# **1. Introduction**

As it becomes all too evident that India’s economy has finally ‘taken off’, two themes have recurred in discourse on its recent and current performance. One is if and when the pace of growth will eventually catch up with China’s, or, rather, why that has not happened already. The second is that the rapid growth of the past decade and half has not spread evenly across all the regions of the country, being too concentrated in about half a dozen ‘advanced states’. Although lagging regions have also grown consistently over the period, this has been at a much lower pace than the ‘advanced regions’ (World Bank 2006a; Purfield, 2006). Just as the contrast between India’s growth performance and that of China’s is most striking in manufacturing, concern with regional inequality within India has also largely related to disparity in industrial growth. It is not necessarily obvious that regional inequality in industrial development per se poses a policy problem for India, any more than does the mere fact that its GDP growth rate has so far been smaller than China’s. Still, there does seem to be considerable consensus among experts on some of factors explaining both instances of disparity.

One point of consensus is that India’s labor markets are less flexible than China’s and probably have made Indian manufacturing industries less competitive in international markets. This is attributed by some to India’s highly intrusive labor laws, which, while common to all parts of the country, have also been enforced to a degree that varies considerably across states depending on the political orientation and tradition of state governments. Several studies report that this in turn has generated significant regional differences in effective labor regulation, and is a major reason why industry has not done so well in some states as in others. A second point of consensus on the reasons why manufacturing is not growing as fast in India as it is in China, is that India’s physical infrastructure is significantly poorer particularly in the area of power supply to industry. As a result of years of underinvestment associated with serious property rights and contract enforcement problems relating to power, India has been in a state of perennial power shortages that have proved to be a significant drag on manufacturing productivity and growth. Moreover, depending on how supportive local governance and politics have been of power sector reforms, the gravity of this problem has varied enormously across states.

There is less agreement as we move beyond excessive labor regulation and power shortages to other institutional factors behind growth trends in India. However, two potential constraints happen to be rated highly by respondents to World Bank business surveys in the country. These are corruption and access to formal external finance. In fact both of these factors are reported to be constraints by a greater proportion of respondents to those surveys than is labor regulation. At first sight the high rating of access to finance seems hard to square with the facts. As a World Bank report points out India has recently been a net exporter of capital, reflecting its excess savings and low interest rates (World Bank, 2006a). Also, thanks to rapid reforms of the stock market since the early 1990s, 2