India’s states are a little too united

While India is just beginning to confront the full economic impact of the Covid-19 pandemic, optimists see reasons to hope. Global manufacturers are looking to diversify supply chains and Indian leaders seem to be trying to attract their business. The recent decision by Uttar Pradesh — India’s biggest state — and a few others to relax stifling labor regulations has revived hope that other states will soon follow, competing to draw investment and jobs regardless of what the central government does or doesn’t do.
This has been a longstanding hope of Indian reformers — that rivalries between states will drive deregulation when politics prevent action in New Delhi. Unfortunately, it’s not how India works. India’s heavy-handed labour laws aren’t entirely the product of decades of socialist central governments; states themselves write many of those rules. Even on issues other than labour, state-level regulations in India are remarkably similar and uncompetitive. The real problem is
that Indian federalism is centripetal: State leaders have historically looked to the national government for policy direction.
They’ve done so for three very good reasons. The first, not surprisingly, has to do with money. Indian states have limited authority over their finances. Very few areas, such as property and alcohol, are exclusively taxed by states — and the recently enacted Goods and Services Tax has left them with even less control over their own revenue. The national government controls the purse strings and shares less than half of total tax revenues with states. Even when different political parties lead national and state governments, the central government can control the latter’s policy and budgetary allocations.
Second, India’s history with socialist planning continues to cast a long shadow. Until very recently, India’s erstwhile Planning Commission largely dictated policy. Even in areas where the states had legislative authority, they sought to comply with the commission’s vision in order to maximise their share of revenue. Striking off on their own to attract foreign investment would risk their share of revenue — and, in any case, would be impossible without clearances from the central government .
Even now, a state such as Uttar Pradesh, a stronghold of the ruling Bharatiya Janata Party, feels such pressures. Initially, the state suspended almost all labor regulations through ordinance, pending new legislation. When BJP leaders in New Delhi expressed concern about the degree of deregulation, the state government hinted it would bring back some of the old rules, leaving the exact impact of its move uncertain.

—Bloomberg