Rise of regionalism promotes new prosperity in India

India: Opening its doors to foreign retailers (Getty Images)

For more than two years, India's splintered coalition government struggled to reach a consensus on whether to open its doors to foreign retailers.

Beholden to powerful regional bosses, the government seemed almost incapable of strong leadership, and the prospect of a long-promised round of economic reforms appeared to vanish over a distant horizon.

But in the past few weeks, the government has not only found a new determination, it also seems to have discovered a way to break the impasse. Last month, the government decided to let in the likes of Wal-Mart and Britain's Tesco, but with one important caveat: It circumvented regional opposition by leaving it up to individual states to decide whether they wanted to go ahead.

In an era when small parties, based on regional or caste loyalties, increasingly hold the balance of power in Parliament, a new narrative is emerging in India. A growing number of economists and political analysts say the path to development lies not in an all-powerful central government calling the shots but in individual states showing the way.

It is a narrative that could point to a brighter future for India's economy, but also one that demands a deeper understanding of the country from foreign investors and policymakers alike. India, analysts say, must be seen not as a homogenous nation run from the capital but as a collection of states with different languages, different governments and different attitudes toward economic policy and foreign investment.

For Arvind Subramanian of the Petersen Institute for International Economics in Washington, the government's approach exploits "competitive liberalization," the idea that instances of successful economic policies in a few states can set a powerful example for others.

Capital and labor, he said, will flow to the best-performing states, pushing the lagging states to raise their games.

By extension, as was the case with foreign investment in the retail sector, that means the central government's role can often be more an enabler of reforms than the sole driver of that process.

Foreign retailers looking to enter the Indian market know that they need to show that their presence will bring real benefits, said Ron Somers, president of the U.S.-India Business Council.

"Proof of concept is essential. Our companies know they are going to have to make this successful," he said.

"As investment comes, and infrastructure starts getting built, warehouses start getting built and shiny new buildings start coming up, we are hopeful more and more states will see the benefit and put politics aside, joining what we believe will be a wave of progress — for farmers and consumers alike."

India is a country of huge regional diversity and massive income inequality, with 22 official languages and 28 states, each with different social, cultural and political traditions, as well as vastly varying levels of industrialization and infrastructure.

Under India's constitution, its states have always enjoyed considerable powers, playing a leading role in law and order, electricity, education, land and roads.

Several states have begun holding regular summits to advertise themselves to foreign investors, while chief ministers jet off to places such as China and the United States to sell their states as investment destinations.

The chief minister of the southern state of Tamil Nadu, J. Jayalalitha, reacted with dismay last year when she was told that South Korean carmaker Hyundai would build its next car factory in the western state of Gujarat rather than expand in her state , amid reports that unreliable power supplies contributed to the decision.

"She was unhappy, pulling up her entire team working on electricity, saying, 'We've got to solve this,' " said Ajay Shah of the National Institute of Public Finance and Policy. "If politicians feel this kind of pressure, it's very good."

Columbia University professor Arvind Panagariya said the economic reforms of 1991 that unleashed two decades of rapid growth also were based on the principle of decentralization, with the government relaxing central planning and investment licensing rules, and allowing states to compete for investments.

It was Manmohan Singh who had announced those reforms as finance minister 21 years ago. But with Singh as prime minister since 2004, his government seems to have forgotten that lesson, rolling out a series of centralization policies regarding state-subjects such as education, employment and health care, Panagariya said.

"Ultimately, everything from water to electricity has to be provided at the level of the state," said Panagariya, adding that states will sabotage central government policies they do not agree with. "But if you do enabling policies, I think things will move more smoothly."

Last week, Indian Power Minister Veerappa Moily unveiled a multibillion-dollar debt-restructuring package for state electricity companies, with relief conditional on the states improving their performance in delivering power. Using the new buzzword, he talked of "enabling legislation," to give states incentives to reform.

"If such reforms are framed in this way, state governments and the people will always appreciate it," he said. "Initially, they will resist, but in the course of time, they will definitely improve. That is the history of reforms in this country."

Shah, the public policy expert, said he is disappointed at how few ideas about governance and reform flow from one state to another. Nevertheless, he said, "we are starting to see 'best practices' emerge in India."

Rather than less democracy and a stronger central government, Shah said, India needs more decentralization and democracy, with more power devolved to city governments in particular.

More devolution and complexity might seem daunting to outsiders, especially investors who have had some success in China and try to apply lessons learned there to India. But the Indian market can be just as fractured and complex as the European market, its states as different as Germany and Greece.

"I still hear people talk about India or Indians as if it is one decision-making entity, either on the political side at one end or consumer side at the other," said Gunjan Bagla, managing director of California-based Amritt Ventures, which advises American investors on how to do business in India.

"Neither approach works very well. Understanding the differences between the states can make the difference between a grand success and a challenging time."