Another critique of Modi growth model goes nowhere

An important project for intellectuals in India these days is debunking the Gujarat growth story. Since many "secularists" dislike Narendra Modi, it has become important to deny him what he claims as one of his achievements: the state's fast-paced growth.

While it is nobody's case that every achievement of Gujarat should be attributed to Modi's leadership or even his tenure, the efforts by many to punch holes in his story are sometimes pathetic. You don't improve your case against what Modi may have done wrong in 2002 by rubbishing what he may have done right at other times.

More often than not, the holes punched in the Gujarat story are bizarre because they are forced. They are also illogical: if Gujarat's growth is not the result of Modi's work, which is what his critics want to claim, you can't in all fairness attribute all of Gujarat's failures to Modi either. The argument cuts both ways.

Another debunking of the "Modi miracle" has been attempted by Arvind Subramanian in Business Standard. He says the Modi model fails on a key governance standard: the metric of the state's own tax revenues (OTR) as a share of state GDP.

NARENDRAMODI

Gujarat, on the other hand, saw a degree of political instability in the late 1990s and early 2000s - remember the Keshubhai-Vaghela political fight - till Modi came to power. AFP

Quoting research by Utsav Kumar of the Asian Development Bank, the author says that Modi's Gujarat does not pass the "smell test" of high or stable OTR-to-state GDP. While traditionally well-governed states such as Karnataka, Tamil Nadu and Andhra Pradesh have maintained stable or rising OTR-to-GDP ratios, the average figure for Gujarat has declined, from 7.84 percent to 6.65 percent of GDP between 1990-99 and 2006-11 (Read all the numbers in this chart here).

The drop is large, but predates Modi. During Modi's tenure, the drop has been from 6.93 percent to 6.65 percent. If anything, he may have arrested the rate of fall in the second half of his tenure.

In contrast, the comparative figures for Karnataka (8.98 percent to 9.57 percent), Tamil Nadu (8.93 percent to 8.54 percent), and Andhra Pradesh (6.78 percent to 7.73 percent) were either stable or better over the two decades, the author says (see chart here).

While Karnataka and Andhra show a rise, Tamil Nadu was stable in the 1990s, but reported a drop that was more or less similar to Gujarat's during the last decade (8.8 percent to 8.54 percent - a drop of 0.26 percent from 2000-2005 to 2006-11 against Gujarat's 0.28 percent).

Subramanian also notes that states which have recently been mentioned in the same breath as Gujarat on growth and improved governance - Bihar, Odisha and Chhattisgarh - have managed to improve significantly on this ratio. Bihar's figures are 4.30 percent and 4.61 percent (hardly earth-shattering); Chhattisgarh's 7.32 percent is excellent (the earlier figures were not available); and Odisha's improvement significant (4.65 percent and 5.63 percent).


What ties these three states' OTR performance together is political stability.

That's the answer to Subramanian when he asks: "In the tax collection data, why can one see a Raman Singh effect, a Nitish Kumar effect, a Naveen Patnaik effect, but not a Narendra Modi effect?"

Gujarat, on the other hand, saw a degree of political instability in the late 1990s and early 2000s - remember the Keshubhai-Vaghela political fight - till Modi came to power.

To assess Subramanian's criticism, we have to examine his assumption that over the long term one would expect taxes as a share of GDP to rise as incomes and growth rise. However, this assumption can be flawed depending on the circumstances of each state, and also the development model adopted.

If you have adopted a private sector-led growth model, where the big investments are in infrastructure, agriculture and manufacturing (as in the case of Gujarat), taxes may not rise in proportion to state GDP. Infrastructure investments (in ports, new cities, roads, power and rural water bodies) are typically long-gestation projects which may boost growth well ahead of tax revenues. For example, Gujarat's investments in infrastructure will start paying off once the Delhi-Mumbai Industrial Corridor takes off, but the failures relate to slow progress upstream and downstream of Gujarat - in Rajasthan and Maharashtra.

Agriculture, where Gujarat has seen a major spike, pays no taxes. Infrastructure such as ports will yield higher customs revenues as trade increases, but these go to the centre and do not accrue directly to the state (so, little rise in own tax revenues). The big investors in the state - Reliance, Essar and the automobile companies - have been lured in with huge tax incentives. The assumption is that they will generate more business and jobs than revenues for the exchequer in the initial stages. They will yield revenues only after their tax-free status ends.


Given this model of development, one would expect growth to precede revenue growth in Gujarat. And this is what may be happening. But we will have to suspend judgment on this for a few more years to check if it really does happen.

In contrast, Chhattisgarh's revenues depend on mining, while the growth of states such as Karnataka and Tamil Nadu has been led as much by services such as software as manufacturing and agriculture. One should thus expect a different revenue-to-GDP skew in such cases. Services are, by definition, highly profitable, unlike infrastructure. Highly profitable service industries employing lakhs create local spends that boost OTR.

The real fallacy of the analysis lies in the fundamental assumption itself: that states should be judged not by growth or other parameters, but by revenues. While over the long term the correlation between economic activity and tax revenues may be positive, it may not be so if a state consciously seeks to give itself a more recessed role, by remaining more an enabler than a spender.

The downside of excess state spending can be seen at the centre today, where high fiscal and current account deficits have together brought growth itself down.

Another state that fares equally badly as Gujarat is Kerala - which is supposed to excel on human development indicators. Between 1990-99 and 2006-11, Kerala's OTR-to-GDP ratio fell from 8.86 to 7.83 percent, a sharp one-percent drop, despite high growth rates driven by private spending.

Subramanian conveniently forgets to make this comparison, since Kerala-Gujarat comparisons are often otherwise made on social indicators to show Gujarat in bad light.

Both Kerala and Gujarat, for reasons that may be peculiar to them, have seen GDP growth but not high tax revenues shares in GDP.

More important is this truism: a ratio rises or falls not only on the basis of the numerator (taxes), but the denominator (GDP). If GDP is growing fine, the ratio will fall even if tax revenues are rising, but more slowly. As a metric, more is not necessarily better when it comes to taxes. What matters is the outcome - growth and equity. In fact, one can invert the OTR-GDP ratio to GDP-OTR to prove that Gujarat is growing faster on a lower government spend, and thus government is more efficient.

Perhaps worried that he may have made too big a point about tax revenues, Subramanian debunks his own argument partially and admits that "this might be a very misleading, even unfair, assessment," since "Modi could argue - consistent with his right-of-centre ideology - that ...he should be celebrated for delivering dream outcomes...". These outcomes being small government and efficient government.

That is precisely the point. Modi's critic has effectively demolished his own argument.

(Read more on critiques of Modi and their flaws here and here).


Published Date: Jan 23, 2013 02:19 pm | Updated Date: Dec 20, 2014 03:24 pm



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