Governance and economic growth in the Indian states

Abstract

In Essay 1, I have assimilated a unique dataset of 30 indicators across three broad dimensions of Accountability, State Capacity and Fiscal Performance. Building on theoretical considerations from the New Institutional Economics literature and the literature on State Capacity, I aggregate these indicators into a governance index for 16 Indian States from 1985 to 2016 in a first attempt to construct a long annual panel data of institutional quality across Indian States. I conduct a disaggregated analysis of the defined governance dimensions to both understand the trends in these dimensions and present a comparative analysis of the States' performance on these dimensions. In Essay 2, I study institutional evolution in the Indian States along two dimensions of Accountability in the institutions and State Capacity in the public institutions of the police, judiciary and the bureaucracy. Against the evidence of divergence in incomes and rising inequality across the States over this period, I use panel data convergence regressions to find that institutional quality has actually converged. The results point to a wedge in the posited relationship between institutions and economic growth by the New Institutional Economics literature, in the Indian context. Further, while accountability of the State elite towards citizens has improved on average, the quality of public institutions of bureaucracy, judiciary and police across States has declined over this period. This has serious implications for the stability of the political institutions in Indian States. In Essay 3, I study the impact of the quality of public institutions on economic growth in 16 Indian States over 30 years. I apply both fixed effects and dynamic panel data GMM methods using the Arellano-Bond estimator in a neoclassical framework for this study. I find that overall institutional quality increases investment in physical and human capital, which have a significantly positive impact on economic growth. Among the dimensions of governance, I find that while Accountability has a significant positive impact on investment and increases incomes, State Capacity does not impact investment or economic growth. Higher State Capacity might be lowering investment in the Indian States by lowering corruption, which acts as a lubricant and removes frictions for economic activity in a highly regulatory business environment in India.