Structural Change, Economic Growth and Trade: Case for Regional Reallocation of Investment in India

The economic structure and rates of growth across the states in India are markedly different, with significant disparities in income per capita growth as well as sector-specific performance. The high-income states have typically led the Indian growth story with their high growth rates, while regional inequality continues to increase. The recent policy focus in India has been to encourage inclusive growth across sectors and disparate regions within the country through development of core public services (water, education, transport, healthcare, etc), especially in the poor and special status states. To understand the structural challenges facing India, it is important to understand which economic sectors have been the most critical in driving regional inequality over the years and how these sectors impact economic growth. Given the new thrust in developmental capital expenditure in the special states (with special economic incentives to help enhance economic growth) and poorer states to boost economic well-being, it is pertinent to evaluate whether such public expenditure has helped alleviating inequality and triggered structural change. We use income and disaggregated sector-specific output data of 31 Indian states and union territories to examine the structural change experienced over the last three decades from 1980 through 2008. Considering the major regime shift implemented in India through economic reforms of deregulation and liberalization during the early-1990s, we also determine how this impacted the structural performance and regional disparity in the country. We examine these relationships in an augmented Chenery-Syrquin model, and test whether the state capital and development expenditure has had structural impact and whether it has lowered regional inequality. We find at the macro level, India experienced higher economic growth with increasing inequality in both the agricultural and the manufacturing sector during 1980-2008, however, as the disaggregated regional growth analysis reveals, at the micro-level, the states with higher agricultural and manufacturing orientation enjoyed higher average economic growth. The high growth states also gained in the post-reform period, indicating that laggard states have lost out even on the trade front due to their structural backwardness. Our estimated Chenery model indicates that liberalization has had significant positive impact on services share in state output, but no significant manufacturing orientation. Moreover, state capital/ development expenditure has also had no significant effect on the manufacturing –orientation of the states, and indeed inequality has further increased for the special states. The special states have increased their service-orientation even as their manufacturing share significantly declined in the last two decades. We conclude that although the state development expenditure can play a critical role in reducing regional disparity, the special status poorer states have failed to utilize state development investment to trigger structural economic change and reduce regional inequality.