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Globalisation and Federalism: Uneasy Partners?

Federalism faces difficult challenges in the era of globalisation, since the latter has generated pressures for reform in economic and political organisations and thereby in inter-governmental relations of all developing countries as well. There are forces in inter-governmental relations pulling in opposite directions, some tending to centralise functions of second tier governments, such as of the states in India, and others moving to decentralise to tiers further down, citing "subsidiarity". Although, globalisation at one level has given some functional autonomy for efficiency gain and competition and to attract private capital, it has restricted the scope for independent sub-state level fiscal policy. The biggest challenge for federalism in the coming years would be to respect the plurality of identity of human beings.


Globalisation and Federalism: Uneasy Partners?

Amaresh Bagchi

Federalism faces difficult challenges in the era of globalisation, since the latter has generated pressures for reform in economic and political organisations and thereby in inter-governmental relations of all developing countries as well. There are forces in inter-governmental relations pulling in opposite directions, some tending to centralise functions of second tier governments, such as of the states in India, and others moving to decentralise to tiers further down, citing “subsidiarity”. Although, globalisation at one level has given some functional autonomy for efficiency gain and competition and to attract private capital, it has restricted the scope for independent sub-state level fiscal policy. The biggest challenge for federalism in the coming years would be to respect the plurality of identity of human beings.

This is a revised and abridged version of a lecture delivered at the Gokhale Institute of Politics and Economics, Pune in March 2005.

Amaresh Bagchi passed away in February 2008. He was preparing this paper for submission to EPW. The paper is being published here with the permission of his family.

remarkable development in the affairs of nations across the world in the last two decades has been the spread of decentralisation and federalism. Beginning with the late 1980s failure of central planning in the Soviet Union and the east European countries and the spread of globalisation, there was a resurgence of interest in decentralisation and federalism everywhere. While there were barely four federally governed nations until the second world war – the United States, Canada, Australia and Switzerland, and while Soviet Union claimed to be a federation the reality was quite different – several independent countries of Europe which fought among themselves for centuries have joined together to form a federation of a unique kind, the European Union (EU). In the Americas, after spells of authoritarian regimes, Argentina, Brazil and Mexico have moved towards more democratic federal systems of government [Kincaid 2002]. In the established large federations of the US, Canada and Australia, power had shifted heavily to the federal governments during the second world war. But in the US there is now introspection to find ways in which power can be transferred back to the states under the slogan of “New Federalism” [Fisher 1997].

1 Introduction

The closing decades of the last century saw substantial offloading of responsibilities by national governments to those below both in the US and Canada. It would appear there is, what Kincaid (2002) calls a “federalist ferment” across the world.

The ferment notwithstanding, federalism is facing challenges from several directions. First of all, the intellectual case for decentralisation and federalism has come under some critical reappraisal. Even some of the key assertions regarding the virtues of decentralisation and the assumptions underlying them have been challenged. Attention has been drawn to the possibility of decentralisation failures and the merits of strong nationhood as a check against centrifugal forces gaining ascendancy and subverting the integrity of nations [Tanzi 1999]. What is more, the very forces that led to the fall of oppressive statism and provided the impetus for decentralisation, viz, globalisation and the demise of statism, are now posing a threat to the soveigrnity of nation states – their life blood – and along with them that of their constituent units with implications that are yet to unfold. Despite the moves towards decentralisation and more room for junior governments in established federations, viz, the US, Canada and Australia, the signals are mixed. Federal government still accounts for 60 per cent of government expenditure in the US. Things have not changed much in Canada either. In Australia the trend if any is towards even more centralisation. Some of the decentralised federal countries

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like Brazil are “recentralising”. Globalisation has generated pressures for reform in the economic and political organisation and thereby intergovernmental relations of all developing countries. There are forces pulling in opposite directions, tending to centralise functions envisaged by second tier governments, like states in India, and decentralise some to tiers further down citing “subsidiarity”.

The choice of the federal form for the US constitution that presaged the emergence of the federal idea across the world was motivated largely by the anxiety to have a central government that can act decisively when required unlike in a confederation, but with effective checks and balances by dividing powers between the federal government and the states. What accounts for the current federalist ferment despite warnings about its risks and inefficiencies are basically twofold. One is the economic benefits of efficiency in the organisation and functioning of the public sector from decentralisation1 – now encapsulated by the principle of “subsidiarity” in the EU’s Maastricht treaty – combined with the gains from the operation of a large common market. The other is commitment to diversity rather than homogeneity. And this is particularly relevant for a diverse country like India. There is also the strength that comes from unity, the ability to face calamities like the tsunami and threats to security like external aggression or terrorism.

After three decades of centralised federalism, in the closing decades of the last century India seemed to be moving towards an era of “cooperative federalism”. Reforms forced by liberalisation gave back to the states the power that had been taken away for the sake of planning and development (e g, in the matter of industrial licensing). However, after a few years of relaxed relationship the centre is again seeking to assert its control over the states in several ways. The rise of insurgency in some parts of the country and international terrorism is calling for a strengthening of the hands of the centre. Economic reforms too, it is said, cannot progress without a radical shift in the manner the states have been functioning. They must follow the discipline of the market and while in some respects they now have greater autonomy, in several critical areas their autonomy is getting curbed as the centre’s hold is many areas remains tight and in some like enforcement of fiscal discipline the centre’s sway is tightening. The transfer system is being used increasingly to promote the national priorities, going into areas that in some instances come within the spheres of the states. There are on the other hand some institutional impediments and deficiencies in India’s federal system – stemming from the ascent of regional parties and multiparty coalitions at the centre – that need to be addressed if federalism is to flourish in its true spirit and not degenerate into a chaotic confederacy.2 On the other hand, while taking pride in participatory democracy, few states in India have devolved real power to the local bodies, the 73rd and 74th amendments to the Constitution notwithstanding. They serve mostly as spending agencies [Rao and Rao 2008]. What do these developments portend for federalism in India, a country that adopted a basically federal structure for its governance after independence?3 Does globalisation have a bearing on the way federalism is evolving in the country or elsewhere? This paper seeks to appraise the prospects in the background of the emerging worldwide trends.

2 Trends in India’s Federalism in the 1980s and 1990s

That the system of economic management under centralised federalism needed change became increasingly apparent in India as the 1970s drew to a close and initiatives were taken to loosen, though not dismantle, the regime of controls and reform the tax system. These yielded some positive results and the growth rate of the economy improved but the macro situation deteriorated culminating in the balance of payments crisis of 1991 leaving the country with foreign exchange reserves that could finance imports for barely 15 days. This provided the push for economic reforms with liberalisation as the keynote. With the demise of one party rule at the centre, time was ripe for restoration of the powers of the states in economic policymaking that had been taken away by the centre in the hey day of planning. Globalisation left little choice but to liberalise and decentralise.

The reforms brought some immediate results – the economy stabilised, inflation was controlled and so was the fiscal deficit. But there were some negative developments too. What attracted most attention was the persistence of deficits in government budgets particularly those of the states. Deficits which were earlier more prominent in union budgets sharply escalated in the state budgets. There was widespread perception that the reforms could not be sustained unless the states too fell in line [see essays in Howes, Lahiri and Stern (eds) 2003]. “Fiscal restructuring” emerged as the foremost task in the reform agenda and that had an impact the autonomy of the states in running their public sector in many ways. World Bank style conditionalities were introduced for the first time in central transfers to the states and following the recommendations of the Eleventh Finance Commission even a part of the grants-in-aid under Article 275 of the Constitution were made conditional on fulfilling fiscal reform targets to compel the states to be more responsible fiscally. The Twelfth Finance Commission linked debt relief to the enactment of fiscal responsibility laws and the quantum of relief to reduction in deficits. No doubt all this created greater awareness of the need for fiscal prudence and restraint in public expenditure. But it has had some negative effects too. A severe compression of expenditure adversely affected development expenditures comprising essential public services like health and education in several poor states [Rao and Chakraborty 2006]. Public investment in agriculture and infrastructure slumped. It also affected the fiscal autonomy of the states as the space left for development was severally constrained,4 and thereby federalism, in many ways.

In India federalism has come under pressure from two other opposing forces. One is the rise of religious identity as the platform of one of the main political parties, with its protagonists seeking to advance the thesis of “cultural nationalism” relegating pluralism to the background. The other is the emergence of coalition governments acting as a brake on the propagation of Hindu nationalism, which its proponents want to establish as India’s hallmark. But, as already noted, coalition politics is also acting as a paralysing and distorting influence on the functioning of the government at the centre impeding the functioning of a healthy

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federal system and driving politics towards quasi-confederacy. That provides a rationale for the centre to reassert its hold over the economy and the polity and intrude in areas earmarked for the states in the Constitution. The emerging picture is far from clear. There is reason to think that globalisation has played an important role in the development. How this has come about is gone into briefly in the section that follows.

3 Impact of Globalisation on Federalism

Inaugurating a seminar on federalism in a globalising world organised by the National Institute of Public Finance and Policy (NIPFP) in New Delhi in 2003, C Rangarajan, chairman of NIPFP pointed to two sets of factors that federalism now has to contend with. One is the impact of globalisation with its focus on free trade in goods, services and technology along with a free flow of capital and labour, as national boundaries crumble and countries get integrated. The other is the rethinking that has been going on about the respective roles of the government and the market and the enlargement of the space of the private sector in providing goods and services that were provided traditionally by the government. An offshoot of the second set of factors is the current emphasis on decentralisation as a way of securing efficiency in resource allocation in the public sector. Though apparently conflicting in their impact, the two factors are interrelated.5

Defined not only as increased trade in goods and services, movement of labour and capital across borders, but also greater “information exchange and the internationisation of ideas” [Islam 2004], globalisation has its benefits and not merely “discontents”, as Joseph Stiglitz would have it. However, its impact on the institutions that distinguish countries from one another, particularly the public sector and federalism, is yet to unfold fully. In a thought provoking paper titled ‘Competitive Federalism and Incipient Globalisation’ presented at the NIPFP seminar, Albert Breton analysed the way globalisation is working to weaken and reduce the public sector and limiting the freedom of action on the part of governments, both national and subnational in many areas, affecting thereby the operation of federalism across the world. Economic globalisation, Breton argued, has often entailed elimination of restrictions on the free movement of capital in the first place and concomitantly harmonisation and standardisation of the rules that govern trade, investment, employment, property rights and environmental policies. This has meant that the rules prevailing in the dominant economies of the world, the US in particular, are tending to prevail everywhere, requiring the elimination of impediments to private ownership of physical assets.

The driving factor in these developments, it is contended, is the mobility of corporate capital facilitated by modern technology and this is having a profound impact on the functioning of governments and the public sector everywhere. Large business corporates, in their quest for maximum returns on their capital, prefer to operate in economies that provide the best environment for their operation such as decisiveness in implementing contracts, labour laws, favourable taxation, environmental regulations and amenities that can enable them to hire labour cheap. Governments are played against one another in this quest and so one finds across the world a downward drift in corporate tax

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rates, insistence on enforcement of child labour and environmental laws in developing countries (while some of the leading advanced countries drag their feet in signing regulatory protocols), lower job security of workers and lower real wages for workers in the lower levels. How these tendencies are working, Breton noted, are not fully known and how they are influencing the behaviour of governments remains to be modelled. However, one visible consequence has been that governments are obliged to provide goods and services to corporate capital at tax prices that do not meet the cost of their production and delivery. Consequently, the public sector is compelled to function at a suboptimal level. This prognostication finds an echo also in a recent article of Kaushik Basu. “There is no question that today the large corporation are getting a wonderful deal playing one government against another” [Basu 2008].

Based on this analysis, Breton asserts, the equilibrium following globalisation cannot but entail welfare loss compared to the situation that would have prevailed otherwise. In the new equilibrium, corporate interests benefit from large “oligopolistic rents” leaving the citizenry at large to be content with fewer (or lower quality) governmentally provided goods and services. It is therefore not surprising that globalisation is accompanied by the transfer of the task of supplying goods and services which were hitherto the responsibility of the public sector to the private sector. Those lacking the requisite purchasing power – the poor

– are largely left out. Basu (2008) attributes the weakening ability of governments to counter the growing inequalities among nations and within nations to this phenomenon. The mushrooming of “super-specialty” hospitals in India while the public healthcare system verges on collapse tellingly brings this out.

As another consequence, the distribution of political power in democratic societies may also shift with greater clout of corporate capital and weaken the public institutions that ultimately bear responsibility for the general welfare of the people. If this prognosis of the dynamics at play has any validity, Breton warned, then the handling of even national defence, justice and international diplomacy also may get transferred to private corporate hands, irrespective of whichever government they may elect. Concurrently, jurisdictions at one level will pass on many of their responsibilities without a matching transfer of resources or adequate powers to raise the required resources to those below – a phenomenon all too evident in India. Whatever power they may be invested with will be constrained by competition to woo corporate capital. The “Wicksellion connection”, that is, the link between spending and taxing decisions that makes for efficient organisation of the public sector will be weakened, if not snapped. This, the weakening of the capacity of governments to compete in providing public services efficiently, was characterised by Breton, as a “negative externality” of globalisation. This characterisation, some may however argue, ignores the benefits of globalisation, and overstates the degree of harmonisation of institutions that globalisation might seem to entail.6

In fact, globalisation has been hailed by many including several leading economists [Bhagwati 2004] as beneficial in many ways such as making the fruits of modern technology available to all countries of the world with almost all sections of the people benefiting (as the spread of cell phones for instance in developing countries testify). Apparently, globalisation is providing a big help in achieving the millennium development goals and poverty elimination everywhere. It cannot be denied that there is force in these contentions. However, the influence may not have been all that benign.

Breton’s warning about the relentless pressure for downsizing governments below what could be regarded as the optimal level cannot be dismissed summarily. Of course, the portrayal of the phenomenon of shrinking governments as an outcome of globalisation working through intergovernmental competition to attract corporate capital might look overly simplistic. It has to be recognised that disenchantment with large governments has much to do also with the innate inefficiencies of the public sector. However, the fact remains that the propagation of decentralisation and privatisation as the way to make governments efficient has received a big thrust from globalisation. Besides, decentralisation has come to be associated with leaner governments. Devolution of powers to sub-national and even lower level governments thus may not in reality mean as large a role for them as might be thought to be happening. That is to say, decentralisation may have meant offloading of only some governmental functions in a truncated public sector. A similar apprehension was expressed by Musgrave in the course of his celebrated debate with Buchanan: when he said, “…devolution not only aims at revising the weights carried by higher level governments but also carries an expectation that lower level government means less government” [Buchanan and Musgrave 1999: 173]. Lower level governments, it would seem, are getting empowered but within a narrowly defined area. In any case the middle level governments, the states, seem to be losing out.

Another fallout of globalisation which too has meant encroachment on state autonomy is the imperative of efficiency through competition in a worldwide market. In order that countries can develop the potential of their economies according to their comparative advantage, and economic decisions and choices are not distorted by domestic taxation, countries across the world are now moving towards a tax regime that allows movement of goods and services across country or state borders free from any tax levied by the country of origin. This accounts to a large extent for the spread of the value added tax (VAT) across over a 100 countries in the last century. However, in order to stem the race to the bottom that competition for corporate capital and trade was generating, there have been moves towards harmonisation in taxation among independent countries. This trend has been most striking in the EU. Codes have been formulated for arresting harmful tax competition not only in the taxation of goods and services under VAT but also in the taxation of corporate income. In the Nordic countries capital income is taxed at a lower rate than income from labour. This too has meant some curb on the autonomy if not sovergnity of nation states. These trends are discernible in India too.7

Imperative of Fiscal Discipline

Another outcome of globalisation that circumscribes the autonomy of the sub-national governments in running their public sector is the imperative of fiscal discipline imposed from above. This has been most visible in the Latin American countries like Brazil and is in evidence in India too. Going by the Musgravian scheme of assignment of functions among different government levels in a federation, macroeconomic management has to be the responsibility of the national government. This is epitomised now by the Maastricht treaty in the EU. Macro-management in an open economy with its focus on the balance of payments and exchange rate calls for certain discipline in the fiscal arena too as large deficits in the government budget unless matched by savings in the private sector tend to create economic instability, both internal and external. The credit worthiness of a country which is a critical factor in the flow of trade and capital in a globalised world is influenced heavily by the “solvency” of its public sector as perceived by foreign investors, which is often judged by the level of its government debt and deficit, taking all levels of government into account. Countries that had in the past allowed autonomy to the sub-national governments in borrowing internally and externally ran into problems of solvency because of unbridled borrowing of their junior governments. This had happened in many countries particularly in Latin America and seemed to be occurring in India too, even though the states in India do not have complete autonomy in the matter of borrowing. Article 293 of our Constitution requires the centre’s consent for a state to borrow so long as it remains in debt to the union government. The states also do not have the power to borrow externally. Even so, many states were in heavy debt and their debt service obligations entailed a big burden on their budgets. The reasons for this predicament are several. These are not gone into here. The net result has been mounting pressure for fiscal discipline all round. While this has led to a healthy trend in the management of state budgets, it has meant a severe contraction of the fiscal domain of the states.

One important reason for this outcome has been that when a country runs into deep trouble because of balance of payments problems and large external debt, and approaches the International Monetary Fund (IMF) for help being unable to borrow from abroad any more, it has to comply with the conditionalities prescribed by the IMF. Loans are given by the World Bank and other international agencies like the Asian Development Bank to assist structural adjustment which invariably carry conditionalities requiring restructuring of the public sector of the borrowing country ranging from downsizing of government by retrenchment and privatisation to tax reforms and reduction of subsidies. The prescriptions based on what has come to be known as the “Washington consensus” is applied when a country finds no alternative but to seek external assistance for tiding over a crisis or for accessing funds to restructure its public sector no matter how large or small its public sector is relative to the need for public goods and services like, health, education and infrastructure. India too was obliged to submit to conditionalities with a strong focus on fiscal adjustment when it went for assistance from IMF and World Bank in 1991-92. Although the country is now well out of any foreign exchange crunch, the imperative of fiscal prudence has now got embedded in government policy through the Fiscal Responsibility and Budget Management Act passed by Parliament in 2003. The states also were made to follow with the Twelfth Finance Commission’s scheme of debt relief anchored on enactment

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of fiscal responsibility laws by a state as a precondition for relief. The wisdom of impossible rigid restrictions on borrowing by the public sector in the face of huge infrastructure gap has been questioned by several respected economists [Bhaduri 2005 and Rakshit 2005]. However, the pressure of international aid and rating agencies leaves no choice. Breton’s apprehension of globalisation reducing the public sector to suboptimal levels may not be all that far-fetched.

4 Positive Fallout of ‘Constituent Diplomacy’

There is one school of thought which argues that there has been a net accretion to states’ autonomy in several countries because of globalisation as the sub-national governments (the constituents of a federation) can now approach international financial and aid agencies directly and negotiate for loans and grants – a window of accessing funds directly which was not open to them earlier. Attention is drawn in this context to the attempts by states in Brazil to obtain assistance from the IMF and World Bank. The states in India too have found its possible in the recent past to negotiate with international agencies, a benefit they did not enjoy before liberalisation.

In fact, a fast growing speciality niche in the field of federalism, post-globalisation, is the conduct of international affairs by sub-national governments. Kincaid has introduced the term “constituent diplomacy” to denote activities undertaken by sub-national political entities (e g, states, provinces and cantons) that cross international borders. Many types of activities come under this rubric such as provinces’ investment promotion offices located abroad as well as what is called the “co-formulation” of foreign policy between national governments and regional authorities. The concept of “constituent diplomacy” it is contended, has the merit of capturing the idea that states, provinces, cantons, landers; and the like are constituent units of a federal polity, often in fact “co-sovereign constitutional polities with the federal government, not sub-national governments”. In Kincaid’s view, constituent diplomacy is increasing around the world not just in terms of the intensity of range of activities undertaken by constituent authorities but also in the proportion of countries around the world, where this phenomenon is surfacing. Distinguishing “constituent diplomacy” from “sub-national” diplomacy,8 Kincaid cites cases where sub-national units have secured significant autonomy from national authorities in their dealings with foreign entities, like governments, international agencies and representatives of private capital [Kincaid 2001].

The federal state as it was originally conceived generally assigned questions of foreign policy to the federation, with a virtual monopoly over the conduct of foreign affairs. This led Alfred Escher a renowned Zunich statesman of the 19th century to describe the federal arrangement as “internal diversity and external unity”. In recent years however, “constituent units and cities of federation are increasingly extending these spheres of activity beyond national boundaries, whether on a unilateral or multilateral basis and whether through formal or through non-binding agreements” [Thurer 2003]. Although the higher level still gets precedence they have to take account of the interests of lower state levels too. Articles 54 and 55 of the Swiss federal constitution for

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instance, enjoin that “the Rights of the Cantons shall be safeguarded and their interests taken into account” in determining the federal state’s foreign policy [Erenzeller et al 2003].

According to Kincaid, what accounts for the “institutionalised” and “legitimised” constituent diplomacy as a facet of federal democracy is not globalisation so much as “democratisation, inter-governmentalisation, human rights, decentralisation, market liberalisation, United States policies, and technological innovation in travel and communications, which have made the current era of globalisation different from that which took place in the 19th century” [Kincaid 2003].

Citing some features of the Indian case, in an article in Publius, a journal of federalism, focusing on emerging federal pressures in India, Rob Jenkins contests the claims advanced by Kincaid and others, regarding the spread of the phenomenon of constituent diplomacy [Jenkins 2003]. Those who feel globalisation has secured autonomy for the states in India to make forays into external affairs rely on reports that tend to show an increasing clout of state government leaders on the international stage. Reference is often made in the context to the visits by Indian chief ministers to the World Economic Forum, and hosting of global business and political leaders like Bill Clinton and Bill Gates, and the growth in stature of state leaders projected as visionaries, comparable to other national leaders and heads of states. Taking note of these developments, some go to the extent of claiming that the “enhanced role of the states has transformed the power equations between the Centre and the states with the latter becoming more assertive” [Sridharan 2002]. But is that the reality?

One view is that at least in India whatever new role the states may be acquiring may not mean a net gain in their autonomy. Thus, while getting more de facto latitude in negotiating with foreign investors in some cases the states’ power to regulate (or deregulate) vital aspects of the activities of firms in their jurisdictions has been overshadowed by central directives enunciated through various national policies. While losing the power to intervene through its control of investment and industrial licensing, the centre has assumed a new role as a regulator concerned with market imperfections and state financial discipline. “As the Centre’s role as an interventist has faded, its role as a regulator has grown” [Rudolph and Rudolph 2001]. The manner in which the plan of Tamil Nadu government under Jayalalithaa for a new secretariat was stalled by a central minister is a case in point.

Reviewing the literature that has grown around the issue, Jenkins assesses the growth of the powers of the states in India in the diplomatic arena with reference to their dealing with two external agencies that are playing an increasingly important role in India’s economic diplomacy, the World Bank and the World Trade Organisation (WTO). Since the 1990s some states have made negotiations and reached agreements with international institutions like the Asian Development Bank, the European Union and the Department for International Development of the United Kingdom. However, it is the contacts made with the World Bank that have drawn the most attention of observers of the phenomenon of subnational diplomacy. These activities might lend credence to the hypothesis of “shared sovereignty” referred to by some as signifying the increase in the capacity of the states to influence their own development performance. Jenkins advances several reasons why the external activities of India’s states should be considered as lacking the autonomy that is critical for constituent diplomacy to be real.

Irrespective of which state borrows, the lending instruments of the World Bank specify the government of India as the official borrower and not just the guarantor of the loan, thereby giving the central government a leverage. It is not merely a formality, “a fig leaf” as Jenkins observes. The centre retains the discretion to decide what provisions will be allowable and it has exercised such direction on many occasions. Even when a state had clout at the centre by virtue of the support extended by its ruling party to the coalition (such as the Telugu Desam Party ruled Andhra Pradesh under the National Democratic Alliance regime between 1999 and 2004) bureaucrats of the central ministries made the World Bank realise that no programme could go through over their head. They expressed displeasure when World Bank officials colluded with state ruling parties who participated in the national coalition and in at least in one case World Bank projects were stalled by officials in Delhi [Jenkins 2003].

The room for diplomatic autonomy of the states was curtailed by the centre not only by exercising its federal powers to withhold assent to any agreement but also indirectly by exercising its leverage on the external actors. The central government can influence the “multilaterally funded programmes even before they are proposed to the states”. While a tight rein over the World Bank may not look objectionable, this has enabled the centre and the Bank to get the states to commit themselves to fiscal management programmes/reforms that the centre wanted. Some of these reforms may have merit but in accepting World Bank loans Andhra Pradesh and Karnataka agreed to carry out extensive reforms of their budgetary policy and system. Jenkins observes, “these are very intrusive reforms certainly representing a charge on sovereignty regardless of whether the reforms themselves are either a good idea in theory or effective in practice”. In the end, the central government sees its will prevail but need not fund the necessary programme from its own revenue. The case against viewing India as qualifying for being put in the category of constituent diplomacy becomes even more compelling when one considers the states’ relationship with the WTO.9

There are several ways in which the WTO as an external actor reduces rather than expands the autonomy of India’s states casting doubt on the claim that liberalisation entailed by globalisation has enabled the states to expand their role in economic diplomacy. Jenkins argues that the question of autonomy in this context may be examined from two angles: (i) the range of policy options available, and (ii) the states’ room for action to meet their policy objectives in the face of volatility created by increased exposure to trade. The conclusion one reaches after examining available incidence is that there can be no doubt that there has been a foreclosing of certain policy options that are available to state governments – or even the central government to whom the states often turn for assistance – as a result of WTO treaty commitments. Some states even complained that the WTO agreement on agriculture negotiated and agreed to by the government of India in 1993-94, violated the right of state governments to determine policy in an area that under the Constitution falls within their sphere. Of particular concern are the ceilings imposed by WTO on domestic and export subsidies and issues of market access in agriculture.

How the states’ ability to fulfil their policy objectives is affected by globalisation is shown by the issues of market access and their vulnerability to the impact of trade. Reduced barriers to trade have had a differential impact on states depending on the share of agriculture in their economy and their crop mix. Raw silk producers in Karnataka have been adversely affected from time to time by competition from imports. Small tea growers in Tamil Nadu and coconut growers of Kerala were exposed to acute price fluctuations as a result of changing rules of international trade. A sharp fall in prices of groundnuts driven by competing imports from south-east Asia hit groundnut producers. Increased exposure to trade and the resulting volatility in prices have not been conducive to domestic sovereignty of their respective governments either.

In trade negotiations, states do not seem to have been able to influence the centre significantly on substantative issues although they may have secured some positive response from the centre on procedural matters sometimes. Whether the amendments to the Indian Patents Act of 1972 that was passed by Parliament in 2005 was discussed with the states is not clear although plainly the states where India’s leading pharma companies are located will be affected in a big way. A remarkable feature found by observers in India’s negotiating process is the relative autonomy of India’s trade negotiators from even their political masters in Delhi, much less from state authorities who might want to get their case advanced. Of course, the WTO does not provide any formal mechanism for sub-national units to influence its deliberations. However, the states can yet influence issues coming under WTO agreements in many ways, for example, by collaborating in determining India’s action within the WTO compulsions. Also, in the implementation process, the states can invoke the safeguard provision which the government of India had secured in the WTO agreements. On both these the states have fared rather poorly.

Even on the “soft end” of the compliance spectrum, e g, the WTO’s Trade Policy Review Mechanism (TPRM) through which the compliance of member-states with their treaty obligations is reviewed periodically, priorities of the government of India do not always seem to reflect those of the state governments. In fact, India’s record in this activity is lacking in two respects: The central government has not involved state governments in any significant way in the process through which WTO team review its own trade policies. Also, it has not used its prerogative of questioning the practices of other countries when WTO-mandated trade policies are reviewed, which could have benefited the states. India’s performance in the TPRM, says Jenkins, might well have looked different had constituent diplomacy been practised vigorously.

Another important area of national policy where state governments could be expected to have an influence relates to the decisions on whether to increase tariffs within WTO compatible bands to provide relief for producers adversely affected by import pressure. Central government officials responsible for

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the implementation of trade policy have not always been sensitive to the pleas of the major trade-affected states. A good example is the crash in edible prices in 1999-2000 that affected farmers of several states particularly Andhra Pradesh and Madhya Pradesh where the effects were felt for a long time. Even at the height of the crisis, despite pressure from the state governments and members of Parliament within the ruling party, the centre did not raise the tariffs, even though that could be done without violating WTO commitments. One wonders, could the farmers’ suicides in Maharashtra have something to do with all this? For all talk of constituent diplomacy, no state in India can approach a foreign government for help even in emergencies without the consent of the centre.10

Brazil is one of the federal countries where constituent diplomacy seemed to be gaining ground with globalisation. A visible impact of globalisation in Brazil was the emergence of fierce competition among constituent units to compete for investment directly instead of through the federal government, signifying what might be called “federative foreign policy”. To deal with the situation arising from sub-national governments negotiating directly with foreign/international agencies for funds a Federative Relations Bureau was set up in 1997, linked directly to the ministry of foreign affairs. Although the emergence of a federative foreign policy is now a reality this served to reassert the authority of the federal government in external affairs. While there has been some accretion of room for action on the part of the states as a ramification of constituent diplomacy, the states in Brazil lost their fiscal autonomy because of the imposition of strict fiscal discipline based on World Bank and IMF guidelines. So much so that a professor at Sao Palo University (Antonio Rodngues) and a keen observer of the federal scene in Brazil felt constrained to observe that the guidelines proposing “fiscal adjustment, economic openness and the shrinking of the role of the state directly hit the formulation and management of economic policy in Latin America” [vide AB 2003]. With the “Real Plan” for economic stability launched in 1994, Brazil embarked on a phase of fiscal adjustments and the dismantling of the state that would reduce the de facto autonomy of the states and municipalities. Now the priority of the federal government was to guarantee the stability of the currency, absolute control over inflation and modernisation of the Brazilian state”. The debts of the states and municipalities were renegotiated linking the process to privatisation programmes of their state-owned corporations and banks.

According to a recent survey of world opinion on the benefits of globalisation, majority of the people perceive the sharing of the benefits unfair. Nevertheless one has to acknowledge, that globalisation has manifold benefits. Jagdish Bhagwati has come out with a strong defence of globalisation pointing to what it has done to make the lives of the poor a lot better all over the world. In any case, with modern technology breaking down national frontiers and billions of dollars moving across countries with the flick of a finger, no country can run its economy in isolation if it is to reap what modern technology offers to improve the lives of the people. The point simply is that its influence on federalism may not be benign in all respects in that it entails harmonisation, if not total uniformity and advent of supranational authorities to

Economic & Political Weekly

september 20, 2008

regulate things that no one nation can.11 At stake is federalism and all that federalism protects. As Musgrave puts it, “Globalisation, decentralisation and diversity may prove to be uneasy partners” [Buchanan and Musgrave 1999: 174].

5 Impact of India’s Federalism

India too had to implement a stabilisation and structural adjustment programme in the wake of the balance of payments crisis in 1991. Initially, the responsibility for adjustment rested on the centre. However, attention turned to the states as the fiscal situation deteriorated after showing some improvement and the consolidated fiscal deficit crept up to nearly the same level as at the onset of the crisis, and deficits in the state budgets turned out to be a major contributory factor. Containing the deficits of the states now emerged as a major objective of the reforms agenda. Reforms in other areas like removing barriers to internal trade and facilitating the flow of investment, it was felt, also called for action by the states. Thus a large focus of the second generation reforms fell on the states, as the fiscal deficit of many states rose to over 5 per cent of GDP and in quite a few, over 7 per cent.

To be fair, the deterioration of the states’ finances was not entirely of their own making, though no doubt competitive populism manifesting in free power to farmers and so on had taken its toll on the state exchequers. Interest rates which were moderate went up with financial liberalisation and then came the pay revision following the Fifth Pay Commission’s recommendations. A decline in tax devolution consequent on a fall in the centre’s revenue growth aggravated the fiscal crisis of the states. Unable to meet the burden the states approached the centre for assistance which was extended as loans but with World Bank style conditionalities designed to set the states’ finances in order. This pattern has now been extended to many of the grants flowing from the centre to the states.

States were required to sign memoranda of understanding (MoU) with the central government subjecting themselves to wide ranging conditionalities policing of which opens up wide scope for central bureaucrats to lord it over the states. Grants for even small sums (Rs 500 crore divided among 28 states none getting more than Rs 60 crore) under a Urban Reform Incentive Fund (URIF) programme required an undertaking to carry out reform measures “in regard to housing, urban planning, municipal resources and urban infrastructure”, and comprise such things as rationalisation of stamp duty in phases to bring it down to not more than 5 per cent by the end of the Tenth Plan period, reform of property tax so that it may become a major source of revenue of urban local bodies, and arrangements for its effective implementation so that collection efficiency reaches at least 85 per cent by the end of the Tenth Plan period. The Jawaharlal Nehru Urban Renewal Mission launched by the UPA government at the centre in 2005, while enlarging the fund that can be accessed for funding projects for urban development also contains elaborate conditionalities which the states have to fulfil to be eligible for grants under the scheme.

All this may well be justified on grounds of “national objectives” like economic efficiency, and externalities. The short point in the present context is that for good or for ill liberalisation and

reforms driven by globalisation have not enhanced federalism and far-reaching relevance of the diverse relations that operate between persons. The political conception of a person as a citizen of

but have rather curbed it.

a nation, important as it is cannot avoid all other conceptions and

It will not be fair to blame all the challenges that federalism in

the behavioural consequences of other forms of group association

India is facing on globalisation. Some of them are of internal

[Sen 1998].

origin, having their root in the institutional deficiencies, and the way politics and the party system are evolving. These are not A great merit of federalism lies in its promise of respecting gone into here. plurality of identity of human beings. An ardent federalist like

Kincaid was constrained to draw attention to the potential

6 Conclusions

erosion of federal systems in today’s era of regional integration The attraction of federalism as a system of governmental organi-and globalisation. In western Europe, presumably in self-interest, sation, it may be reiterated, lies among other things in its com-regional and local governments as well national governments mitment to diversity, rather than homogeneity and to quote Kin-have ceded considerable authority to the EU. At the same time caid again, “in its promise not to obliterate one’s home, village, global market competition is creating pressures on all governcity, province, nation, region or continent in the course of dele-mental systems to deconcentrate or decentralise certain powers gating powers to general and functional jurisdiction of larger ter-in order to give constituent governments more freedom and ritorial scope”. In the last analysis it is a matter of one’s identity. authority to compete for investments and trade and to enable the No doubt one can have several identities but as Amartya Sen put enterprises to compete in the large markets. However, he reminds it in one of his many illuminating lectures: readers: “The accommodation of human diversity, remains the

...subjugating all affiliations to one overarching identity – that of

leading challenge for federalism. It is also the leading challenge membership of one national polity or people – misses the force for the world” [Kincaid 2002: 13].


1 For a lucid exposition of why a central government cannot deliver local public services efficiently even with advances in technology to set up an efficient system [Oates 2003].

2 Under quasi-confederacy the constituent units have veto power over central government decisions [Inman and Rubinfeld 1996] for a succinct delineation of the characteristics of a confederation as compared to a “compound” republic.

3 Whether India is “federal” has been a matter of continuing debate. Many are inclined to treat the constitutional structure of India as quasi-federal, citing its unitary features. However federalism as a basic feature of India’s constitution has been acknowledged by the Supreme Court in the celebrated Bommai case.

4 This was brought out sharply in the address of the chief minster of Rajasthan in her address at the meeting of the National Development Council held in December 2007.

5 For a brief account of the discussions at the seminar [AB 2003]. 6 For a cogent propagation of this view [Islam 2004].

7 The exemption of dividend income and long-term capital gains from listed equities from income tax and adoption of a uniform floor rate of state VAT in India also point to the same trend.

8 The term “constituent diplomacy” is preferred to sub-national diplomacy on the ground that subnational diplomacy seems to imply that states are inferior to national governments and so inferior also in the arena of international relations [Kincaid 2001].

9 The discussion on this issue contained in the next few paragraphs draws heavily on Jenkins (2003).

10 US offered help to West Bengal in tackling a bird flu attach a couple of years ago in the state but the state needed clearance from the ministry of external affairs before it could accept the officer.

11 For a contrary view asserting that globalisation does not necessarily entail uniformity in institutional structures of nations [Islam 2004].


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Public Finance and Public Choice: Two Contrasting Visions of the State, MIT Press.

Ehrenzeller, B, R Hrbek and G Malinverni (2003): Federalism in a Changing World: Learning from Each Other, McGill Queens University Press, Canada.

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  • (2002): ‘Introduction’ in Ann L Griffiths and Karl Nerenberg (eds), Handbook of Federalism, Forum of Federations, Ottawa.
  • (2003): ‘Foreign Relations of Subnational Units’ in Blindenbacher and Killer (eds), Federalism in a Changing World – Learning from Each Other.
  • Oates, Wallace (2003): ‘Assignment of Responsibilities and Fiscal Federalism’ in Blindenbacher and Koller (2003).

    Rakshit, Mihir K (2005): ‘Some Analytics and Empirics of Fiscal Restructuring in India’, Economic & Political Weekly, July 30.

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