in india is uniform across all states, its impact...

23

Low productivity growth and considerable intra-state disparity in the distribution of opportunitiesare the two most important causes for relatively lowand unsteady economic growth and slow pace ofpoverty reduction in AP. Low productivity growthcould be due to a host of factors, such as, poorinfrastructure, administrative and regulatorybarriers to operating business, stringent labor laws,land market distortions, unsustainable fiscalpolicies, large-scale government ownership ofbusiness, high indirect taxes and non-tariff barriers,restrictions on foreign ownership, lack of goodinstitutions, and so on. On the other hand,disparity in the distribution of opportunities couldbe the result of the state's colonial history,geographical endowments, culture and socialtraditions, political representations, lack of pro-poor public policies and so on.

The national level macroeconomic policies andincentives facing a firm are uniform across statesand yet, their economic performance varies widely.This indicates that state-level policies, institutions,the way central policies are implemented at thestate-level, and certain idiosyncratic characteristicsof the state and its people play a significant role inexplaining the growth and development outcomesof the state. For example, factories in AP tend touse more labor-intensive technology than firmsbased in Gujarat or Maharashtra. So while thenature of the inflexibilities of the current labor laws

in India is uniform across all states, its impact islikely to be more pernicious in AP than in otherstates. Based on state-specific characteristics, weidentify the following five factors to be the keybarriers to higher growth and sustained povertyreduction in AP:

OVER-STAFFED FIRMS AND ANINFLEXIBLE LABOR MARKET

AP's labor force consists of 43 million people or 57percent of the state's population, of which as muchas 65 percent live in rural areas. It has the highestparticipation rate in the country with nearly 81

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Box 2 - Major Barriers to AchievingHigher and Sustainable Growth and

Poverty Reduction in AP

1. Over-staffed firms and an inflexible industriallabor market

2. An uncompetitive market structure in agriculturewith few alternative production and marketingarrangements

3. Low level of domestic and international tradeand FDI flows due to tariff, non-tariff andinfrastructure-related barriers

4. Inadequate dissemination of policy changesinvolving administrative and regulatory burdenand weak implementation

5. Socio-economic rigidities that have resulted in askewed distribution of opportunities.

percent of the population in the age group of 15-55reported to be working. A significant portion of itstotal work force, 40 percent, is agricultural labor. APin fact has the second highest number of agriculturallaborers in the country after Bihar. It also has thehighest number of agricultural laborers per cultivator(4:2) in the country. Organized manufacturing sector(i.e. industrial undertakings registered under theFactory Act) constitutes only 3 percent of the laborforce. The rest 35 percent of the work force isemployed in unorganized manufacturing, non-manufacturing industrial sectors, and services, whichalso includes central, state and local governmentadministrations. The extremely low level ofemployment in industry and inability of the workersto move in the employment chain from low payingjobs in agriculture to high paying jobs in industryand services is primarily attributed to a constrainedand inflexible industrial labor market.

The stringent labor market regulations in India havebecome a constraint on growth and poverty alleviation(see Box-3). The experience of Andhra Pradesh is nodifferent, which is home to a disproportionately largeindustrial labor force. The state accounts for only 6percent of the country's industrial output but 13percent of the industrial labor force, and during thelate 1990s, accounted for almost one-fourth of all theindustrial strikes in the country (figure-10, toppanels). Our survey indicates that, on average, firms inHyderabad have 15-20 percent more workers thanthey would have employed had there been no penaltiesin adjusting their workforce, compared to 10 percentin Mumbai and 5-7 percent for some of the Chineseprovinces. Consequently, the level of laborproductivity in garment industry, as measured byvalue-added per worker, in Hyderabad is one-third ofMumbai and one-sixth the level in Kuala Lumpur. APfirms are also found to use less non-permanent orcontract workers than firms in other states includingMaharashtra (figure-10, bottom panels).

In addition to overstaffed factories, the state also hasa legacy of trade union activism and industrialdisputes. During the mid-1990s, nearly three out ofevery ten workers involved in industrial disputes werelocated in AP (figure-10, top panel). It had theunenvious reputation of being the state with thehighest number of industrial disputes and lockouts inthe country, after West Bengal. While the frequencyof the labor strikes and disputes in AP has comedown in recent years, much of the damage hasalready been done. The state therefore needs to moveaggressively on labor market reforms if it intends towin back the investors' confidence.

It is important to note that, except for few instances,AP's state labor rules are not unduly restrictive thanwhat exist in other parts of the country20. But, giventhe overstaffing situation, industries in AP aredisproportionately more affected by the inflexibilityof the regulations than the more capital intensiveindustries in say Gujarat or Maharashtra. Forexample, while no firm in India employing morethan 100 workers can temporarily layoff or retrenchworkers without the state government's permission(Chapter V.b of the Industrial Dispute Act, 1957),AP firms, which are saddled with disproportionatelymore labor force than optimal, are the ones who aremore likely to use this provision than firms in otherstates. But unfortunately, like in other states, GoAPhas rarely given permission to firms to exerciseChapter V.b21. The strikes and labor disputes on theother hand are attributed partly to the historicalpresence of large number of public sector industriesand the influence of some of the center-left politicalparties, who have a strong presence and largefollowers in certain areas of the state.

The Government of AP also seems to have perhapsunwittingly made some state labor rules morestringent than those prescribed in the correspondingCentral Acts. For example, the Contract Labor(Regulation and Abolition) Act, 1970 is applicable to

MAJOR BARRIERS INHIBITING AP’S ECONOMIC GROWTH

24

20 In fact, according to Besley and Burgess (2002), AP's labor rules have been historically less pro-labor than in states like West Bengal and Kerala.

21 During the last 20 years, permission under Chapter-VB has been given only to public sector enterprises that are being privatized and to only oneprivate sector company (following the ban on production and sale of liquor in the state)!

contractors who employ more than 20 workers,whereas the corresponding AP state rule isapplicable to contractors who employ more than 5workers. Through various notifications, GoAP hasalso prohibited employment of contract labor incertain operations in the following industries:paper, cement, sugar, steel, State Electricity Board,and also in canteens in all factories andestablishments (recently GoAP has undertakensome measure reform in this area; details are inSection 5). It is therefore not surprising that, oursurvey results show that AP firms use less non-permanent or contract workers than firms in otherstates including Maharashtra. Since the use oftemporary workers is primarily to assist firms toadapt to changing conditions and are cheaper than

permanent workers, firms located in AP must be ata disadvantage compared to other firms due to suchprovisions in their own state Act.

The labor law field has been reduced to a statutorymaze raising the cost of compliance. There are atleast 28 different Central and State legislations andnumerous state rules and notifications that governthe functioning of the labor market in the state. Amajority of these legislations are pre-constitutionaland were enacted by the Parliament and madeapplicable to all the States. The important Centrallegislations are: The Trade Unions Act, 1926; TheIndustrial Disputes Act, 1947; The Factories Act,1948; The Minimum Wages Act, 1948; and TheContract Labor (Regulation and Abolition) Act,1970. The major State Act is the A.P. Shops and

UNLOCKING ANDHRA PRADESH GROWTH POTENTIAL

25

Box 3 - India: Do Labor Regulations Hinder Economic Performance?

There has been considerable debate in the literature on the effects of labor market regulations on economicperformance. While India is not unique in legislating steps to be followed to dismiss workers and for compensation incase of dismissal, nor are its legal provisions particularly onerous by international standards, what is unique in India isthat government permission is needed before dismissal and that this permission is very seldom granted. There isconsensus that this has had several negative effects (see Zagha, 1999):

i. The laws have made it costly for firms to adjust to changes in market conditions and technology.

ii. It has encouraged firms to remain small and informal.

iii. It has encouraged employers to make greater use of casual labor, to subcontract and lease capacity to small firms,to resort to lockouts, and to use Voluntary Retirement Schemes.

iv. It has prevented public enterprises from reducing excess labor.

A number of studies cite onerous labor market regulations for India's poor performance in the registeredmanufacturing sector. For example, Stern (2001) points to improvement of the investment climate as being critical toincreasing productivity and reducing poverty and identifies reform of India's cumbersome labor regulations as apriority. Sachs, Varshney, and Bajpai (1999) echo this sentiment by pointing to restrictive regulations on laborredundancy as being a key reason as to why India has done poorly in terms of export performance. Using a survey ofabout one thousand manufacturing establishments drawn from ten Indian states Dollar, Iarossi and Mengitsae (2001)show that the 'cost of labor regulation' is found to be important in explaining cross-state differences in productivity.Fallon (1987) and Fallon and Lucas (1993) argue that strengthening job security regulations through centralgovernment amendment of Industrial Disputes Act in 1976 and 1982 was associated with a reduction in labor demandin firms covered by the regulation but not in small firms uncovered by job security regulations. The stringency ofemployment protection regulation has thus been used to explain the phenomenon of jobless growth in industry duringthe last two decades.

Perhaps the most compelling evidence linking the direction of labor regulation and the pattern of manufacturingdevelopment in the Indian states comes from a study by Besley and Burgess (2002). They find that regulating in a pro-worker direction has been associated with lower level of investment, employment, productivity and output in registeredmanufacturing and the effects have been quantitatively significant. They also find that these pro-worker regulationshave been a constraint on growth and poverty alleviation.

Source: Besley and Burgess (2002), Dollar, Iarossi and Mengitsae (2001), Fallon and Lucas (1993), Sachs, Varshney, and Bajpai (1999), Stern(2001), and Zagha (1999).

Establishments Act, 1988. For each of these subjectsthere are different enactments. For instance, forpayment of wages, there is Payment of Wages Act,1936. For insurance of employees, there isEmployees State Insurance Act. For provident fund,there is The Employees Provident Fund andMiscellaneous Provisions Act, 1952. Forcompensation in case of accidents, there is TheWorkmen's Compensation Act, 1923. The list is solong that even a professional legal practitioner maynot have full understanding of these statutes.

The statutory compliance expected from theemployer/management in each of the Acts isunrealistic. The employer knows this and so does thegovernment inspector. As a consequence, both tend to

act in their self-interest. The employer finds it cheaperto bribe the inspector than to comply with theregulations. The inspector, on the other hand, prefersto overlook non-compliance than to file a claim againstthe employer. The only loser in this statutory maze isthe labor, the very group that is supposed to beprotected by the law in the first place (see Box- 4).

LACK OF A COMPETITIVEMARKET STRUCTURE ANDALTERNATIVE PRODUCTION ANDMARKETING ARRANGEMENTS INAGRICULTURE22

In Andhra Pradesh, marketing of agriculturalproduce, and to a limited extent the production


26

Figure10: Overstaffing and industrial disputes have affected the productivity of AP's industrial sector

Source: ASI, Investment Climate Surveys, The World Bank (2000, 2003)

22 This section draws on the Government of India's Report of Expert Committee on Strengthening and Developing of Agricultural Marketing (2001),also referred to as the Guru Committee Report.

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arrangements in agriculture, like most other statesin India, are highly regulated, dominated by publicor quasi-public sector organizations, andmonopolistic or at best oligopolistic in nature(figure-11). For example, the bulk of agriculturalproduce today, by statutory order (AgricultureProduce Marketing Regulation, APMC, Act), issold in the market yards which are built,maintained, and regulated directly by state

government officials or market committeesconstituted by the government. Once a particulararea in a state is declared as a market area under theAPMC Act, no other person / association / agencyis allowed to carry on any wholesale marketingactivity in that area. Similarly, some of the factors ofproduction and most extension services inagriculture are generally dispensed by a monolithpublic or quasi-public sector organization in a


27

Box 4 - Who Benefits from Stringent Labor Institutions?

Stringent labor institutions, like large firing cost, strict labor standards, pro-union regulations, pro-labor minimumwage legislation, generous unemployment insurance, and central coordination in wage bargaining, tend to benefita narrow segment of the population comprising the organized and unionized labor, intermediaries in the labormarket, and corrupt officials, at the expense of a much larger segment of the labor force comprising theunemployed, those employed in the unorganized sector, and/or agricultural laborers who are seeking jobs in theorganized industrial sector.

A study by McKinsey & Co. on the Indian construction sector shows that, labor sub-contractors - mostly individual,non-registered entities - who directly procure and engage the labor required at the construction site make large profitsby withholding labor benefits to the workersand by flouting various provisions in the laborlaws, sometimes in collusion with corruptgovernment officials (see figure below). Thelabor laws that are commonly violated arethose concerning contract labor, minimumwage, child labor, and industrial employmentact. The violation occurs primarily due to highcompliance cost of these regulations,inadequate enforcement, and lack ofknowledge about the rights on the part of thelabor. The labor sub-contractors thus enjoyprofit margins that average around 40 percentin an industry with no capital requirement!On the other hand, the labor, which issupposed to be protected by these legislations,is denied its rightful benefits.

More stringent laws and stricter enforcement of such laws thus tend to do more harm than good to the labor as aclass. A study by IMF shows that generous unemployment insurance, larger firing costs, greater unionization, andhigher direct taxes on households' labor income and larger social security contribution tend to be associated with ahigher unemployment rate. A study on labor market regulations of the Indian states by Besley and Burgess, finds thatpro-worker labor market regulations have failed to promote the interest of labor, and more worryingly, have become aconstraint on growth and poverty alleviation. The study shows that, regulating in a pro-worker direction was associated withincreases in urban poverty, which suggests that attempts to redress the balance of power between capital and labor can endup hurting the poor.

In AP, the labor regulations protect only 2.1 percent of the state's labor force, i.e. 1 million laborers who are employedin the registered manufacturing sector out of the 34 million labor force in the state. Labor reform in AP could thuspotentially be pro- poor, as it would benefit a much larger segment of less well-off workers who could find it easier toenter the organized sector in a liberalized environment.

Source: McKinsey &Co. (2001), IMF's World Economic Outlook (2003), and Besley and Burgess(2002).

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highly regulated and protected environment. Thereare also a number of restrictions on transport,storage, and distributions of agriculturalcommodities (Essential Commodity Act, 1955),which though put on hold temporarily in severalstates, have not been repealed through legislation.

The institution of regulated markets (i.e. marketyards) and government intervention in the factormarkets were formulated to ensure smooth andorderly development of the sector and to protectfarmers from being exploited by the factor suppliersand output buyers. However, because of theirmonopoly status, these have over time come toimpede growth more than facilitate it. The system hasalso created a large number of intermediaries whoconsume a disproportionate share of the final price,thereby eliminating incentives for improvedproductivity and quality. According to a study byMcKinsey (1997), out of every one rupee of profit inthe fruit and vegetable food chain, 92 paisa goes to thecommission agents, transporters, wholesalers, andretailers and only 8 paisa reaches the farmer. Thus onthe one hand, the farmers have no freedom to find thebest buyer for their product and, on the other hand,services to farmers are ineffective and inadequate,leaving them without appropriate technical adviceand timely information on agricultural prices.

Low and declining investment inagriculture

AP has been rather less successful in raising the levelof public investment and attracting privateinvestment into agriculture compared to states likePunjab and Haryana. Consequently, its investmentto GSDP ratio in agriculture has fallen dramaticallybetween the mid 1980s and mid 1990s, while inPunjab, which already had achieved a high degree ofmechanization in agriculture by then, investment hasincreased significantly (figure-12, left panel). Lower

investment in agriculture would mean insufficientextension services and deterioration in the quality ofmarketing and distribution infrastructure and thus islikely to have played a critical role in lowering thestate's agriculture productivity growth. While thedecline in the investment to GSDP ratio was reversedduring the second half of the 1990s, it remainedconsiderably below the level achieved by states withhigher agricultural yield. Much of this fall can beattributed to the sharp decline in private sectorinvestment as many rich farmers and landlords (so-called absentee landlords) relocated to urban areas tostart new occupations and thus lacked the incentiveto make appropriate investments in agriculture. Thepublic investment also declined in real terms, withpublic expenditure on irrigation stagnating, partiallycrowded out by the rising subsidy bill. As recently as1999/00, the budgeted subsidy for the state ricescheme was more than the entire capital expenditurefor agriculture and irrigation.

Low productivity due to widespreadinformal tenancy arrangements:Like its industrial sector, AP's agriculture sector isover-manned23. As noted earlier, AP has the highestnumber of agricultural laborers per cultivator (3:2)and second highest number of agricultural laborers inthe country after Bihar (figure-12, middle panel).Thus nearly 63 percent of the total workers in AP areemployed in the farm sector (including both thecultivators and the agricultural laborers), comparedto 56 percent in Maharashtra, 52 percent in Gujarat,49 percent in Tamil Nadu, and only 39 percent inPunjab24. The large presence of agricultural laborersalso seem to indicate a more concentrated landdistribution, which in turn is associated with a largershare of the chronically disempowered, people wholack the wherewithal and/or the incentive to makethe necessary productivity enhancing investments. Ithas also given rise to widespread informal tenancy


29

23 The over-manning in both agriculture and industry is a direct outcome of AP's high participation rate (proportion of people in the working agegroup that are employed). While a higher participation rate per se is a good thing, unless the workers are productively employed, it would resultin low labor productivity, as is the case in AP.

24 The numbers for some of the relatively richer states are likely to be biased downward, and vice-versa for the poorer states, because there is a largepool of migrant agricultural laborer who move from the latter to former states during sowing and harvesting season..

and sharecropping arrangements in the state, as thelegal framework for formal leasing is extremely rigidand unworkable. These informal arrangements havethree deleterious effects on agricultural productivityand growth. First, due to their uncertain and short-term nature they provide little incentive for actualtenant-cultivators to make long-term productivityenhancing investment on land. Second, even whencultivators wish to invest, their access to the formalcredit system is limited by their inability to show anylegally recognized rights to the land. A third importantpossible effect is that actual tenant-cultivators are notrecognized as members of the over 10,000 water-userassociations (WUAs), only those with formal rights tothe land are recognized. This means that manycultivators cannot formally participate in the variousWUA activities including having a say in the executionof works and allocation of water.

Lack of innovation in production andmarketing arrangements

States like Punjab, Haryana, and Karnataka, haveexperimented with alternative production andmarketing arrangements that have resulted in improved

productivity and higher income for the farmers. Forexample, Punjab Agro-Industries Corporation, PAIC,with large support from a farmers' lobby (BharatiyaKissan Union) and a farmer-based political party (AkaliDal) brought in PepsiCo in 1988 to promote contractfarming in the state. This was followed by the entry ofother domestic and multinational corporations (e.g.Nijjer, HLL- a subsidiary of Unilever) into contractfarming. Although contract farming in Punjab is yet toflourish and become a popular mode of production inthe state, but at least a good beginning has been made.This year, PAIC has announced a new scheme topromote wide-scale use of contract farming in the state,although it is too early to assess the impact of this newscheme25. Contract farming, when undertakenproperly, has been found to be associated with higheryields, improved cropping pattern, higher risk-adjustedprofits for farmers and timely availability of goodquality produce for processors.

Punjab and Haryana were also the first states tointroduce 'direct market' or 'apni mandi,' whichbrings farmers directly in contact with the consumersand provides them with the opportunity to take


30

Figure-12: AP's agriculture has suffered due to declining investment and low labor productivity

Source: Benziger (1996), McKinsey (1997), Roul (2002), Census 2001.

25 The Bank is undertaking a study on Punjab's experience with contract farming.

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advantage of favorable prices and improve their netmargin- a concept that has been later adopted byother states including AP. Similarly, Karnataka hasamended its APMC Act to allow the National DairyDevelopment Board (the largest Cooperative in thecountry) to set up wholesale fruit and vegetablesmarket in Bangalore with subsidiary collectioncenters which is expected to promote integratedmarketing of horticulture produce grown in thestate. AP has unfortunately lagged behind in termsof undertaking new initiatives and introducing newideas and innovations in its agriculture sector. Onthe contrary, it imposed considerable intra andinter-state movement restrictions on paddy and ricethroughout the 1980s and 1990s. It continues toimpose a 1 percent market fee, 4 percent sales taxon paddy, and 5 percent rural development cess - attotal of 10 percent tax - on marketing of paddy,further dampening the incentive of the producers toraise yields. Finally, there are storage limits formillers, which increase storage costs and deter thegrowth and modernization of the storage industry.

Lack of diversification of agriculturalproduction and large subsidies

The level of agricultural power subsidies and foodsubsidies in AP are among the highest in the country(figure-13) and the state is also one of the largest

beneficiaries of the Centre's Minimum Support Price(MSP) program. These subsidies have significantlydistorted the consumption and production pattern ofagricultural commodities in the state. The 'ricescheme' has led to over-consumption of rice andunder-consumption of other cereals in the state. Thelow agricultural power tariff and the favorable MSPon paddy, on the other hand, have reduced farmers'incentive to diversify to other cereals and non-cereals.

The excessive cultivation of paddy (which is alsoone of the growth engines) using undergroundwater has had two adverse implications: the watertables have receded considerably in several parts ofthe state and the agricultural power subsidies havegrown to an unsustainable level. In fact, theagricultural power subsidies have become the singlebiggest risk to the state fiscal sustainability. Evenworse, these subsidies are being primarily capturedby well-off farmers and are thus distributionallyregressive in nature (see Box-5).

LOW LEVEL OF DOMESTIC ANDINTERNATIONAL TRADE ANDINVESTMENT FLOWS

International trade and foreign direct investment arewidely believed to play a central role in the process of


31

Figure 13: Agricultural Power Tariff and Subsidies in Selected Indian States - 2000/01

Source: GoI, Planning Commission, SEB Sources

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economic growth and development. They influencethe growth process by creating, what is commonlyknown as, technological externalities - knowledgespillovers or technology diffusion - for the localeconomy. The diffusion could take place through avariety of channels that involve the transmission ofideas and new technologies. Imports of high-technology products, exposure to internationalmarkets, adoption of foreign technology, andacquisition of human capital through foreigneducation are some of the important conduits for theinternational diffusion of technology. Besides, foreignfirms are a natural conduit for information aboutforeign markets, foreign consumers, and foreigntechnology, and they provide channels through whichdomestic firms can distribute their goods. Exports

help firms to take advantage of economies of scale inproduction, require producing goods and services ofinternationally accepted standards, and could providemore attractive returns than the domestic market.

Firms located in AP are found to have low level of

international integration compared to their

counterparts from the more industrialized states. AP

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32

Box 5 - Who Benefits from Agricultural Power Subsides in Andhra Pradesh?

The agricultural power subsidies in Andhra Pradesh are one of the highest in the country. Who among the farmersbenefits from these subsidies? An incidence analysis of the subsidies shows that:

� The vast majority of households in the state (nearly 87 percent) do not benefit from agricultural power subsidiessince they do not cultivate crops or own electric pumps.

� Among the farmers, the medium and large farmers receive a disproportionately large share of the total agriculturalpower subsidies. Approximately 39 percent of the subsidies accrue to large farmers who represent 15 percent ofelectric pump set owners, while marginal farmers, who represent nearly 39 percent of all electric pump set owners,receive only 14 percent of the subsidies. Since the current tariff is based on the average horsepower of the pump setand not on the actual usage of electricity, and larger farmers consume more electricity than farmers with marginaland small farm size, the distribution of subsidies is also quite regressive (see figure below).

� Only a very smallfraction of poor andSC/ST householdsbenefit from thesesubsidies. While SC/SThouseholds represent 18percent of electricpump set owners, theyreceive approximately10 percent of the totalagricultural powersubsidies. On average,SC/ST electric pumpset owners receive a subsidy that is almost half that received by non-SC/ST households (see figure above).

Studies have shown that, an increase in power sector tariff with commensurate improvement in the quality of powerneed not be detrimental to the farmer's economic interest. Based on a study on Haryana, the India Power Supply toAgriculture Study (World Bank, 2001) found that tariff rates could be increased in a phased manner by nearly 500percent from their present level without making farmers economically worse-off as long as the increase is accompaniedwith improvements in power supply conditions.

Source: The World Bank, 2001, 2003.

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only 1 percent (figure-14, left panel). Exportsconstitute less than 10 percent of GSDP in APcompared to 19 percent in Karnataka, and 22percent in Gujarat and have stagnated in recent years(figure-14, middle panel). With lower penetration ofFDI and exports, firms in AP have relied ondomestic technology and local markets to grow andthus are less productive than their counterparts inmore industrialized states. Consequently, AP'sindustrial sector is highly fragmented: the firms inAP on average are one-third the size of firms inMaharashtra and/or two-fifth the size of firms inGujarat (figure-14, right panel).

Large unexploited potential in trade

What is true of the benefits of international tradeand foreign direct investment is also largely true oftrade and investment between states in a largecountry like India, though the gains fromtechnological externalities as well as the risks ofcapital outflows and exchange rate uncertainty arelower in inter-state commerce than internationaltrade. Given its sheer size, India has the potential tobecome one of the largest common markets in theworld and it is therefore important for AP to take abroader view of exports, which include inter-statecommerce as well as international trade.

The role and importance of inter-state commerceand international trade at the sub national level has

not been explored much as there are no reliableestimates of the size of AP's inter-state commerce,its composition or direction. Even the data oninternational exports originating from differentstates, including AP, are limited. It is this lack ofunderstanding and non-availability of trade datathat has led to under appreciation of trade as asource of growth in the policymaking circles at thesub-national level.

A primary survey of nearly 900 firms in AP wasundertaken to estimate the value, composition, anddestination of AP's inter-state commerce andinternational trade. The data was gathered throughinterviews conducted with the respondentsbetween September and November of 2002. Thesurvey was administered on the following fourgroups: (i) Producers/manufacturers/ serviceproviders; (ii) Exporters; (iii) Wholesalers/distributors; and (iv) Transporters. The surveyfocused on 16 sectors that have been identified asgrowth engines by GoAP's Vision 2020. Thesurvey covered a sample size of around 982establishments in the three regional divisions of AP- Telengana, Coastal Andhra and Rayalseema. Thesurvey questionnaire also had questions aboutbarriers to trade (see Appendix - A2).

Given its production and consumption structures,AP has a natural advantage to engage in


33

Figure 14: Low level of integration has led to fragmented production

Source: ASI, Investment Climate Surveys

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specialize in agro-based products, minerals and

selected services. For example, in rice milling, AP's

share in all India registered manufacturing output is

an impressive 39 percent. In fisheries and

horticulture processing, AP's contribution is 22

percent and 19 percent, respectively. Similarly, in

non-metallic minerals, AP's share in all India

production is 12 percent. In addition to this, nearly

25 percent of flower, 19 percent of egg, 12 percent of

rice, 11 percent of fruit, 10 percent of fish, and 9

percent of IT services in India originate from AP. On

the other hand, AP's share in garments, leatherproducts, and heavy engineering are less than 1 percent (figure-15, top panel).

The state enjoys a marketable or exportable surplus(state production minus state consumption) in anumber of commodities. In case of egg and fish, thesurplus of the state is to the tune of 70 percent and75 percent, respectively, i.e. nearly 70-75 percent ofproduction are consumed outside the state (figure-15, bottom panel). In milk and rice, the approximatesize of exportable surplus could be as much as 43 and22 percent respectively. How much of this surplus is


34

Figure 15: AP's share in all India production and indicative size of potential trade in selected commodities

Source: Inter-State Trade Survey, The World Bank

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actually exported? Not enough. Our surveyindicates that, between 40 to 60 percent of thesurplus is actually exported and the rest either getswasted or consumed internally. This depresses thedomestic prices and lowers the profitability of theproducers and distributors.

Composition and destination of AP'sinter-state and international exports

The bulk of AP's inter-state exports, comprisingmostly primary sector commodities and low valueadded manufacturing goods, is sold to its southernand western neighbors. Horticulture, dairy, poultry,rice, fisheries and mining make up nearly 60 percentof its exports. The remaining 40 percent is made upof cement, pharma, garments and leather products,and IT services. The top five destinations of AP'sinter-state exports are Maharashtra, Tamil Nadu,Karnataka, Kerala, and West Bengal (figure-16).

The composition of AP's international exports hasundergone a dramatic transformation in recent yearswith IT services accounting for nearly one-third ofits total exports. Primary commodities, like fisheries,horticultures, mining, dairy and poultry togethermake up for 40 percent of the exports. Cement,

pharma, garments and leather products andmachine tools account for the remaining 26 percent.The study of major destinations of AP'sinternational exports throws up a surprise, withBangladesh emerging as the second largest exportsmarket for AP after US, accounting for nearly one-sixth of its entire exports. The other key destinationsfor AP's exports after US and Bangladesh are EU,Japan, UAE, UK and Australia (figure -17).

Barriers to inter-state andinternational exportsMany state governments in India, not until longago, viewed exports as a negative externality. Thebenefit of higher foreign exchange from exportsaccrued to the Centre while the loss of tax revenue(exports are exempted state sales tax) was borne bythe states. Since formulating policies andregulations governing international exports wereessentially the prerogative of central government,states shied away from providing additional supportin terms of state level policy or requisiteinfrastructure to promote exports from theirrespective states. The state governments, unwillingto absorb any loss in revenue from inter-statecommerce, developed an elaborate and


35

Figure 16: Composition and destination of AP's inter-state exports

Acronyms: GJ- Gujarat, KN- Karnataka, KR- Kerala, MH- Maharashtra, TN - Tamil Nadu, UP- Uttar Pradesh, WB - West Bengal, IT - Information Technology;


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cumbersome system of internal border tariffs andother non-tariff barriers that have come to impedegrowth of trade in the state. The following is a briefdescription of a subset of these impediments:

Tariff barriersAP, like most Indian states, imposes a 4 percentCentral Sales Tax (CST) on goods that are exported toother states for final consumption and a variable entrytax, from 1 to 10 percent, on goods entering the state.The revenue collected through CST and entry tax as ashare of total revenue has declined significantly in thestate from 15 percent in mid-1990s to 6 percent in2000/01, both due to ad-hoc declines in the CST taxrate on selected items and growing recourse bybusiness to a method called 'branch transfer,' in whichthe goods are exempted from payment of CST. It hasrecently been proposed that the CST rate will bereduced to 2 percent and will be completely dispensedwith in four years. In addition to tax on goods, manystates including AP impose an additional road tax(path kar) on commercial vehicles of other statescarrying these goods when they enter AP. Thesemeasures cause a significant resource distortion due to

delays at check posts as well as the inefficiency arisingfrom the additional tariff barrier.

Non-tariff barriers There are a number of non-tariff barriers thatprotect domestic producers and transporters fromcompetition from outside the state. GoAP givesprice preference of the order of 10-15 percent tosmall-scale units, located in the state26. There arerestrictions on the sale of selected raw materials oninter-state sale, like a minimum value addition needsto take place inside the state. There are proceduralrequirements like a number of forms and permits(i.e. C form and entry permit) that must accompanythe sale invoice without which goods are not allowedto enter the consuming state. Obtaining requisitequantity of C forms and entry permits are a majorsource of harassment for the dealers wishing toimport goods into the consuming state. Byproviding a protective market to the local producersand transporters, these measures discourageinterstate commerce and, in the long run, tend toadversely affect the efficiency of the very group it istrying to assist.


36

Figure 17: Composition and destination of AP's international exports


26 Government of Andhra Pradesh through its G.O. Ms No. 48 Industries & Commerce (SSI) Dept. 20-9-1999 has issued orders reserving 17 specificproducts for Government/ Government Undertakings to be purchased exclusively from local SSI units who are registered with CommissionerIndustries in the rate contract system.

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Relatively high taxes on intermediateindustrial inputs The relatively high tax rate on intermediateindustrial inputs in the state may also have acted asa deterrent for out-of-state firms to locate theirproduction base to AP. Comparison of basic tax rateacross states shows that, AP has the highest basicsales tax rate among its comparators (i.e. Gujarat,Karnataka, Maharashtra, and Tamil Nadu) in thefollowing products27: chemicals, tyres, tubes andflaps for automobiles, cement, paper, petrol, andliquefied petroleum gas (figure-18, left panel). Onthe other hand, it has the lowest tax rate in consumernon-durables like, perfumes, cosmetics, lotions, hairdressings, toothpastes, soaps, detergents, shampoos,shaving products, washing and cleaning preparationsand other toilet preparations, among itscomparators. As AP is one of the largest producers ofproducts like paper and cement in the country anddoes not produce much consumer non-durables, it isevident that the present tax structure of the state ismostly geared towards revenue maximization andless concerned about the deadweight loss associatedwith the high tax rate. The average tax rate also

seems to have increased over time (figure-18, right

panel). The flip side to having higher tax rates is

that, AP's fiscal situation is perhaps marginally

better than some of the leading industrialized states

as reflected by their credit ratings. So while it is not

advisable that AP reduces its tax rate en masse but

undertakes a revenue-neutral rationalization of the

tax structure to eliminate any inherent bias against

industrial production.

Infrastructure related constraints

Poor infrastructure facilities have repeatedly been

singled out as the number one constraint to low

productivity in India. Not surprisingly, they also

emerged as important barriers to inter-state

commerce and international trade. The problem

appears to be more severe in AP, where three of the

top five barriers to trade are infrastructure-related,

namely cost and quality of power, road conditions,

and ports (figure-20). Infrastructure as a barrier to

growth figured prominently in the investment

climate survey too, where AP was placed behind

Chinese provinces and certain South Asian

countries.


37

Figure 18: Comparisons of AP's average tax rate with other states and with its own past

Note: Tax rate data are from States' website; the commodity weights are same across all states (i.e. national level weights are used).

Source: Sales Tax Reckoners from various States.

27 The inter-state comparison of tax rate is based only on the basic tax rate. States like Karnataka and Tamil Nadu however impose turnover tax, overand above the basic sales tax and so the effective tax rate in these states are likely to be higher than what is reported here. AP, on the other hand,does not have a turnover tax.

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Quality and cost of power supply toindustryWithin the infrastructure sector, power sector isoften singled out as the number one constraint tosmooth industrial production. In AP, the situationseems to be particularly serious, with the industrialand commercial users paying one of the highest

tariffs in the country (figure-19), primarily to cross-

subsidize the huge agricultural power subsidies in the

state. Despite paying such a high tariff, the quality of

power has left much to be desired. For example,

production loss due to power outages and surges is

1.4 percent on average in Shanghai, 2 percent in

Guangzhou, and 2.8 percent in Chengdu compared


38

Figure 19 - Industrial and Commercial Power Tariffs in AP are one of the highest in the country

Figure 20: Infrastructure-related variables are found to be a major barrier to trade in AP

Source: Trade and Investment Climate Survey, The World Bank; GoI, Planning Commission, SEB Sources

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to 6.4 percent in Vijayawada and almost 7.7 percentin Hyderabad (figure-20, lower panel). More firmsin AP therefore have their own generators (whichadd to their costs) than their counterparts in otherindustrialized states.

There are indications that, the quality of thepower supply and to a limited extend the cost ofsupply to industry and commercial establishmentshave improved in the last few months. This hasbeen possible due to some major reforms,including commercialization of the sector andsetting up of an independent regulatory authority.Apart from marked improvement in power supplyto industry, the theft levels have also come down.And while several structural weaknesses stillremain, India's two rating agencies CRISIL andICRA rated Andhra Pradesh's State ElectricityBoard as the best in the country. The state,however, has not yet been able to tackle thedifficult issues of metering and low tariffs in theagricultural sector. The growing power sectorsubsidy is having an adverse impact on the statefinances and crowding out more importantexpenditure in irrigation and social sectors.Reducing power sector subsidy to agriculture andsupplying quality power at an affordable price tothe industry are important pre-conditions for APto achieve a robust industrial growth in the nearfuture.

Sea, air and road transport

Ports emerged as the other importantinfrastructure-related barrier to trade. With anaverage turn-around time of 6 days compared to 6-8 hours in Singapore, Indian ports are highly costinefficient, having detention cost of about $15,000- 20,000 per day. By one estimate, container delaysat Indian ports cost about $ 70 million per year28.The binding nature of port capacities increases bothfree on board (fob) and cost insurance and freight(cif ) prices of Indian exports, as exporters have tobear detention cost in terms of paying forwarehouse facilities, higher insurance charges, and

others. AP's own port, Vishakapatnam, is usedprimarily for bulk cargo and is not suitable forcontainer traffic. Many AP based factories thereforeuse the ports in Mumbai and Chennai, locatedalmost 600 to 700 km from Hyderabad, whichincreases their transportation costs and shippingtime. In air transport, which is another criticalinfrastructure-related barrier in AP, the state capitalHyderabad continues to remain less well connectedthan Bangalore and Chennai, both in domestic andinternational flights. The non-availability of jumboX- ray machines at airport makes it mandatory forall containers to be opened up for inspectionresulting in export cargo taking anywhere from 8 to21 days for clearing. Appendix-A3, which is basedon a truck ride from Hyderabad to Chennai by oneof the members of the team that prepared thisreport, provides an anecdotal evidence of howinfrastructure and regulatory problems of roadtransport could add to the transportation andtransaction costs and reduce the competitiveness ofgoods produced in AP. The Andhra PradeshInfrastructure Development Enabling Act (APIDEA), 2001, which provides the legal frameworkfor increased private sector participation ininfrastructure projects, has led to increased privateinvestment, though more needs to be done toensure that the quality of infrastructure in AP iscomparable to some of the high income states inIndia.

Access to and cost of financeWhile entrepreneurs often like to complainabout their access to adequate finance, thisappears to be less of a bottleneck in AP. WithinAP, two-thirds of respondents reported havingtaken a bank loan, which compares favorablywith rest of India as well other emerging marketeconomies (figure-21). Of those that did not,three quarters had not applied for one, as theydid not need such financing. While applicationrequirements and collateral are seen ascumbersome, they were not generally cited as


39

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prohibitive. Within AP, SMEs are less likely thanlarge firms to have a bank loan, but the rates aresimilar to those for all India, as well in countriessuch as Korea and Thailand (figure-21). Theaccess of small and tiny firms, as well as farmers,to formal credit system however continues to be aproblem in AP and a Bank study is currentlyunderway to examine this issue.

INADEQUATE DISSEMINATIONOF POLICY CHANGES ANDWEAK IMPLEMENTATION

The burden of regulation and administrative set-updoes not appear to be unduly heavy in AP comparedto other industrialized states, but remainssignificantly higher than global best practices. Forexample, the average waiting time for a telephoneconnection in AP is 26 days, less than the 111 daysin Bangladesh and 48 days in Pakistan, but morethan the 16 days in China (figure-22, left panel).The time to get connected to the public power gridwas 87 days on an average in AP, while thecorresponding number is 49 days in Bangladeshand only 13 in China (figure-22, middle panel).Entrepreneurs in Hyderabad report having not onlymore inspections, but needing to spend moreoverall time with officials and are more likely to facepressures to give 'gifts' to officials. The LaborDepartment was often cited as imposing the

greatest burden, with five separate types ofinspectors that can intervene in a firm's business, aprocess that has been discontinued recently. The taxauthority is also commonly cited as requestingadditional payments (up to 80% of respondents inHyderabad acknowledged this and 60% inVijayawada). The time that managers have to spendinteracting with government officials in AP is athird more than what is spent in China andsignificantly more than the time spent inBangladesh (figure-22, left panel). Within AP, theissue appears to be more pressing in Hyderabadthan in Vijayawada. One repercussion is that halfthe respondents in Hyderabad report hiringfacilitators to assist in getting permits and licenses -a rate higher than most other locations.

Unlike the other barriers identified in this report,where no significant policy decision has been takensince the beginning of reform, GoAP has movedaggressively in reducing administrative andregulatory barriers in the state. Some of these recentpolicy changes are discussed below:

Single window clearance for newinvestmentThe Government of AP has enacted "Industrial SingleWindow Clearance Act No. 17 of 2002" to expeditethe processing and issuance of various approvals /clearances / permissions required for setting upindustrial undertakings in the state. The government


40

Figure 21: Access to Bank Finances

Source: Investment Climate Survey, The World Bank

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has constituted two nodal agencies, one at thedistrict-level and the other at the state-level, to receiveand process applications within a time-boundframework. There are four committees that havebeen entrusted with the task of approving, reviewingand monitoring the application process (figure - 23).The District Committee, chaired by the DistrictCollector, approves undertakings with investmentbelow 1 crore (i.e. small scale industry) and the StateCommittee, chaired by the Commissioner ofIndustries, approves applications with investmentabove 1 crore (i.e. large and medium scale industry).In case of rejections of clearances or approvals of largeand medium units with modification under the statelaws by the concerned authority, the DistrictCommittee forwards it to the State Committee andthe latter may forward it to the EmpoweredCommittee. The Empowered Committee, headed bythe Chief Secretary to Government, passesappropriate orders referred to it by the StateCommittee and when necessary refers the applicationto the State Board for decision. The State Board,chaired by the Chief Minister, is the final authorityon the matter and passes the appropriate orders onthe application referred to it.

The real benefit of the Single Window Clearance(SWC) Act is not the approval structure as shown

in figure-23, which does not give an impression ofbeing a simple, flat, and decentralized structure,but rather the provision of deemed approval and,to a limited extent, the time limits set under theAct for various clearances. For example, approvalfrom the power company about the feasibility ofproviding power and the final power connectionto the industrial undertakings has to come within7 and 25 days, respectively, failing which it isdeemed approved subject to payment of therequired fee. The same condition applies to watersupply. The clearances from gram panchayat andlicenses from Municipality, if not made availablewithin 7 days, are deemed to be cleared. Apartfrom the issue of acquisition and alienation ofland, which has a set time limit of 45-60 daysunder the SWC, the time limits for all otherclearances are between 7 to 30 days.

Annual inspection and prompt follow-up action

Frequent and surprise inspections by governmentinspectors can be a major form of harassment forindustries and a source of corruption and red tape inthe system. In AP, a number of steps have been takento streamline the inspection procedure. All inspectingofficers in AP are now required to draw up a scheduleof inspection in advance and inspect only the


41

Figure 22: Administrative and regulatory burden of firms continues to be highin AP from an international perspective

Source: Investment Climate Survey, The World Bank

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undertakings which are specifically allotted to themand inspection per undertaking is limited to one eachyear. After conducting the inspection, the officer has tosubmit a report to his senior in the prescribed formatwithin two days of the date of inspection alongwiththe proposals on the follow up action to be takenagainst the employer. The senior officer afterexamining the proposal has to issue necessaryapprovals within seven days to do either of thefollowing: file claims, take up prosecutions, issuewarning, or drop the charges according to the meritsof each case. Any inspections other than the onespecified in the law or inspections not reported tosenior officers are to be treated as "unauthorized" andthe erring official is made liable for action (e.g. seeGovernment Order Ms. No. 33, August 27, 2002).

Self-certification facility for all industries To attract investment and reduce bureaucratic hasslesin some of the emerging sectors of the economy,namely in information technology services (ITS),information technology enabled services (ITES), bio-technology establishments, export oriented units,units in export processing zones and tourism-basedindustries, GoAP allowed 'self-certification' of variousprovisions in selected statutes in 2001. Recently thisfacility has been extended to all types of industriesexcept the major hazardous industries. The statutescovered under self-certification are: The Factories Act,The Maternity Benefit Act, The AP Shops andEstablishment Act, The Contract Labor (Regulationand Abolition) Act, The Payment of Wages Act, TheMinimum Wages Act, The Employment Exchanges


42

Figure 23 : The approval system under the Single Window Clearance (SWC) system

Source: Note on Single Window Clearance Act, 2002, GoAP

Application of theIndustrial Undertaking

District CommitteeChairman: District Collector

State CommitteeChairman: Commissioner of Industries

Approved or RejectedConditional approval

with modification to state lawConditional approval

with modification to state lawApproved or Rejected

Empowered CommitteeChairman: Chief Secretary

Conditional approvalwith modification to state law

Approved with necessarymodification or Rejected

State BoardChairman: Chief Minister

RejectedApproved with the

necessary modification

(Compulsory Notification of Vacancies) Act, andtheir corresponding state rules (see Governmentorder Ms. No 28, April 21, 2001 and GovernmentOrder Ms. No. 26, June 28, 2002).

Simplified Common Annual Return All industrial units in AP are required to submitinformation about their operation to the DistrictIndustries Centers once a year. The earlierprocedure involving the submission was quiteelaborate, involving a number of different forms,which sought a large volume of information thatwas unnecessary or redundant. With a view to cutdown on administrative hassles, GoAP introduced aCommon Annual Return (CAR) in 1995.Subsequently, after discussion with various industryassociations, GoAP has further streamlined theprocedure and has introduced a simplified CAR.The simplified CAR is only one and a half-pagelong and takes nearly 30-40 minutes to complete ascompared to the few days necessary to comply withthis requirement prior to 1995, when one form hadto be prepared for each line department. The newpolicy has significantly brought down the burden ofpaperwork facing the firms.

Simplification and consolidation ofrecords and registers for small andtiny industriesThe small and tiny industries (STIs), like themedium and large industries, are required tomaintain a large number of registers and recordsunder the various statutes, some of which are: theFactories Act, the Payment of Wages Act, theMaternity Benefit Act, the Workmen'sCompensation Act, the Payment of Gratuity Act,the Minimum Wages Act, the AP Shops andEstablishment Acts, and the AP Labor Welfare FundAct. Maintaining a large number of registers could beextremely cumbersome and expensive for STIs thathave limited manpower resources. GoAP has takensteps to simplify and consolidate records and registersfor STIs. In AP, STIs are now required to maintainonly two basic registers: attendance register andsalaries and wage register. The registers could be inthe form of bound books or compilation of loose

sheets containing the relevant information (e.g. seeGovernment Order Ms. 10, January 9, 1999).

It is however unclear as to whether the firmmanagers, especially in the small and medium firms,are aware of these policy changes and whether theiradministrative and regulatory burden has declinedunder the new regime. Our survey results show thatfirm managers are not always aware of the recentchanges and the time they are spending interactingwith government officials still remains at anunacceptably high level. Many investors arereluctant to use the single window clearancemechanism, citing problem with itsimplementation, as the rate of rejections seems to behigher in the new system than in the older system. Itis therefore important that the regulations andstandards be made transparent and widely availableand implementation is made more effective. If firmshad clear guidelines of what is expected and facedstiff penalties for infractions, compliance would goup at the same time that regulatory costs coulddecline. However, to make this work it is essentialto have an efficient and objective judicial system.Although, given the backlog of cases and concerns ofcorruption within the judiciary itself, this optionwill take time to implement effectively.

STRUCTURAL RIGIDITIES HAVE RESULTED IN A SKEWED DISTRIBUTION OF OPPORTUNITIESWhy is AP so diverse, especially in its allocation ofpublic goods? Our analysis shows that much of it isa byproduct of deep-seated structural rigidities inthe economy, like the state's colonial legacies,geographical endowments, and caste-baseddisparities.

Colonial history

The districts in Telengana came from the Nizam ofHyderabad's territories while the rest of AP wasunder direct British rule. Under the Asafjahi rulersof Hyderabad, much of local administration,including land revenue collection was in the hands


43

of local landlords (doras). The landlords enjoyedenormous social and economic power, including aright to unpaid labor (vetti) and other gifts frompeople in their domains. While their formal rightswere abolished after Hyderabad was taken over bythe independent Indian state, the actual exercise ofthese rights continued in many places at least untilthe 1970s. The British districts were, on the wholemuch more centralized. Apart from the threedistricts of north coastal AP - Srikakulum,Vizianagram and Vishakhapatnam - all of BritishAP was under the ryotwari system, where thepeasants dealt directly with the colonial statewithout the intervening mediation of the locallandlord. North coastal AP ended up with adifferent system as the British had already enteredinto a permanent revenue settlement with landlordsin the area. As a result, these areas have a systemsomewhat similar to that in Telengana, where theright to collect revenue from the peasants was in thehands of landlords, who also typically enjoyed acertain amount of extra-economic power over thepeasantry.

There are broadly three channels through which theright to revenue collection may be expected to havean impact on economic outcomes of today. First,areas with landlord-based systems typically tendedto have a more concentrated land distribution,which in turn is associated with a larger share of thechronically disempowered, people who lack thewherewithal and /or the incentive to make thenecessary productivity enhancing investments. Atthe same time the landlords in these economies maylack the incentive to make the appropriateinvestments as they may prefer to live in the urbanareas (so-called absentee landlords) and /or cannotrely on the tenant to maintain the investmentsproperly. The tenants on the other hand probablycare less about investments that make agriculturemore productive, at least relative to programs that

redistribute land to the landless, and so demand forpublic investment in agriculture is likely to be lowerin landlord controlled areas than in Britishcontrolled districts.

Second, it is plausible that the nature of therevenue collection system affected the nature ofpolitical power in the post-independence era. First,the fact that the wealthy and therefore thepolitically powerful landlords were often notcultivators themselves, weakened the politicalpressure on the state to deliver public goods thatwere important to farmers. Second, the fact thatthe landlords wielded extra-economic power led toantagonistic relations between the peasants and thelocal elites. In particular, there is a long tradition,both in north coastal AP and in Srikalulum, ofsocial movements (often led by naxalites) aimed atthe removal of vetti and other traditionalobligations towards the landlords29. These areoften resisted by force, and sometimes in collusionwith the local authorities30. Third, the fact thatthese areas started with a lot of inequality hastended to create a demand for redistribution thathas been resisted by the landlord class. This was,obviously, another driving force behind the strongand continuing influence of Naxalite-led socialmovement in AP.

Finally, the British colonial state invested ininfrastructure that was of direct economic interest tothe empire and thus the revenue collection systemhad a direct impact on agricultural infrastructure. Asis well known, in AP, the British invested heavily inbarrages and canal irrigation. That this investmentwas in the ryotwari areas of South-Coastal AP wasprobably not entirely by accident, since it isrecognized that it was much easier to increase therevenue rates in ryotwari areas.31 This laid the basisfor South-Coastal AP becoming the economicallydominant part of the state.


44

29 See Balagopal, K., "Peasant Struggles and Repression in Peddapally", Economic and Political Weekly, May 15, 1982.

30 See Balagopal, K. and M. Kodandarama Reddy, "Forever `disturbed': peasant struggle of Sircilla-vemulwada", Economic and Political Weekly, Nov27 1982 and Balagopal, K., "Agrarian politics by other means", Economic and Political Weekly, July 7, 1984

31 Bagchi (1976) proposes a version of this argument.

Caste, religion and domestic socialconflicts

Caste and religion might also play a role for threereasons: first because certain castes, such as thedesignated scheduled castes and scheduled tribes,have traditionally been discriminated against, andwhile such discrimination is now illegal, it persistsin many places, making it harder for these groupsto get their fair share. Moreover, a consequence ofpast discrimination is that these groups are nowpoorer and less educated than other groups thatthey have to compete against for the favors of thestate, which may make it harder for them to getwhat they want. Second, because of a history ofantagonism between different castes and betweendifferent religious groups, the potential forcollective action may be relatively limited (Box-6).32 Third, even if they can work together,their priorities may be very different: the highcastes, who have always had access to education,may care less about the adult literacy centers thatthe scheduled tribes want, than about getting anew junior college33.

Geography

In AP, the coastal districts constitute a separate agro-climatic zone, with corresponding differences in bothagricultural productivity and the demand for publicgoods. Rainfall is another variable that clearly affectsboth productivity and the pattern of demand forpublic investment. For example, the demand forreliable water supply may be higher in the drierdistricts in the west and south of AP. Wetter districtstypically can sustain higher population densities,which, in turn makes the cost of making publicgoods more accessible. Moreover, areas that havehigher productivity based on geographicaladvantages may turn that into higher political clout,

which allows them to extract more public investmentfrom the state.

Understanding the differences

Using latest available estimates of forty-threedifferent infrastructure measures across the twenty-five districts of AP, we estimate an econometricmodel to explain how much of the inter-districtvariations in these measures are accounted for byvariables based on the colonial status, geography,and caste and religion measures of the districts34.The results show a remarkably consistent pattern.The districts that did not have landlords (i.e. southcoastal Andhra) have a significantly higher level ofinfrastructure in 23 cases and in no case do theyhave (statistically) worse infrastructure than thelandlord districts (i.e. north coastal Andhra andTelengana). Non-landlord areas are clearly ahead inaccess to healthcare, means of transportation, postalservices and less dramatically in access to water andeducation. Being classified as a non-landlord districtmakes a difference of almost 5 percentage points interms of access to public goods.

Districts that were under the directadministration of the British (i.e. Telengana) werefound to have a mixed level of ruralinfrastructure. It is usually higher for education,health, transportation and postal services andalmost always lower where water or power areconcerned. Since the coastal effect, tends to besmall, a positive non-British dummy typicallymeans that Telengana is ahead of north coastalAndhra. Similarly, Telengana and Rayalaseema,one a non-coastal non-British area and the other anon-coastal non-landlord area, are comparable interms of their access to public goods. The fact thatthe coast effect is usually positive in the few caseswhere it is significant, tells us that Telengana is


45

32 The tribal belt of Andhra Pradesh or what is sometimes called the agency area, is a semi-circular stretch of land from Srikakulum to Khammam. Itis inhabited by tribes such as the Gonds, Koyas, Konda Reddis, Bagatas, Valmiki, Gadabas, Savaras, JatAndhra Pradeshus. These areas have had along history of tribal uprisings-there was one in 1879-80, one in 1915-16, one in 1922-24, and of course, the Srikakulum movement etc. A majorsource of conflict has been the conversion of common forests into state forests. See Balagopal, K, "A tale of arson", Economic and Political Weekly,July 18, 1987. Also see "The Gond movement in Adilabad and its repression", Balagopal, K., Economic and Political Weekly, May 25, 1985

33 This is similar to the argument in Alesina, Baqir and Easterly (1999).

34 We adopt a logit specification for our regression analysis.

somewhat behind south-coastal AP, but the

difference is small. However, in terms of canal

irrigation, Telengana lags substantially behind both

south-coastal AP and Rayalaseema.

We also find that districts with a large proportion ofscheduled tribes are typically backward. Thenegative effect comes almost entirely fromeducation, power, transportation and postal services.The effect, wherever it is significant is very large: anall-scheduled tribe district has on average 18

percentage points less primary schools than an all

non-scheduled tribe district, 8 percentage points less

junior colleges, 15 percentage less domestic power, 9

percentage points less of postal services and 8

percentage points less bus services. By contrast,

where this effect is not usually significant, as in the

case of most health and water variables, the

coefficient is of indeterminate sign (sometimes, for

example, it is large and positive), suggesting that

there is no clear underlying pattern.


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Box 6 - What Do Ethnic Diversity and Domestic Social Conflicts Have To Do With Economic Growth?

The link between ethnic diversity and domestic social conflict (DSC) with economic growth may not be obvious tosome. But studies have shown that they are the key to understanding why growth rates lack persistence and whycountries choose public policies that are growth-retarding in nature (e.g. Easterly and Levine, 1997; Rodrik, 1998).

When ethnic diversity and social divisions run deep and the institutions of conflict management are weak, economiccosts of exogenous shocks - such as abnormally low rainfall - are magnified by the distributional conflicts that aretriggered. Such diversity and resultant conflicts diminish the productivity with which a society's resources are utilizedin a number of ways: by delaying the needed adjustment in government policies and by diverting activities fromproductive and entrepreneurial spheres to political spheres.

Rodrik summarizes the idea in his paper with the following formula:

In other words, the greater the latent social conflict in an economy and the weaker its institutions of conflictmanagement, the larger will be the effects of shocks on growth. The term 'latent social conflict' captures the depth ofpre-existing social cleavages in a society, along the lines of wealth, ethnic identity, geographical region, or otherdivisions. On the other hand, the "institutions of conflict management" is a proxy for democratic institutions, anindependent and effective judiciary, a non-corrupt bureaucracy, and institutionalized modes of social insurance.

Easterly and Levine show that cross-country differences in ethnic diversity explain a substantial part of cross-countrydifference in public policies, political instability, and other economic factors associated with long-run growth. Inparticular, high levels of ethnic diversity are found to be strongly linked to low provision of infrastructure, low levelsof education, high black market premiums, and poor financial development. Rodrik also finds that countries thatexperienced the sharpest drop in GDP growth after 1975 were the ones with divided societies and weak institutions ofconflict management.

Andhra Pradesh, for historical reasons, is ethnically diverse. It has been subject to a number of domestic social andethnic conflicts, some in urban areas (e.g. riots in Hyderabad during the 1980s, see Varshney), but primarily in ruralTelengana and North-Coastal Andhra (see Balagopal). These conflicts, it is believed, have influenced public policychoices, private investment, and thereby have an effect on growth and employment opportunities in the state. In lightof these, efforts to reduce social conflicts and to create and improve the existing institutions of conflict managementshould be an integral part of the long-term growth strategy of the state.

Source: Easterly and Levine (1997), Rodrik (1998), Varshney (2001), Balagopal (1982, 1984).

Political Weekly, July 18, 1987. Also see "The Gond movement in Adilabad and its repression", Balagopal, K., Economic and PoliticalWeekly, May 25, 1985

∆Economic Growth=-External Shock ×Latent Social Conflict

Institutions of Conflict Management

in india is uniform across all states, its impact...

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