The paper has tried to analyze how incentive competition is increasing regional imbalance in the manufacturing and service sector growth. The paper has found that the incentives have increased the already existing imbalance in both the sectors. The FDI is flowing into states where there was already investment. Thus states should concentrate on improving the necessary conditions to attract private investment along with offering incentives which is just a sufficient condition.
India liberalized its economy in the year 1991. Prior to this the main thrust of the Indian economic policy was to bring about a balanced regional development and India relied upon Five Year Plans to achieve this objective. But some of the political economic developments inside and outside the country pushed India on the throes of severe economic crisis which made Indian policy makers to rethink on the policy being pursued hitherto. There were sweeping reforms to overhaul the entire economic structure. There was change in the federal power structure with state governments becoming more powerful vis-à-vis central government which ultimately gave rise to the concept of incentive competition. Incentive competition has impact on regional growth by affecting private investment. The paper is organized as follows: In the next section we have looked into the policy prior to the economic reforms. In the third section we have examined policy after the reforms. In the fourth section we have seen how the concept of incentive competition got evolved and what are the economic rationales behind it. In the fifth section literature review has been done. In the sixth section analysis has been undertaken to see how incentive competition is aggravating regional imbalance of manufacturing and service sector growth. Then some of the limitations of the study have been examined. Finally, some policy implications have been drawn as to what should be done to attract private investment and to achieve balanced growth.
Policy prior to 1991 Economic Reforms 政策前到1991年的经济改革
Immediately after independence India embarked upon the plan regime. Probably India is the first non-communist country to implement a full-fledged industrial policy and the aim of this policy was to bring about a balanced regional development by directing the resources to backward and underdeveloped regions. This policy was greatly influenced by Indian top leaders association with the Fabian Socialism and Labor Party leaders of UK like Harold Laski. It has also drawn inspiration from what was then regarded as highly successful Soviet Planning model. The purpose of the policy was to co-ordinate investment decisions both in the public and the private sectors and to seize the 'commanding heights' of the economy by bringing certain strategic industries and firms under public ownership (Ajit Singh, 2008).#p#分页标题#e#
Successive Five Year Plans were designed to bring about a balanced economic and social development. The objectives of the plan were to achieve balanced industrialization, increased economic growth and equitable distribution of the gains achieved through high growth. In the words of First Plan:
It is no longer possible to think of development as a process merely of increasing the available supplies of material goods; it is necessary to ensure that simultaneously a steady advance is made towards realization of wider objectives such as full employment and removal of inequalities.
The Indian planners relied upon public sector investment, import substitution industrialization policy and regulating the private sector to achieve these objectives. There were policies to decide upon the magnitude, composition and direction of investment. There were controls on prices. The policies that were aimed at influencing the inter-state distribution of industries were industrial licensing, the location of public sector industries, location policies for metropolitan cities, small-scale industries location policies, the distribution and pricing policies for intermediate industrial inputs, and other government location incentives (Sekhar, 1983).
Some of the important characteristics of the Indian planning regime before 1991 can be summed up as follows.
The Indian planners emphasized the role of heavy industries and sought to develop capital goods industry as early as possible.
The plan envisaged primary role to the public sector in carrying out the economic activities.
The private sector will play a role in the economy not by the test of private profitability but in accordance with the requirements of the national plan.
There was inward orientation in the sense that whatever can be produced within the country should be produced regard less of cost factor. The technological self-reliance was emphasized.
The economic power was heavily concentrated in the hands of the Central Government. The decision to set up an industry, what industry should be established, where it should be located etc., issues were used to be solely decided by the Central Government. State governments didn't have any say on these issues. Industrial Policy Resolution 1948, Industrial Policy Resolution 1956 and Industrial Development and Regulation Act 1951 etc., signals the fact that the central government had an absolute sway over matters pertaining to the initiation and regulation of development in one of the key sectors of the economy. The Industrial Development and Regulation (IDR) Act, 1951 was the principal instrument for channeling the investment in the industrial sector in socially desired directions. The act controlled not only entry to an industry and expansion of capacity, but also technology and import content (Ahluwalia, 1991). In implementing its balanced industrial strategy the government used a wide variety of measures like industrial licensing, strict regime of import control, administered prices, MRTP Act etc., But all these controls, restrictions had an adverse impact on the entrepreneurial zealousness which in turn had a bad consequence on the general economic performance of the country. Thus the efficiency criterion was overlooked for the sake of equity. Isher Ahluwalia (1991) has listed out some of the adverse consequences of this policy regime which are as follows.#p#分页标题#e#
Barriers to entry into individual industries limited the scope for competition.
Indiscriminate and indefinite protection of domestic industries resulted in the breeding of inefficiency.
The adverse impact of protecting small-scale industries and promoting regional dispersal of growth on the choice of the optimal scale of production.
Administrative hurdles nurtured red-tapism, nepotism, and corruption.
All these resulted in dampening entrepreneurship and there was little or no incentive for up gradation of technology.
The establishment of a large number of major industrial projects in less developed regions has not had any significant impact on the industrial or overall economic growth of these regions (Ramadhyani, 1984). Thus the country didn't gain much in terms of growth.
Policy after 1991 economic reforms 1991年经济改革后的政策
Year 1991 is major turning point in the Indian economic history as the country witnessed sweeping reforms in that year. Gulf war and the breakdown of Soviet Union in the 1990s had a major impact on the economic happenings of the country. These developments coupled with our restrictive economic practices intensified the economic crisis. There was severe balance of payment crisis and inflationary surge which made our policy makers to rethink on the development strategy being pursued since its independence. Neo liberal economists blamed excessive control of private investment by the government, inward looking industrialization strategy, over protection of public sector industries and predominance of public sector in county's economic activities for the economic crisis of 1991(Singh and Ghosh, 1998). The present reforms were based on clear recognition of the need to integrate the domestic economy with the global economy through trade, investment and technology.
The area where radical changes were brought in during the reforms was in the area of industrial licensing. Earlier it was essential to obtain license for new investment as well as for the expansion of the existing capacity. Now licensing is required only to a small number of industries, most of which subject to environmental and pollution considerations. The controls over investment and expansion through Monopoly and Restrictive Trade Practices Act have also been removed. Some reforms were done in the tax structure too. It was decided to move towards a simpler system of direct taxation with moderate rates and fewer exemptions. In the area of public sector the government started the process of disinvestment with government retaining 51 percent equity and also management controls. Similar pro market reforms were undertaken in the areas of banking, insurance and exchange rate policy (Ahluwalia,2000).#p#分页标题#e#
Concept of Incentive Competition 激励竞争概念
Striking feature of the reform is that it brought about a thorough change in the federal set up of the country. Though India is a federal country much of the decision making power was concentrated with the Central Government. It was Central Government which used to decide upon the magnitude, composition and direction of investment thereby leaving little room for the state governments to decide upon the policies best suited for the socio-economic, socio-cultural profile of each state. With the easing of central government's control over investment decisions, state governments were given considerable freedom to pursue the policies which are best suited them. The reforms brought about a shift in the power structure with state governments acquiring more power vis-à-vis Central Government in decision making process. There was an attempt towards decentralizing the decision making process. There was devolution of power from Central Government to State Governments if not completely but to a certain extent (Shand and Bhide, 2004). With the reforms the central government started withdrawing from major economic activities and there was a decline in the importance of public investment which made the state governments to feel the need to attract more and more private investment. Since then states have started competing against each other for attracting investment by creating investment and business friendly environment. And the mechanism they have relied upon to do this is incentives. It is through incentives they are competing to attract more private investment. And this trend came to be known as "incentive competition".
Rationale behind Incentive Competition:
With the New Economic Policy of 1991 there was a pro market environment. If not absolute freedom there was a certain amount of flexibility given to the state governments in their respective economic activities. States became autonomous to certain extent in their economic matters. Some of the rationales behind the incentive competition are as follows.
Principle of comparative advantage: Each state can produce a commodity in which its having comparative advantage
Encourage competition: It encourages competition among states which helps to improve production efficiency
Economies of scale: Now economies of scale could be operated due to large scale of production
Trade is an engine of growth: It leads to increased trade as each state can interact with potential investors
Globalization: In an era of globalization where there is more decentralization of power, it becomes imperative for states to offer incentives to attract private investors
Political economy aspects: With the increased regionalization of politics, the politics at the state level is being driven by state issues than by central issues and the economic performance of each state has become an issue of potential electoral importance.#p#分页标题#e#
Literature Review 文献综述
Bajpai and Sachs (1996), found in the post reform period the central government has freed up states which has allowed greater dynamism by fostering greater competition among the state governments. Some have made use of this opportunity by bringing in more reforms while some still lagging behind. For the purpose of analysis they have divided the states into three categories i.e., reform oriented states (Andhra Pradesh, Gujarat, Karnataka, Maharashtra, and Tamil Nadu), intermediate reformers (Haryana, Orissa, and West Bengal) and lagging reformers(Assam, Bihar, Kerala, Madhya Pradesh, Punjab, Rajasthan, and Uttar Pradesh). With the initiation of reforms in 1991 the role of private investment has acquired a greater deal of significance. States are now in competition with one another to attract private investment both domestic and foreign. The southern states accounted for the 34 percent of the proposals that have been approved in 1998 and Gujarat and Maharashtra accounted for 21 percent in the corresponding period. On the other hand, the states in the North and the East are far behind, except for investments in Delhi.
Shand and Bhide (2004), the economic reforms of 1991 brought to the fore the role of state governments in attracting private investment. In the previous regime of centralized planning the role of state governments was limited to lobbying for public sector investments. In the new environment of liberalized economic policies the states are realizing the need for more competitive strategies to attract private investment in their own states. For further analysis they have divided the 14 states into High Performing State Economies (Karnataka, Maharashtra, Tamil Nadu and Gujarat), Medium Performing State Economies (West Bengal, Andhra Pradesh, Kerala, Haryana, Madhya Pradesh and Rajasthan) and Low Performing State Economies (Orissa, Punjab, Uttar Pradesh and Bihar). In the industrial sector there was increase in the average growth rate for HPSE and MPSE whereas decline for the LPSE. HPSE registered an increased growth in the service sector whereas the growth rate was almost steady in the MPSE and fell in the LPSE.
Ahluwalia (2000), the liberalization has eliminated many of the controls earlier exercised by the central government and increased the role of state governments in many areas that are critical for economic development. The co-efficient of variation of growth rates has increased in the post reform period. Growth accelerated sharply for Gujarat and Maharashtra whereas it decelerated in Orissa, Uttar Pradesh and Bihar. He attributes this variation across states to the business environments in the states. States with investment and business friendly environment performed well than the other states.
Rossiter(2010), is of the view that in the post 1991 period the center began the long retreat from its highly regulatory environment. The reduction in financial transfers and public investment posed major challenges to the state governments. They have to compete with each other via the investment climate for FDI and domestic investment. The nationalist parties of Tamil Nadu and the Congress-BNP split in Karnataka have produced a strong movement towards liberalization whereas liberalization process in Kerala has been slower due to ideological factors by communist parties.#p#分页标题#e#
Papola (2011), reforms removed central government regulations on investment and industrial location and gave more freedom and opportunity to states to base their industrial development on specialization. Trend towards easing of regulations and promotion of investment-friendly climate in states is one of the factors which explain differential growth rate of manufacturing sector across the states. States like Gujarat and Maharashtra, Karnataka and Andhra Pradesh have offered 'best' and Uttar Pradesh and West Bengal 'poor' investment climates.
Besley and Burgess (2004) have examined how the industrial relations climate in Indian states has affected the pattern of manufacturing growth. The states which amended the Industrial Disputes Act in a pro-worker direction experienced lowered output, employment, investment and productivity in registered or formal manufacturing. In contrast, output in unregistered or informal manufacturing increased. Some states like Andhra Pradesh, Gujarat, Karnataka, Tamil Nadu and Maharashtra show striking growth, while states like Assam, Jammu and Kashmir and West Bengal stagnate.
Analytical Part 分析部分
The states are competing against each other through incentives to attract private investment. Private investment is of two types i.e., private domestic investment and Foreign Direct Investment. Given the time horizon i have looked only into FDI to examine how incentive competition is aggravating regional imbalance of manufacturing and service sector growth.
Data and Methodology:
The data for the study is taken from Annual Survey of Industries (ASI), Handbook of Statistics on the Indian Economy, RBI, Department of Industrial Policy and Promotion and EPW Research Foundation (EPWRF).
A policy indicator has been calculated by assigning "1" to states for each policy they are perceiving. Otherwise the value would be "0". The indicator is simple average of number of policies for each state. States with high indicator value are offering more policies and states with low indicator value are coming out with fewer policies. Median FDI flow has been calculated on the basis of which states are divided into High FDI Attracting States (HFAS), Medium FDI Attracting States (MFAS) and Low FDI Attracting States (LFAS). Gujarat, Karnataka, Tamil Nadu and Andhra Pradesh come in the category of HFAS, Goa, Chandigarh, West Bengal, Kerala are in the MFAS category and Bihar, Rajasthan, Uttar Pradesh, Madhya Pradesh, Orissa come under LFAS.
Coefficient of variation has been used to examine the regional imbalance of manufacturing and service sector growth. It is one of the most commonly used measures of variation. It is defined as the standard deviation divided by mean. Symbolically, CVx x /µx , where x is the standard deviation, µx is the mean of the variable X (say, employment or output). A higher value of the CV implies higher regional imbalance of manufacturing and service sector.#p#分页标题#e#
The study has been undertaken for a period of 17 years from 1993 to 2010. The entire period has been divided into two sub periods from 1993-94 to 2000-01 and from 2001-02 to 2010-11 to see the variations happening in these sectors across the categories as a result of state sponsored incentives. It is after 1991 reforms that the concept of incentive competition came into vogue. Since then some states started offering incentives and the rest of the states started following them in the later years. Though the states started offering incentives in 1993 the impact of the same could be felt with a lag. Keeping this lag effect in view the study period has been divided into two sub periods.
In the below table an overview of the policies being pursued by major states of the country are given. . The policy indicator which has been estimated for further analysis has been calculated on the basis of these below mentioned policies.
In the following table states are ranked according to the median FDI inflow. One can see a correlation between states' policy indicator value and their ranking on the basis of median FDI flow. States like Andhra Pradesh, Karnataka, Gujarat etc., which are having high policy indicator value are also topping the list of high median flow. And states like Madhya Pradesh, Orissa, Bihar which are having low policy indicator value are in the bottom of the list of ranking of states on the basis of median FDI flow. But there are few exceptions like Delhi and Maharashtra. Though their policy indicator value is low they are the first top two regions in the list of states according to median FDI flow. We will look into the reason behind this in the later part of this paper.
Now we will look into the category wise contribution to the country's manufacturing and service sector output. As it is already mentioned the entire study period has been divided into two sub periods from 1993-94 to 2000-01 and from 2001-02 to 2010-11. The percentage category wise contribution has been given in the table. As one can see from the tables there has been rise in the coefficient of variation from 0.42 in the first period (1993-94 to 2000-01) to 0.67 in the second period (2001-02 to 2010-11) in the manufacturing sector whereas there has been a continuation of the already existing imbalance in the service sector with a marginal rise from 0.64 to 0.66 in the corresponding sub-periods. We can link this variation across the time periods to the variation in FDI inflow in the same corresponding period. The coefficient of variation for region wise FDI inflow has increased from 1.22 in 1990s to 1.61 in 2000s. As the imbalance in the FDI inflow is rising, there is also a rise in the imbalance of manufacturing and service sector across the regions.
Spearman rank correlation has also been calculated for both the time periods to see the degree to which FDI inflow and manufacturing and service sector output are correlated. The correlation coefficient for manufacturing sector has increased from 0.49 in the first period to 0.60 in the second period whereas for service sector it has increased from 0.08 to 0.21. Here an attempt has been made to link correlation coefficient with that of the category wise contribution and coefficient variation of manufacturing and service sector. For the manufacturing sector whose correlation coefficient value is higher in both the sub periods there has been a noticeable change in the category wise contribution and coefficient of variation, whereas for service sector whose correlation coefficient is too low, the category wise contribution and coefficient of variation has more or less remained same. One of the reasons for this low correlation of service sector with FDI inflow may be here that the service sector has not taken into consideration IT/ITeS which are largely influenced by the FDI and one of the principal major contributors to the service sector output of the country.#p#分页标题#e#
Coming to the question of why some places like Delhi and Maharashtra are receiving highest amount of FDI even without offering more incentives leads us to another interesting question of can states attract FDI without offering any policies or incentives. Answer for this can be found in the path dependency theories. As the industry concentrates geographically participants elsewhere are at a disadvantage, and thus there will be a tendency to move into the hub, further increasing its relative efficiency. Agglomeration economies are one of the reasons for the operation of this path dependency theory arguement. When there are agglomeration economies the forward and backward linkages are usually stronger. Thus the investors invest in a place where there is already investment to reap the benefits of agglomeration economics and forward and backward linkages. Lall and Chakravorty (2005) have found that new private sector industrial investments in India are biased toward existing industrial. Subrahmanian (2003) has found that there has not been a major change in the ranks of the states under the pro-market liberalised policies from what it was in the pre-reform period, "the already developed states continue to hold the top rank, which implies the continuation of the earlier pattern of the industrial development under the state-lead policy regime". Maharashtra was an industrialized state in the pre-independent era and thus given the path dependency arguement there is no wonder in the state attracting high FDI. Factors like governance, security, geographical location, availability of human resource etc., also play a role in attracting investments. This explains why more FDI is flowing into Delhi despite few policies and incentives.
Limitations of the Study:
Some of the major limitations of the study are as follows.
Data problems: There are some problems regarding the data used for the purpose of study. Some of the problems of ASI data are worth mentioning. Firstly, certain types of establishments such as software manufacturers and everything in the service sector are left out by the ASI since the definition of industry was set by the Factories Act. Secondly, the survey data are naturally subject to the problem of variation in response, and therefore, in coverage (Ahluwalia, 1991).
Exclusion of private domestic investment: The study has overlooked the role of private domestic investment, which is one of the components of private investment along with FDI, in aggravating the regional imbalance of manufacturing and service sector.
Neglect of certain factors: The study has not taken into consideration the role of factors like location factor, governance factor, security factor, etc., while estimating the policy indicator. Incentive is not the only factor which determines FDI amount. Thus to have an unbiased and clear cut picture of how incentives are aggravating regional imbalance one needs to take into consideration these factors also.#p#分页标题#e#
Effectiveness of the policies are disregarded: All policies are not equally effective in attracting the investors.
Cost of incentive competition: The incentives being given by the states in the race to attract high FDI involve a cost. Thus it is wrong to assume that the states can achieve high growth by offering incentives. These costs are of different nature. Firstly, it puts pressure on the states' exchequer. Secondly, sometimes the competition turns out to unhealthy meaning to say intensive competition among the states make them losers by benefitting the foreign entrepreneurs. Thus to look into these kinds of costs is very important. It is also good to look into the opportunity cost of offering incentives. In other words instead of offering incentives the states can invest the same amount of money in improving the quality of human resource, governance, etc., which also brings in FDI. Thus a cost-benefit analysis could be a meaningful exercise.
As it is clear from the empirical part the incentives have increased the already existing regional imbalance from 0.42 to 0.67 for the manufacturing sector and from 0.64 to 0.66 for the service sector. It is seen that incentives are flowing to the regions where there was already enough investment. Thus the state governments while framing their policies to attract private investment should keep in their mind that the incentives are sufficient condition not a necessary condition to attract private investment. Thus the governments should give attention towards improving governance, security, human resource development, etc., which are necessary to attract investment before offering incentives. Thus incentives have to be accompanied by these necessary conditions if the state has to attract private investment.