Indian Federalism: How does the policy of liberalization affect centre-state economic relations

Table Of Content's

1. Introduction

2. Institutions as norms, rules and modes of political transaction

3. A model for institutional change
3.1 Institutional Functionality
3.2 Effects of changes in external structure
3.3 An index for reform incentives

4. Informal institutions

5. Incentives of IMF structural adjustments and free trade on reform measures

6. The reform of India’s centric federalism since 1990

7. Conclusion

8. Bibliography

1. Introduction

At the wake of the 1990's India found herself at the brink of a severe economic depression. Finally the debt crisis, affecting the developing world since 1980, has reached the subcontinent and forced decision makers to liberalize the Indian market. Since then, India was able to jump on the train of free trade and submitted an astonishing performance in annual growth rates, as well as in attracting international investors. But still there are some crucial structures which distinguish India from other transforming countries, encumbering not only a reasonable distribution of the prosperity created out of the economic adjustment to the world market but also the enforcement of liberalization itself. So many scholars expected India to drag her feet in the liberalization process, due to the opposition of economically weak groups, negatively affected by a globalized market economy, but politically empowered through institutions created by India’s long democratic tradition (Lanyi 2000). The missing of this resistance was one of the most puzzling experiences of the last ten years.

Supplementing Rob Jenkins’ popular thesis that India is going through a “reform by stealth” (Jenkins 1999) led by witty politicians, perfectly able to play the tunes of these various institutions, this article will provide a neo-institutionalist position with emphasize on the impact of the IMF’s structural adjustments programme on the federal and local level, which led to a change in the formal as well as in the informal institutions themselves. There are four points in Jenkins’ approach open to criticism and able to undermine the achievements of his research:

a) the reductionist and static understanding of institutions
b) the neglect of international entrepreneurs and structure influencing institutional policy
c) the neglect of specific Indian “realities”, forcing institutions to adapt in the face of liberalization
d) the overemphasizing on the relevance of informal institutions and corruption as a means to achieve desired political outcomes.

The thesis provided in this essay will be that the observed shift towards an increased directive ability of the central government is only a short-term phenomenon masking a steadily accelerating devolution of power that capacitates state- and local authorities to autonomously negotiate their self-interest in a globalized world over the long run. This process not only leads to an obvious need to redesign fiscal federalism, but will also call for an abolition of several centre-favouring precautions of Indian federalism.

2. Institutions as norms, rules and modes of political transaction

Many scholars argue that institutions can be seen as the rules of the game (Lanyi 2000), which set the operational scope of political actors and therefore reduce transactional costs by creating reliance and habituation. But this is only halfway down the road. As a reflection of the norms and attitudes of politicians as well as societies, institutions are also subject to change. Moreover institutions may be revised due to transforming environments and political structures. The reason for this phenomenon is that the practice and shape of institutions as good as never will match the idea giving birth to it. There will always be a gap between “vision” and “reality”! To give an example relevant for this analysis: federalism as an institution is based on the principle of secondary liability, which, as a norm of federalism, constitutes an institution too. While the general idea of secondary liability is to give regions and states the authority over all aspects they are capable to manage themselves, the extent of autonomy granted to federal states varies in respect to values and structural constraints perceived by political actors. A change in the constraining structure, e.g. if there’s an increase in global competition, leads to a shift in the functionality of the specific design of the federal system, without any political actors contributing to this process.

This approach is not to be confused with a mere “function follows form”-scheme, as the resulting “malfunctions” generate new modes of political transactions and imbalances are sought to be compensated by new forms of agency. Thus form also follows function. But the impact of structure on institutions and actors mustn’t be underestimated. The latent shortfall of legislative adaptation behind structural change can be seen as a function of time and as the engine of institutional change. The longer the legislation doesn’t react, the higher is the probability that significant reforms prevail over mere modulations of political behaviour.

3. A model for institutional change

In this chapter it will be attempted to design an equation of the above-mentioned relations. There are some basic assumptions to be closer explained. First, it is believed that changes in external structure have negative impacts on the functionality of institutions. This seems restrictive, but as institutions are tailored to fit a familiar environment based on experience, it should be legitimate to assume that also structural changes with desirable social outcomes provoke institutional revision. Second, the model conceives institutional functionality as generally framed by legislative and political activity aiming to reduce the costs of structural constraints for domestic polity and hence for institutional politics.

3.1 Institutional Functionality

In its basic form institutional functionality will be defined as the sum of legislative and political efficiency. Legislative efficiency means the degree to which legislation is able to set proper conditions for political action in the background of external structural constraints. Political efficiency means forms of political transactions, evolving to make the best possible use of these legislative conditions or accordingly to fill in the blanks where legislation fails to counter structural constraints. At an assumed starting point (t = 0) the equation may look like this:

illustration not visible in this excerpt

It is further assumed that “a” may be always bigger than “b” as legislation sets the rules for and limits the scale of actors’ choices according to their preferences and therefore has a stronger impact on institutional functionality than mere political action. The sum of legislative and political efficiency is supposed to be “1”, representing the highest, actually achieved degree of institutional functionality under given external constraints.

As legislative efficiency refers to legislation’s ability to balance external constraints, it can be regarded as the proportion between legislation and structural constraints:

illustration not visible in this excerpt

Accordingly, also political efficiency can be set in relation to structural constraints. Here a new coefficient of political action “c” has to be introduced, representing the transactional costs (e.g. rise of corruption, loss of transparency) of adapted informal channels of interest pursuit, diminishing the impact of political action:

illustration not visible in this excerpt

The higher transactional costs will be, the smaller the coefficient gets, so that “c” can be also expressed by:

illustration not visible in this excerpt

Finally the equation for institutional functionality can be expressed by:

illustration not visible in this excerpt

To sum it up. Institutional functionality is seen as a function of the two distinct variables legislation and political action, which are differently affected by external structure. This does not mean that the approach neglects the fundamental role of political actors in the making of legislation. It will be visible in the next chapter that a change in political action will precede legislative reform, when it comes to a shift in external structure, hence legislative authority remains in the hands of political actors. Anyway, the division is useful to highlight the effects of a change in external structure on the functionality of institutions, because the predictions won from this model are eminently different to those generated from models, which don’t make this distinction. These differences will be elaborated in the following.

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