakdown of the Constitution or a financial emergency subject to the approval of Parliament.

These provisions make the Indian Constitution a quasi-federal one. To be sure, these Consitutional powers given to the Union (central) government in this regard are in the nature of enabling provisions, to be used when necessary in the national interest. So in practice, states could have had autonomy over broad areas of policy. Even powers in the concurrent list were, for the most part, introduced only to enable the central government to lay down the broad framework of policy, with the states formulating and implementing programs within that framework. Had the central government followed this policy in general, the states would have been autonomous with respect to the major part of governmental activities.

Economic Planning and Centralization

However, the adoption of centralized economic planning with a large role assigned to central public enterprises led to considerable augmentation of the powers and responsibilities of the central government. For purposes of planning, the central government extended its activities and control to most of the important sectors of the economy. Using powers given under Entry 52 in the Union List, the Industrial Development and Regulation Act was passed which conferred on the central government the power to control all important industries. Establishing the Planning Commission within the central government gave it considerable power over the entire planning process, including the allocation of plan expenditures. The introduction of physical controls such as licensing of industries, import control, and control over foreign investment, intended to regulate the market, simultaneously diminished the area of autonomy of the states. The nationalization of large private banks by the central government added considerably to the process of centralization. Overwhelming economic power thus came to be wielded by the central government.

Such centralization of economic decision making had led to inefficiencies in the allocation of resources, since market forces were suppressed. Also, the subnational governments found their freedom of action greatly diminished, and felt that the Indian Constitution had lost much of its federal character.

Liberalization and the Enlargement of States' Area of Activities

Economic reforms launched in 1991 were mainly designed to convert India's economy into a market-oriented, open economy. This transition involved the gradual removal of most of the physical controls such as industrial licensing, exchange control and import controls over a wide area, and the phased abolition of price controls. Another important aspect of liberalization has been a steep reduction of investment in public enterprises, public sector disinvestment, and the opening of most industries to the private sector.

As a result of these policy changes, state governments, no less than private enterprises, have had their spheres and freedom of action enhanced. Each state now is free to develop its economic, social, and intellectual infrastructure in such a way as to attract and develop industries best suited to its natural and human endowments and geographic location. With the abolition of industrial licensing by the central government, states now have the power to approve of the establishment of large industries. States are also in a position to compete for foreign direct investment, with automatic approval of such investment assured in most areas. All these developments represent considerable decentralization of economic decision making.

Since a major part of current investment in the economy is by the private sector, the Central Planning Commission's control over investment has been drastically reduced. State government investments in sectors such as education, health, power, roads, and irrigation are (in most cases) only nominally under the scrutiny of the Central Planning Commission. These are areas in which a major part of public sector investment will take place in the future, all mainly in the sphere of the states.

One can conclude that liberalization in India has not only led to a much more efficient economic system but has strengthened federalism. The state governments now enjoy powers that, in the spirit of the Constitution, they were meant to enjoy, but which the central government, in order to implement centralized planning, had previously prevented them from using.

Toward a Common Market

In the field of taxation, the states had used the powers given to them by the Constitution, unhindered by central government intervention, except for prohibition of levying sales tax on sales at two stages, prior to export, and limitation of the rate of sales tax on "goods declared to be of special importance in inter-state trade." Tax provisions of the Constitution were not really designed to create and sustain an efficient productive system within a common market. To cite an example, the cascading type of sales tax that was levied in European countries in the inter–world war years and old taxes surviving from the Mughal era like Octroi (tax on the entry of goods into a local area) were assigned to the states that used them. The founders had clearly stipulated that states could not tax interstate sales; however, the central government endowed itself with that power through a Constitutional amendment and levied a central sales tax on interstate sales, whose rate was raised from time to time to raise additional resources. These cost-increasing and distortionary taxes could be levied because the resulting inefficiencies were protected by import controls and high taxation of imports. To counteract the higher costs resulting from inefficient taxes, exports were subsidized in several ways that led to further distortions. Liberalization and globalization have meant that, in order to maintain competitiveness, the states have had to be persuaded to switch to economically efficient taxes, such as state value-added tax. Thus, liberalization, which made possible the enhancement of the area of powers that could be wielded by the states, has at the same time led to pressure for restraining them from actions that would adversely affect growth and national welfare. But the restraints that are being imposed would also mean that each state would be protected from the adverse effects of "wrong" tax policies of other states.

Raja J. Chelliah