NEOCLASSICAL growth theory predicts that, in the absence of institutional harriers to the mobility of capital and labor across national or regional boundaries and for economics with similar technology and preferences, per capita incomes lend to converge over a period of time during economic growth. The study by Cashin and Sahay (I996) is one of the few attempts to test this prediction at the regional level for a particular country. The study analyzes the growth trends in 20 states in the Indian Union over the period 1961-91 and concludes that (1) “there has indeed been convergence in real per capita incomes across the states of India during the period 1961-91” (Cashin and Sahay. 1996. pp. 163-64); (2) while the cross-sectional dispersion in real per capita incomes increased over the years, the center-state grants ensured that the dispersion in real per capita disposable incomes remained broadly constant over lime; and (3) labor mobility was not an important factor contributing to convergence, particularly because of the existence of barriers.
A close examination of the paper, however, brings out a number of conceptual and methodological issues, both in the tests for convergence and in the analysis of the equalizing impact of intergovernmental transfers. First, the convergence is observed only when the manufacturing output share variable is included in the regression. We argue that, for controlling sectoral shocks, the inclusion of this variable is irrelevant. However, if the manufacturing output variable is taken as a policy variable, the results point toward conditional rather than absolute convergence. Second, the inclusion of four “special category” states makes the sample heterogeneous. Third, as net state domestic product includes the effect of federal grants, including them again to analyze the equalizing impact is conceptually erroneous. Finally, it is incorrect to exclude tax devolution from the analysis of equalization. Each of these points is discussed below.
Barro, Robert J., and Xavier Sala-i-Martin, 1991, “Convergence Across States and Regions,” Brookings Papers on Economic Activity: 1, Brookings Institution, pp. 107–58.
Boadway, Robin W., and Frank Flatters, 1982, Equalization in a Federal State: An Economic Analysis (Ottawa, Canada: Canadian Government Publishing House).
Cashin, Paul, and Ratna Sahay, 1996, “Internal Migration. Center-State Grants, and Economic Growth in the States of India,” Staff Papers, International Monetary Fund, Vol. 43 (March), pp. 123–71.
Rao, M. Govinda, 1996, “Intergovernmental Fiscal Relations in a Planned Economy—The Case of India,” paper presented at the conference on “Fiscal Decentralization in Developing Countries,” Montreal, Canada, September 19–20.
Rao, M. Govinda, and Raja J. Chelliah, 1996, Survey of Research in Indian Fiscal Federalism (New Delhi, India: Indian Council of Social Science Research).
The “Gadgil” formula used to distribute plan transfers does not apply to special category stales. While for the general category states 30 percent of plan assistance is given as grants and 70 percent as loans, the grant-loan ratio is 90:10 for the special category states.
In their study of the U.S. economy, Barro and Sala-i-Martin (1991} exclude federal transfers from the personal incomes of states to measure the equalizing impact of federal transfers.
Tax devolution was made progressive also by choosing the inverse