# **1. Introduction**

Two themes have recurred in recent discourse on the current growth performance of India’s economy. 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 the growing evidence that the rapid growth of the past decade and half has not spread evenly across all the regions of the country, being rather 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 with China’s is most conspicuous in terms of the growth of manufacturing industry, concern with regional inequality within India has also largely related to disparity in industrial growth. It is not obvious that regional inequality in industrial development poses a policy problem for India, any more than does the fact that its growth rate has so far been smaller than China’s. There is nonetheless remarkable consensus on some of the factors explaining both cases 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. Some attribute labor market rigidity to intrusive employment codes, which, while common to all parts of the country, have also been enforced to a degree that varies substantially across states depending on the political orientation and tradition of state governments. Several studies report that this 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. Another point of consensus on the reasons why manufacturing is not growing as fast in India as it has 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 has 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 of a consensus as we move beyond excessive labor regulation and power shortages to other potential reasons why India’s industry is not growing as fast as China’s, or why industry is not doing as well in its lagging states as it is in more prosperous ones. However, two potential constraints happen to be rated highly by respondents to the business survey on which this paper draws. 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 the survey than is labor regulation. At first sight the high rating of access to finance seems hard to square with the facts. As pointed out in a recent World Bank report, India has had excess savings and low interest rates for a number of years now and has consequently been a net exporter of capital 2