Karnataka must move away from subsidies to growth-enabling reforms

A new chief minister has taken charge in Karnataka. How this leadership confronts economic challenges will reverberate on the national stage. Karnataka is a site of important policy innovations that are often adopted elsewhere. It is disproportionately important for India as the prime centre of the information-technology (IT) revolution. Despite holding less than 5 per cent of the country’s population, Karnataka generates over 9 per cent of its economic output, largely driven by its massive services and IT sectors.  

From a distance, Karnataka is a land of glamorous towers and high technology. All over India, young people dream of the career track of obtaining a college degree and finding a job in Bengaluru. The multicultural life of the young in Bengaluru today represents India’s greatest cosmopolitan and sophisticated culture, surpassing that seen in even Mumbai in some respects.

However, when we look a little deeper, there are visible weaknesses. The gap between the rate of growth in Karnataka’s gross state domestic product and other big states’ is narrowing and on most social indicators it fares badly in comparison to states like Tamil Nadu, Kerala and Maharashtra. What can the new government in Karnataka do to foster economic growth and improve social outcomes? 

The phrase “economic growth” is normally applied to the country as a whole. We tend to think that economic growth is the job of the Union government. It is traditionally the business of policy wonks in macroeconomics, finance, companies and globalisation. 

But there is an important sense in which we can and should have a growth strategy in every state. The states of India are the size of European countries. Each has its own local context. Each needs to devise its own growth strategy, doing the best it can with whatever powers and resources it possesses. India is too large and heterogeneous to rely solely on macroeconomic levers pulled in New Delhi. Growth requires an enabling environment constructed at state and municipal levels. 

How would this work? In an ideal world, the state government would do a great job with the wide array of public goods that fall in its domain. It would provide flawless policing, courts, public health, land and property records, and urban infrastructure. But in India, every state government is overwhelmed by challenges. State capability is low and the machinery of government fragile. It is then useful to ask: What public goods should be prioritised because they have the highest impact upon economic growth in the state? We must accept the limitations of state capability and direct scarce administrative bandwidth towards interventions that yield the highest economic returns. This method would induce a growth strategy in each state. 

In Karnataka’s unique context, the dominant idea of high growth is hosting the operations of sophisticated modern corporations and attracting clever migrants, Indian and foreign. This immediately suggests numerous areas for work where the state can do better. The state apparatus must pivot from legacy political preoccupations to the explicit goal of facilitating this economic engine. The state must remove frictions that hinder corporations and migrants from arriving. 

What does this entail? 

The new chief minister needs to nurture the urban agenda. This ranges from rebuilding Bengaluru to transforming 25 other cities into beautiful, world-class urban centres. Bengaluru suffers from acute infrastructure deficits. Commute time, water shortages, and poor sanitation impose direct costs on corporations. Fixing this requires capable municipal corporations, decentralised power, and substantial capital expenditure. 

Karnataka needs to reform labour laws. The paternalistic instinct of the state to micromanage the relationship between employer and employee hampers growth. Treating workers as responsible adults allows market forces to determine employment contracts. This flexibility ensures that more firms will be willing to operate and expand headcount. 

The modern world involves round-the-clock work. The criminal-justice system and the courts need to function better to deliver safety. A night shift cannot function if streets are unsafe, and sophisticated firms cannot operate where contracts cannot be enforced. 

The land market needs to work correctly. Currently, land assembly is fraught with friction, opaque records, and litigation. The state must deliver land resources with clear titles in large quantities to incoming firms and migrants. Reforming the land market reduces transaction costs, enabling faster capital formation. Alongside this urban and industrial focus, there is a strong range of possibilities in ecotourism, which can induce high incomes locally without a heavy industrial footprint. 

State-level policymakers should not do industrial policy. The temptation to offer tax holidays, capital subsidies, and bespoke concessions to specific companies or specific industries is high. But industrial policy distorts resource allocation and breeds cronyism. 

Economic-growth strategy is about public goods where the state does not pick winners. Better cities, safety, and land markets benefit everyone. The ultimate benefits will be large, and they will inevitably prove to be different from those envisaged today. When the state provides a foundation for public goods, the market will discover the right industries. 

For example, friendly and friction-free foreigner registration and related processes in the police stations of Bengaluru, and a sensible and civilised policy on alcoholic beverages are factors in enhancing freedom and opportunity. This will improve the environment for a wide variety of industries — from electric vehicles to garment manufacturing — and the consumers and the market will choose the winner. 

This agenda also requires strategic thinking in public finance. Spending on urban development in Karnataka is way below the median of big states. Related to it, Karnataka is weak on recovering user charges for most services, starting with electricity. As a result, the share of non-tax revenue in total revenue in the state, too, is way below the median of big states. Both expenditure and revenue reforms are needed. Money must be reoriented away from malfunctioning subsidy programmes to effectively produced public goods. 

The new administration in Karnataka has a narrow window to establish credibility. Merely intensifying or trivially tweaking conventional policies will not deliver useful change. By embracing an economic strategy anchored in public goods, it can achieve a level shift in the growth rate.

The author is an honorary senior fellow at the Isaac Centre for Public Policy and a former civil servant