Why Effective State Business Relations matters for economic growth? Massimilano Cali (Overseas Development Institute) Vinish Kathuria (IIT Bombay) Effective SBRs: When does it happen and why does it matter? December 18, 2009 (Jaipur)

2 The politics of growth in India India’s growth acceleration could relate to attitudinal shift of the state towards business. “The trigger for India’s economic growth was an attitudinal shift on the part of the national government in 1980 in favour of private business” (Rodrik-Subramanian, IMF Staff Papers, 2005). “Indira Gandhi shifted India’s political economy around 1980 in the direction of a state and business alliance for economic growth” (Atul Kohli, EPW, 2006) Sinha (2003) argues that the proactive policy followed by Gujarat vs. business ensured “higher investment flows as well as a higher implementation of investment intentions” relative to West Bengal and Tamil Nadu

3 The puzzle of regional growth differences  Strong economic growth in India since the mid 1980s but not all regions have benefited equally States like AP, Gujarat, Karnataka, Kerala and TN have grown over 4.5% per annum per capita income. States such as Assam, Bihar and Madhya Pradesh have grown at around 2% or less in the same period.  Can variation across states and over time in the State-Business Relations (SBRs) explain part of this heterogeneity?

4 SBRs and Economic Growth – what are the linkages?  Effective SBRs can increase economic growth both by increasing the rate of investment, and the productivity of that investment. 1.Synergistic SBRs leading to credible govt commitments to key policies can minimise uncertainties on future policy 2.Create institutional environment where state provides high quality public goods such as infrastructure, effective public administration and secure property rights 3.A well organised pvt sector reflected in active & representative business associations can support provision of public good 4.Absence of collusive behaviour diminish space for rent-seeking by firms and public officials.

5 Testing these ideas empirically Quantitative methods that can rigorously establish the effects of regional institutional quality (SBR) on economic performance. We use the SBR index constructed in this programme to test the effects of SBRs: 1.At macro level on economic growth in 15 major Indian states ( ) 2.At micro level on industries’ productivity in 15 major Indian states ( )

RESULTS a) Impact of SBR on economic growth b) Impact of SBR on manufacturing productivity growth

12/18/20097SBR and Manuf Productivity Scheme of Analysis – SBR and economic growth SBR Total Four Components of SBR separately – - SBR Private - SBR Public - SBR Practice - SBR Collusive

8 Findings – SBR and Economic Growth  Positive contribution of SBR on economic growth (after controlling for other factors).  On average a 1% increase in the SBR measure leads to a 3% increase in long-run growth.

9 Disaggregated SBR Findings – to see which dimension is driving the growth?  Among the four components of the SBR measure, the component having greatest impact is SBR practice.  (i.e., Synergistic interaction between public and pvt sectors, and credible commitment by State towards growth- oriented policies → high quality investments by pvt sector → growth)  SBR collusive effect is less strong vis-à-vis SBR practice  Other SBR dimensions – SBR private, and SBR public having no impact on growth.  Results fairly robust – even with lag of SBR public

10 Counterfactual Findings…… (relevance of SBR)  Other things being equal, if Bihar (one of the worst performing states in India) had the same average (fitted) value of the SBR index over as Gujarat, its annual rate of growth would have been 2.5 percentage point higher over the same period.  This is a substantial increase over Bihar’s actual average rate of growth of 1.4%.  Similarly Bihar’s growth rate would have increased by 12% relative to its growth trend over the same period.

12/18/200911SBR and Manuf Productivity Scheme of Analysis – SBR and Manufacturing productivity growth SBR Combined manufacturing SBR Organized manufacturing SBR Unorganized manufacturing

12/18/2009SBR and Manuf Productivity12  Our results show that SBR is a key factor influencing productivity growth of Indian industry after controlling for other factors.  Results are robust to alternative measures of SBR and alternative measures of control variables.  As expected, SBR is found to have no effect on productivity growth of unorganised sectors  It is the formal or organized manufacturing sector that gains favorably from the effective SBRs. How does effective SBR influence manufacturing productivity growth?

13 Summary of our findings  Developmentally oriented business associations along with a responsive state that was credibly committing itself to private sector development were catalysts for synergistic state-business relations to emerge both at the national and sub-national levels since the mid 1980s.  Political scientists such as Aseema Sinha and Stanley Kochanek have documented the transformation of FICCI and the emergence of CII as developmental business associations.  This replaced the rent-seeking and collusive relationships that had characterised state-business relations in India since the 1970s.  Where such synergistic state-business relations emerged in Indian states, economic growth and manufacturing productivity growth followed.

12/16/2009SBR and Manuf Productivity14 Policy Implications  An implication of our research is that national state and peak business associations should support and broker more collaborative relations between sub-national states and the private sector where such synergistic SBRs have not emerged to the same degree.  SBR need to be strengthened esp. for states like Assam, Bihar, Orissa, and UP if these states have to grow faster and their manufacturing sector has to be more productive.  The key is to strengthen the actual practice of SBRs once the formal organisations that carry out such interactions are established.

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