The Hindu Business Line : Regional growth on the wings of wax?

Vested interest that is making local politicians hesitate to tax many non-corporate services or pursue reforms vigorously are some sort of wax wings that allow States to fly for a while. But not for long, as the bad policies leave the States with little to invest, and as the wings melt away, soon enough they crash-land. States, says R. VAIDYANATHAN, must avoid this Icarus Paradox.

The growth of the economy, starting with the 1980s and more particularly in the 1990s, has been mainly due to the service sector. More important, the growth in the economy was due to proprietorship and partnership firms in service activities such as construction, trade (wholesale and retail), hotels and restaurants, non-Railway transport, real-estate, business and other services.

There is a correlation between the growth of the service sector and the increasing importance of regional parties due to the regulatory and tax issues falling in the domain of States. But the reasons for the success of regional forces can become causes of their failure too. That is the Icarus Paradox.

Table 1 shows the rising contribution of service activities such as trade, hotels and restaurant, transport, other business services to the growth of the economy. The share of the non-corporate sector (proprietorship and partnership firms) in the service activities has been significant and in most cases exceeds 70 per cent. The service activities dominated by non-corporate entities have grown much faster than agriculture or organised manufacturing. Indeed, the phenomenal growth in construction, trade, hotels and restaurants, non-Railway transport and business services is the main reason for the significant performance of the economy since the 1990s.

STATE CONTROLS

It is important to note that the service sector, dominated by non-corporate organisations, is regulated more by State government rules and regulations than of the Union Government. Except for direct and indirect taxes (income-tax and central excise) all other imposts are in the hands of the State governments. Most of the regulations pertaining to the non-corporate sector are made by the States. Some of them are listed in Table 2.

None of these Acts, regulations or instruments of taxation has undergone any major reform or change in the last 15 years. Regional politicians have a hand in most of the non-corporate activities, which are regulated/controlled by the State governments.

The growth of the regional political parties in recent years, particularly after the formation of the United Front regime in the mid-1990s wherein these outfits played a critical role, is well documented. After the 1990s, both the major political parties — the Congress and the BJP — have become dependant on the various regional outfits to hold power at the Centre. In a sense, even the Communists can be considered regional parties as they have a dominant presence in three States.

The instruments to generate taxes from the service activities of the non-corporate sector are also in the hands of the State governments. Table 3 lists some of these. The combined tax revenue of the States was 5.6 per cent of GDP in 2000-01 and it is 6 per cent in 2005-06. It has not any shown substantial increase vis-à-vis the growth of the services sector.

POLITICAL ANGLE

The wholesale/retail trader, the cinema hall owner, the local transport operator, the construction contractor, the liquor vendor, the hotelier, the real-estate dealer, the doctor, the lawyer, are all organically linked to the State-level rulers; many of the local political leaders are also involved in these activities.

It is very difficult to identify the areas of interest of the elected representatives of the regional parties, since most of them declare, on paper, to be "social workers".

But informal surveys in two southern States have found that more than 80 per cent of the elected representatives had direct or indirect interest in these activities. Hence, the phenomenon of the State governments demanding a larger share of Central resources rather than attempting to raise additional resources themselves.

Even in the case of West Bengal an excellent article (Political Economy of West Bengal by A. Sarkar in Economic and Political Weekly, January 28, 2006) brings out the role of the "informal sectors" in the unusual political stability enjoyed by the State. For other States the strength of the regional parties lies in the growth of entrepreneurship in these sectors. Of course, even members of national parties are active in these sectors. But the ability to confer favours and benefits is more at the State level and hence the opportunity for the regional parties to devise populist schemes to augment their support base. At the same time, they also blame the Centre for not providing enough share of resources.

WINGS CLIPPED

But the reasons for the success of these regional forces are also slowly becoming the causes of their failure in terms of their inability to raise additional resources and the reduced role of government in the context of reforms. That is why more than 60 per cent of the State government revenues goes towards salary and wages, pensions and interest, leaving little for investments. That is why they are not able to move forward.

Icarus, as mythology tells us, attached wings made of wax and feathers to his shoulders and flew into the sky. He flew higher and higher, until he came close to Sun.

The heat melted the wax wings and Icarus fell to his death in the Aegean Sea. What made him soar was the very reason for his decline. Danny Miller, Professor of Entrepreneurship at École des Hautes Études Commerciales at Montreal, in his pioneering work, talks about decline of organisations due to the Icarus Paradox. The same could happen to our regional parties, especially as many outfits have also become family enterprises.

As in all businesses, succession and other struggles become common. It will be interesting to observe in the coming years how this paradox gets resolved in our polity. Otherwise the reasons for success of our regional parties could become the causes of their failure as in the case of Icarus Paradox.

(The author is Professor of Finance and Control, Indian Institute of Management, Bangalore, and can be reached at vaidya@iimb.ernet.in. The views are personal and do not reflect that of his organisation.)

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