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Tuesday, May 17, 2011

Federalism & Business: States in India Deregulating for Economic Growth

The gross domestic product in India for the year ended March 31, 2011 was estimated to have grown at a robust 8.6%. Gordon Chang at Forbes argues that besides Delhi’s own fiscal and monetary stimuli, competition between the states of India for business has been a formidable factor. Federalism, it turns out, can be good for business—yet at what cost? Chang omits this element, writing only that “As the states try to outdo each other, India’s investment climate improves.”

Chang cites Abheek Bhattacharya, who points to Tamil Nadu for its protection of property rights and Gujarat for its minimal regulations. Both states have been growing at double-digit rates. However, if the lack of regulations means that the economic growth has been at the expense of the environment and health of the citizenry, perhaps the weakness of the federal government is not such a boon to India. Federalism proffers the potential of a check and balance between the federal government and the state governments such that a “race to the bottom” element among the latter can be checked by a baseline of regulations issued by the federal government. To be sure, the latter is not without its own risks.

Whereas a race to the bottom risks the destruction of the country for short-term economic development, federal regulations risk a consolidation of power at the center. Federalism functions optimally if it is in balance. Chang undercuts such balance in suggesting that the “intense rivalry could even end up moving New Delhi in the right direction.” While such change would risk consolidation at the expense of federalism, Chang again cites Bhattacharya.

Although Bhattacharya had said on the John Batchelor Show that the states are essentially laboratories for nation-wide change, he had not meant that New Delhi would take over; rather, the more “laggard” states would simply realize that they need to “catch up” to the other states by loosening restrictions on growth. While evincing a “race to the bottom” in some respects, such convergence would not risk consolidation, as would New Delhi being moved “in the right direction.” Indeed, were the other states to join Tamil Nadu and Gujarat, any federal involvement should be antipodal to the deregulation at the state level to check any downsides. However, such a check and balance could risk eventual consolidation under the guise of protecting the environment and the Indian citizens.

In short, dangers exist in both runaway state and federal power. Just as economic growth and minimizing externalities needs to be balanced, so too must federalism for it to operate optimally as a system of public governance proffering governmental checks and balances. In a general sense, any system characterized by a maximizing variable that can break through the systemic constraints is doomed to implode. Accordingly, attention should be directed, at least in part, to the system itself so it may continue to be viable.


Gordon Chang, “India’s Accidental Economic Formula,” Forbes, May 15, 2011.

Abheek Bhattacharya, “India Looks to the States,” The Wall Street Journal.