"Alice: Would you tell me, please, which way I ought to go from here?
The Cheshire Cat: That depends a good deal on where you want to get to.
Alice: I don't much care where.
The Cheshire Cat: Then it doesn't much matter which way you go.
Alice: ...So long as I get somewhere.
The Cheshire Cat: Oh, you're sure to do that, if only you walk long enough." State Governments have already walked in a particular direction long enough to position their states as attractive investment destinations. This has involved imitating industrial policies and trying to out-compete each other by leveraging key fiscal / operational levers available with the State dispensation.
State government incentives can broadly be categorized as:" Fiscal Incentives such as VAT refund / Interest free loan, electricity duty, exemption on stamp duty, entry tax exemption, interest subsidy, capital/investment subsidy, power tariff subsidy etc.
" Non Fiscal Incentives like subsidized land, quality supply of water & power, dedicated power feeders for large units or industrial areas, dedicated high speed road connectivity, common effluent treatment plant for industrial estates / clusters, common facilitation centers etc.
These incentives are further sweetened into a customized package should the investment / promised employment cross a specific threshold.
The banal sameness of above is cashed in by investors. Globally MNC boardrooms focus on an India strategy. Post an India investment decision, the second level decision on manufacturing location follows. The incentives offered by Government of India are similar* for any location in India, therefore state level incentives start impacting the direction of needle. Global players and Blue Chip organisations play one state against the other to maximise state incentives including free land, VAT holiday for double digit number of years, reduced power tariff and capital subsidy etc.
Driven by the need to generate jobs and resultant positive economic externalities, states compete with each other to offer higher incentives oblivious of their fiscal capacities. This is tantamount to following a beggar thy neighbour policy. As federal incentives are temporally static, due to inter-state competition, the country ends up paying much more than what we should have offered for a major investment to come in.
Additionally, headline attracting blockbuster FDIs or investments by blue chip Indian organisations have a limited frequency. Greenfield mid cap investments / expansions are more regular. There is a cascading escalatory impact on the incentives offered to the latter. In ultimate analysis the federal structure ends up coughing up more than economically necessary.
On a larger plane, in line with the economic cycle, as investments dry up, states tend to offer higher incentives while competing for limited opportunities. Therefore marginal utility of every additional unit of incentive is high. Over a period of time, as investments trickle in, the states are forced to improve their operational / procedural ease of doing business to continue being an attractive destination at the same incentive level. This should ideally force other competing states to follow suit and create a better enabling environment. With a base level ease of doing business, greater degree of investment is likely to happen at similar incentive levels and the marginal utility of additional incentives starts tapering. This is a virtuous cycle ultimately resulting in a dynamic equilibrium between the level of investment and the incentives offered. Better ease of doing business reduces the need to offer ludicrous incentives and provides states a fair ground to compete on.
However, to achieve the above ideal, few issues need to be pondered upon:
How does the industry use the additional incentives?With land / tax / power related incentives, plant level break-even is likely to be achieved much faster & therefore capital frees up quicker. Is this advantage being passed on to consumers in form of lower prices or is an investment being made in organization level R&D / additional production facilities? Or, is the freed up capital simply being pumped out as dividends to shareholders? While there can't be simple answers there is a need to further appreciate the utilization of incentive surplus by the industry.
By way of additional incentives, can better externalities be targeted beyond the specific one of additional jobs?Bulk of additional incentives offered to cast off the dark shadow of a competing state are related to upfront capital subsidy / highly subsidized land / increased VAT holiday period / lower power tariff etc. The percentage of incentives targeting R&D, tech transfer and skilling is a miniscule percentage of the total incentive package, ironically mirroring the percentage of country's spend on R&D when compared to total national spend on education. If similarity of business environment and physical infrastructure / connectivity can be achieved across multiple states, then the discussion on incentives can be taken to the next logical level of targeting R&D, technology transfer and university linkage etc.
Does either party live up to tall promises?One of the major reasons behind investor's haggling for better fiscal incentives is the extremely wanting contractual obligation regime in India. The focus should be on signing water tight MoUs between State Governments and industry. The state governments should deliver external connectivity, clear land titles, licenses etc. in promised time and the industry should generate promised direct employment within the specified period. A third party audit of such MoUs by agencies such as Transparency International is likely to go a long way in improving country's business environment image and international ranking on the parameter of enforcing contracts.
What is getting pushed in name of local support?With increasing incentives for FDI & large investments, the demand for supporting local industry grows louder. While it is very important to support local industry specially by making them nationally and internationally competitive, the need to offer incentives which are prima facie market distortionary needs to be examined in greater detail.
Where should the monies be deployed?Global capital flow is a vector - The India decision is already made. Investments will flow with or without large degree of incentives. The size of Indian population and growing demand are the prime drivers for investment. Within the country, some locations have definite strategic advantages. The days of license raj when a license could be location specific, are all but over. PSU investments are increasingly driven by market factors - history has shown that a majority of forced PSU investments which were not in sync with the geo-economic reality of the day have failed to usher in a barrage of similar investments from private sector, honourable exceptions do exist. Therefore, If a percentage of the proposed incentive kitty of a state is spend in collaboration with the Government of India / other states on improving port / dry port / air port connectivity of designated industrial zones and in improving procedural / operational ease of doing business of such zones then it would be easier to attract investments. Coastal economic zones and proposed industrial corridors are a welcome step in this direction. This would substitute the haphazard unplanned industrialization with planned development across hitherto unindustrialized regions.
Strong leadership, effective administration, procedural ease, strategic location, access to markets, local skill base, fiscal / operational incentives & over all ease of doing business are few of the many considerations which impinge on an investment decision. As the global manufacturing bases experience mild tremors, it is pertinent that India should be able to draw a sizeable degree of manufacturing related capital flow. However, unhealthy competition between states may not be the best way to achieve the same. There is a need to borrow a leaf from Cooperative Federalism on this front as well. Government of India and State Governments should together plan, design and develop strategically located, world class manufacturing zones of tomorrow wherein the combined incentive kitty is able to garner best value for money for the country as a whole.
Guest Author
Author is an IAS officer currently posted as Director Industries, Government of Andhra Pradesh. Views are personal.