There is a neoliberal consensus pioneered by Hayek and Tiebout in the 1940s and 1950s in the idea that a market economy-like organisation of sub-national units in a federation will result in overall gains in institutional performance. Literature has focused on the efficiency gains to be derived from making sub-national units competitive guided by the principle that devolved government is better able to respond to voters’ choices. This rests on the assumption that local and national needs vary significantly. In this article, I ask whether the prioritisation of service delivery in healthcare and education sectors is indeed something that varies across states in India. The Indian federal system has been increasingly under pressure to devolve power to the states since the economy was set on a path to liberalisation. Initially, this pressure came from the outside, through international institutions (Bretton Woods, largely) but this opportunity was instantaneously accepted by sub-national politicians who promoted, rightly, the cause of their constituencies. This has taken shape in the form of reduced centralised monitoring of service delivery, and the funds previously allocated to this end are now being directly transferred to states who have unconditional leeway to allocate it to various uses. This occurred too suddenly without a mechanism in place to safeguard and ensure the equitable delivery of essential services in healthcare and education, and an ever widening gap among states.

Source: Data from CMIE States of India, RBI

Building on to this, we also have inter-regional issues due to clustering economies. Some states benefit whilst others (often, the poorer ones) lose out by disgraceful margins. There is a race to the bottom on regulatory easing for corporations, and inter-state bargaining for central resources is competitive, rather than cooperative. Transplantation of a European approach to governance and institutions in the Indian context has meant that natural resources are being plundered by sub-national governments to promote corporate interests, as their citizens remain deprived. Public hospitals and primary healthcare infrastructure are slowly decaying into obscurity as shiny, private health players enter the market. This is the same case within the education sector, cheap, private schools largely targeting the middle class are driving away resources and interest away from the public school system, which in its crippled state cannot justify a case to be the recipient of sub-national governments’ interest. 

As can be observed in Figures 2 and 3, poorer states like Uttar Pradesh, Jharkhand, Bihar, and Rajasthan continue to allocate smaller portions of their devolved incomes on health and education spending. These states have some of the lowest per capita gross domestic state products in the country – one might expect that in a well-functioning system of fiscal devolution, governments of these states would prioritise spending on these two sectors. Unfortunately, a corollary to what we see in Figure 1, richer states (many in the South) benefit more from decentralised forms of governance, while poorer states’ institutional choices move further away from achieving their electorates’ goals.

Source: Data from CMIE States of India, RBI

Source: Data from CMIE States of India, RBI

Indebtedness

With the onset of liberalisation measures in the late ‘80s and early 90s, sub-national governments were tasked with the close monitoring of their own finances. The abruptness of such an institutional transition meant that the lack of experience of several states resulted  in mismanagement, leaving their finances in disarray. In response to this, the Finance Commission of India, the institution constitutionally mandated to oversee this process initiated the drafting of fiscal responsibility legislation ‘FRL’ at the centre which was then to be re-enacted in state assemblies accounting for specific needs. Net devolution to states in form of statutory transfer of share in central finances, discretionary transfers, grants and loans collectively increased (in nominal terms) by 1280.67% overall between the period. This quantity of devolution, however, is disproportionately smaller than the devolution of fiscal management responsibility to states. The motivation for devolving fiscal responsibility stems from the need to reduce transaction costs for the principal (citizens) by inducing agents (local government) to be accountable to the central government’s developmental goals. The Twelfth and Thirteenth Finance Commissions drove policy imperatives through which they targeted fiscal consolidation at the state level. These were complemented by forgiveness of debt schemes and allowing states to borrow from the open market.

As a result of this, several states’ fiscal distress was brought forward to public awareness and in response they channelled strained revenues to servicing debt burdens. Some states who brought their fiscal purses in order were heralded for their efforts and were set as national examples of what is commonly called ‘good governance’. Interestingly, the richest and poorest states have similar shares in the total outstanding liabilities of all states combined i.e. the rich borrow almost as much as the poor. Unsurprisingly, service delivery outcomes suffered, although this varies across regions – states were driving away budgetary allocation from these areas towards debt management. When they did not do so with success, they received central bailouts of many forms. This begs the question – how laissez-faire is this federalist approach afterall? From the patterns of movement in public finance, I am convinced of one thing, that cooperative federalism is not an Indian reality, and competitive federalism does not unanimously raise the bar for member governments, instead clearly defines winners and losers within a federation. 

Local capture 

An important question to ask here is how much of the money devolved is being traced and monitored effectively? Treating the country like a marketplace, and states as actors might be a viable approach, but what mechanisms exist to ensure social contracts are enforced? After almost three decades of decentralisation drives, we still have no ministry monitoring this and no Parliamentary Budget office at the centre or even states to assist representatives in understanding the intricacies of public finance in India. The Finance Commission (a Constitutional body meant to oversee devolution of central resources) does not hold much power to steer decentralisation efforts and initial structural transformation in the usage of public finance The federal system in India is more responsive to political needs resulting in  debilitating competition among a class of actors (namely, the states) to grab the largest possible share in the funds available for devolution at the centre. The net outcomes of this bargaining as assigned by the centre often results in policy distortions due to coalition politics. This could result in a corrupt administration being granted larger funds and the equitability of developmental outcomes following adversely affected. 

The vacuum created from the absence of a body to regulate decentralisation, is captured by local opportunists. Municipal bodies across the country, are almost unanimously viewed with animosity by citizens who rarely believe that they are in place to serve their interests. Elections are often a battle between interest groups who garner support for representatives who are most likely to favour their individual goals, as opposed to a debated selection of the most suitable candidate to address a constituency’s collective problems. 

Theoretically, this is what a decentralised utopia looks like – local governments, adapting systems to better address ever evolving needs of the society they serve. Should this be the case, why do we see so many leakages in budgets? Figure 4 shows that states allocate more to capital expenditure overall, than the centre – in this sense, there is reason to devolve more funds to the states. The problem with averages though, is that they do not reflect the internal divergence, in this case, that richer states benefit more from devolution than poorer states (see Figure 1). Devolution in this sense is not progressive. 

Source: Data from CMIE States of India, RBI

Accountability mechanisms 

This brings me to the discussion on what can be done to hold sub-national governments accountable. Active citizen engagement in the budgeting process is a key first step that state governments must take to foster a culture of keeping themselves answerable to the public. It is unlikely that such a move towards transparency will be solely led by the government, and hence will need strong initiative from the non-governmental and civil society organisations. Private players can lobby to promote sectoral interests and even successfully receive allocations in budgets, but where this approach fails is if governance systems are not programmed to make these allocations effective.  

Are sub-national governments always “genuinely inclusive”? Unfortunately not.  In India, they are haemorrhaging devolved finances, increasing bureaucratic red tape for citizen users and now they do not have to be accountable to big government (except when they need bailouts). Successful examples of local development states are largely Eurocentric and transplanting such conclusions to other regions can risk resulting in catastrophic governance outcomes. Yes, Northern Italy and Basque regions have very successfully achieved economic success in a sustainable manner through their cooperative clustering and networks. But what can we say about collective Italian and Spanish economies?  Specific case studies, while extremely useful in informing systematic approaches to institutional economics and political economy, must also be contextualised to fit a variety of contexts in the global south, with younger federal systems. We need adaptive learning to better comprehend for ourselves, and the societies we work for, the evolution of these dynamic socioeconomic structures. India is an extraordinarily complex medley of factors barely comprehensible to even the most reputable experts. Capture and regional inequity are the biggest failures of decentralisation drives in India. To successfully address these, we need adaptive learning, civil societies to organise and coordinate for budget realism and tracking, and a cooperative private structure. 

Sripriya Iyengar Srivatsa is an ODI Fellow and Senior Economist at the Ministry of Finance in Sierra Leone; her research interests include fiscal devolution in low-middle income countries, governance programming and gender budgeting methods.