Article By : Gaurav Kumar
It is always easier for a country to grow if your neighbour is rich. The USA and the European nations were among the first ones to get industrialised. Almost all the European nations have high per capita incomes and are among the most welfare states. If one nation lags behind in Europe, other rich neighbour compensates. This results in the growth of region as a whole. Presence of rich neighbouring country helps in increasing exports, leading to further industrialisation. In the past seven decades, we have seen rapid industrialisation in Japan and South Korea. In the recent decades, same has been repeated by China. Although decades of double-digit high growth rates have created alarming “Debt to GDP ratio” in China, it has increased per capita income to a decent level. China’s growth helped its neighbours grow too. Vietnam, Phillipines and South Korea developed hand in hand following China as a growth pole. India also saw average growth rate of 7% for the last three decades, which is commendable for a democratic country.
Income Disparity In States
It is common to have income disparity after sudden high growth. Most of the industrialised nations, we talked above have seen income disparity, but not like India. China, which has comparable population and area with India, also saw increased disparity in states, but the contrasting difference is, their poor provinces have grown much faster than wealthier peers, helping reduce income disparity. As the labour rates grew, industries kept shifting their manufacturing bases to the provinces having low wages. This helped in development of country as a whole and bringing down disparity, Whereas in India, far from converging, its states are becoming ever more unequal. A recent shake-up in the tax system might even make matters worse. Apart from few metropolitan cities like Bangalore, Mumbai, Chennai, Delhi etc, rest of the places can be considered more or less poor, according to the global standards. We have per capita income (adjusted to purchasing power parity) of 6600 dollars, but this average conceals a vast gap. A state like Kerala is having per capita income of 9600 dollars, almost near the global median, whereas a state like Bihar having 13 crore population is having per capita income of 2000 dollars, almost equal to per capita income of Mali or chad, in the bottom decile globally. Though, the case was different before LPG reforms. In 1990, the three richest large states had income just 50% greater than the three large poorer states, which was roughly the same divergence we see today in USA or EU. The divergence was even better than China. Now, the times have changed and the diversity increased so much that, the trio is three times richer.
Theoretically, poor regions use the technologies developed and goods manufactured by richer ones. Companies prefer setting up new plants in poor regions due to low wages, but the opposite happened in India. Rich states like Tamilnadu, Maharashtra, Gujarat saw more industries being setup while poor state like Bihar and Madhya Pradesh saw industries being closed. If we had state barriers like USA, we could have partially blamed it for this anomaly, as they also restrict free flow of labour, but In India we have open and porous state borders, which theoretically should have helped poorer states getting more industries due to low wages, but this didn’t happen in real. Regions within China have converged rapidly, partly owing to the market, as factories move production inland where wages are cheaper, and partly to government attempts to lift poorer regions by investing heavily in their infrastructure.
Why is divergence, a deep Puzzle in Indian Scenario?
The puzzle’s solution is, the presence of divergence in domestic market. Moving goods and labour from one state to other can be as tiresome as exporting. Red tapism, lousy infrastructure and cultural barriers can be the reasons behind it. Although, there is migration from less developed to industrialised states, it is far less than required, which can be blamed to language and cultural barriers. Even cuisines differ enough for internal migration to grumble. It is also harder to have access to benefits and state subsidies outside your home state.
According to recent statements of Arvind Subramaniam, chief economic advisor to Indian government, such arguments are overdone. We may not have huge internal migration like China, but it is still sizeable and has been rising as a share of population even as convergence has gone into reverse. Interstate trade is healthy suggesting suitably porous borders.
In my views, it is the growth model followed that have resulted to this scenario. India’s growth has largely relied on service sector. Even today, service sector contributes 60% of GDP and is the largest employment provider in India after agriculture. Most of the world economies have shifted from Agriculture to manufacturing to Service sector, while in India’s case, we shifted directly from agriculture to service sector. On one hand, It created huge income for country, but on the other, it also created income differences as northern states were dependent on agriculture whereas southern states saw huge service sector boost. In my other blog, (click here to read) I have explained Why south India is more developed than North India. It is mostly due to geographical reasons and availability of port facilities. As a state’s economy grows, other sectors like insurance, banking, education, tourism , entertainment etc follows, leading to further growth. Thus the income gap goes on increasing.
Now the basic question arises is, why don’t the companies shift their industries or manufacturing bases to states having low wage rates. The answer lies in the former paragraph. We shifted directly from agricultural sector to service sector leaving manufacturing lagging behind. In china, even though wage rates are high, they have huge textile sector investments. China has 45% market share in world textile exports, whereas a country like India, having low wage rates, has not been able to capture even 5% market share. History shows that all the developed countries have gone through a phase in which textile sector was the largest employment provider. Textile industries are also easy to relocate inside a country. As the wage rates in a state grows, the sector moves to low wage states. At a point of time, India was the largest cotton producer and could have replaced China, to be the next textile hub, but the opportunity is now grabbed by Vietnam, Bangladesh and some more African countries. These countries have low wages even when compared to India. Even Indian textile companies are slowly moving to Bangladesh and Vietnam. This is the only sector which do not require formal education and just a little bit skill training is needed. Employment generation is also huge compared to service sector for the same capital investment.
What about rest of the manufacturing industries?
Even if poor states have low wage rates, they lack skill training and infrastructure. A more likely explanation for the reason that some states lagged behind in the first place is poor governance, which is still largely in place. Bihar’s low wage costs make it look attractive on paper as a place to set up a factory, But many firms seem to conclude they do not compensate for its difficulties.
If this idea is correct, the introduction of the new goods-and-services tax (GST) on July 1st might have worsened the trend. Lots of state level levies have been replaced with a single tax. Barriers to inter state trade have become markedly lower, but states have forgone some fiscal autonomy, such as offering tax breaks to lure in investors. This may make it harder for poor states to catch up.
However, the forces of convergence are gaining strength. Despite falling behind on income, poorer states have been catching up on human-development measures such as infant mortality and life expectancy. Fertility rates in the northern Hindi belt are fast falling to levels already reached by, for example, Tamilnadu, a rich southern state. India’s “demographic dividend” is largely an opportunity for its poorer states, if they can create enough jobs to grasp it.
Bihar and Madhya Pradesh have seen double-digit growth rates in the previous decade and are the fastest growing states of India. This is mainly due to banking and telecom sector growth. Madhya Pradesh have achieved tremendous growth in agriculture due to huge investment on network of canals. Bihar is too catching up.
Government policies like MGNREGA is leading to decrease in migration and rising labour costs in cities. On one hand this is a welcome step for villages but on the other hand it may lead to shortage of low skilled labours in cities. Government will have to keep a sharp eye on this. Labour reforms are due in Parliament. We have to make policies, provide appropriate skills and develop good infrastructure to facilitate shifting of manufacturing industries in poor states.
The more the divide grows, the more we will see secession tendencies in states.