Economic growth is the most powerful force for

Transcription

1 Chapter 2 IMPROVING THE CLIMATE FOR INVESTMENT AND GROWTH FIGURE 2.1 (Index, 1985/86=100) BIHAR AND ALL-INDIA GDP ( ) All India Bihar Economic growth is the most powerfl force for redcing income poverty. Linkages between growth and poverty redction, and the role of the government in promoting growth, are complex and depend on a range of instittional, cltral, historical and physical parameters. Bihar has, in general, grown slower than the rest of India, with less robst links between growth and poverty redction as compared to other states. Accelerating growth and strengthening these linkages will be critical for improving Bihar s capability to redce poverty and attaining the MDG targets, in particlar the goals of halving the proportion of those living on incomes of less than one dollar a day and the proportion of people sffering from hnger. Given the dependence of Bihar s economy on agricltre and the large percentage of the state s poor that are dependent on rral incomes, improving agricltral performance is particlarly important for growth and poverty redction. This chapter examines Bihar s growth performance in the context of the comparative advantage that the state enjoys in agricltral prodction, and its crcial dependence on the investment climate. Growth Performance in Bihar Bihar s Gross State Domestic Prodct (GSDP) data indicates that growth performance has been qite weak, averaging barely 5% dring the 1980s, which was below the national trend rate of 5.6%, and then trning flat in the first half of the 1990s when the national growth rate remained above 5% (Table 2.1). Post bifrcation, Bihar contines to lag seriosly behind other states in India. Over the period to , when data for the new 23 TABLE 2.1 GROWTH PERFORMANCE OF BIHAR : TO Former Bihar Former Bihar Divided Bihar to to to GDP Agricltre Indstry Services India to to to GSP Agricltre Indstry Services Note: Period growth rate is the average of annal growth rates over the period. Sorce: Central Statistical Organization, GoI.

2 24 state of Bihar is available, the growth rate averaged 3.8% or less than two-thirds the national growth rate of 6.1% per annm. 1 This has widened the GSDP gap at an accelerating rate over the past decade (see Figre 2.1). Comparisons in per capita income growth reveal an even less favorable trend for Bihar. This is mainly de to the state s high poplation growth rate, which averaged 2.5% between the 1991 and 2001 censses, the highest in the contry and well above the national average of 1.9%. Moreover, nlike the other states whose poplation growth rates have been declining over the decades, Bihar s poplation growth rate in the 1990s was higher than the 2.1% experienced in the 1980s. This has aggravated Bihar s poplation pressre and depressed income growth, making fertility control an important development isse. The sectoral composition of Bihar s economy reveals the important role of agricltre in aggregate prodction. In ndivided Bihar, the contribtion of agricltre, fisheries and forestry in total otpt was 33% dring (Table 2.2). Bihar lost most of its indstry and mining to Jharkhand after the bifrcation, and agricltre now represents 39% of GSDP (as compared to 23% for the contry). In contrast, Bihar s indstrial sector is the smallest among India s major states, contribting only 12% to GSDP (compared to 27% nationally) and employing fewer than 10% of the workforce. The tertiary sector is Bihar s largest, generating 49% of the state s GSDP, mainly in trade and transport services, finance, real estate, and government (pblic administration). The nsatisfactory performance of agricltre, Bihar s most important sector, is responsible for the state s low aggregate growth rate. Agricltre provides employment for three-qarters of the workforce, and is the main sorce of income for the majority of Bihar s rral poor. Hence improving agricltral incomes is the key to redcing income poverty. Agricltre showed negative growth in the early 1990s, and since the mid-1990s throgh it has grown by less than 1% per annm, implying a negative growth rate of agricltral otpt per capita. In contrast, indstrial growth averaged 10.5% per annm from the mid-1990s, exceeding the national growth rate, thogh from a very low base. Small-and medim-scale enterprises predominate in Bihar s indstrial sector. The performance of services has been higher than agricltre (6.4% p.a.), bt is below the national average growth rate of 8% per annm. Moreover, services appear to be relatively capital intensive and have not absorbed a share proportionate to their GSDP level in the workforce. The linkage between growth and poverty redction in Bihar also appears qite weak relative to other states, inclding the relationship between non-farm growth and poverty redction. Several factors accont for this, inclding Bihar s poor initial conditions of both rral development and hman resorces. Recent research sggests that Bihar s low rates of literacy and overall weak hman resorce development are major cases for the lack of an adeqate link between non-farm growth and poverty redction. (see Box 2.1). A serios impediment to Bihar s growth is the shortage of investment flows from pblic and pri- TABLE 2.2 PERCENTAGE DISTRIBUTION OF GROSS STATE DOMESTIC PRODUCT PRICES (AT FACTOR COST) Bihar Undivided (qick estimates) Bihar ( ) Primary sector of which Agricltre and AH Secondary sector of which Manfactring Tertiary sector of which Transport, Comm.&Trade Finance and Real Estate Pblic Administration Other Services Total Sorce: Directorate of Statistics and Evalation, GoB, Patna. Bihar: Towards a Development Strategy

3 BOX 2.1 WEAK PRO-POOR GROWTH IN BIHAR In India, overall economic growth in the non-agricltral sector has been pro-poor insofar as increases in the growth rate have redced poverty levels. However, this correlation varies, and in Bihar it has been weak. A likely reason is that economic growth redces poverty to a lesser extent in a state with poorer initial conditions of rral development and hman resorces and with a higher scale of neqal land distribtion. Ravallion and Datt (2002) have constrcted a time series of 20 hosehold srveys across the major states from 1960 to They fond that non-farm economic growth redces poverty at a different rate across states - Bihar appears to have the lowest elasticity of poverty to non-farm otpt, averaging 0.3%, or arond one-qarter the rate of the observed contry mean of 1.3% per annm. (see table), and less than one-tenth that of the highest elasticity of 3.5% per annm, as fond in West Bengal. Even a small variation in the annal rate of poverty redction has a significant long-term impact on poverty rates. If all states had Bihar's annal rate of poverty redction (0.3%), the national headcont index in 1995 wold be 43% instead of the actal figre of 30%. Ravallion and Datt (2002) se empirical evidence to show that non-farm growth does not redce poverty effectively in Bihar, de to its very limited rral and hman resorce development and highly neqal distribtion of land. Among the constraints to pro-poor growth, the role played by literacy is particlarly noteworthy. For example, nearly two-thirds of the difference between non-farm otpt elasticity of poverty for Bihar and Kerala (one of the top performers in pro-poor growth) is attribtable to Kerala's sbstantially higher initial literacy rate. 25 Actal and Simlated Mean Annal Rates of Poverty Redction across States Annal rate of Headcont index poverty redction in 1995 Actal mean across all states Bihar West Bengal Note: The first row shows the nweighted means of the actal rates of poverty redction and the actal headcont index in 1995 across states. 1/: The headcont index in 1960 was 48%. Sorce: Ravallion and Datt(2002) This evidence is consistent with a decline in income distribtion, which erodes the contribtion of growth to poverty redction. Deaton and Dreze (2002) estimate that for Bihar the relationship between the distribtion netral growth in consmption expenditres and the decline in poverty headcont is arond -1.0 for rral hoseholds and arond -0.8 for rban hoseholds. In other words, a 10% increase in consmption expenditres evenly distribted across hoseholds wold redce rral poverty by arond 10% and rban poverty by arond 8%. Increased ineqality in expenditre distribtion dring the last two NSS srveys, however, appears to have redced this by arond one-tenth in rral areas and one-half in rban areas, according to estimates by Deaton and Dreze (in 'Poverty and Ineqality in India: A Re-Examination, EPW, September 7, 2002). vate sorces. Constraints on pblic investment are discssed in Chapter 3. Private investment flows to Bihar are also highly limited. Data on projects crrently nder implementation (i.e. projects where financing has been finalized and work has begn) shows the very low level of private project investment in Bihar. As of December 2003, Bihar acconted for abot Rs. 800 crore or 0.4% of the total, as compared with Uttar Pradesh (3.5%), Orissa (3.7%), and Madhya Pradesh (6.1%), as illstrated in Figre In order to create an environment condcive to high growth rates, a comprehensive development strategy is reqired that will address the main constraints to growth, while working with highly limited pblic resorces. One important objective shold be to se pblic resorces effectively to encorage greater private sector investment and other non-governmental resorce flows for prodctive prposes. This will reqire examining the instittional and market environments in which investment and bsiness is being condcted, as

4 Rs. Crores FIGURE 2.2 STATE-LEVEL PRIVATE PROJECTS UNDER IMPLEMENTATION BH KR JH RJ WB HY UP OR PJ MP TN KN AP MH GJ 26 Sorce: CMIE, Dec well as the physical constraints to economic activity. The following section examines the specific constraints to growth in agricltral prodction, and considers some examples where Bihar has demonstrated strong performance from which relevant lessons cold be drawn. Constraints to Agricltral Growth 3 The bifrcation of Bihar has increased the importance of agricltre in its economy. Nearly 90% of the poplation lives in rral areas and depends directly or indirectly on agricltre. Fortnately, Bihar is well endowed with land resorces. The soils are predominantly thick allvial (Gangetic) deposits, or swamp and Terai soils, rich in ntrients, sch as nitrogen, potash and phosphoros. The state has srpls water resorces with potential for doble and mltiple cropping. However, thogh prodctivity on demonstration plots is comparable with the best in the contry, there are some droght prone areas with lower prodction potential. The state ths presents an overall pictre of abndant natral resorces with the potential to achieve growth eqivalent to, or even better than, the more developed agrarian states in the contry. Indeed, Bihar is self sfficient in foodgrains, and has srpls capacity for export. It is a leading prodcer of spices and ranks third in frit prodction and second in vegetable prodction in India. Against this rather positive scenario, Bihar s agricltral performance has been far below its potential, as is evident from the decline in per capita otpt over the past decade. The growth of agricltre has also been highly volatile, with annal otpt swings between mins 20% and pls 30%, which has had significant implications for poverty alleviation and income secrity of the poor. Bihar s gross sown crop area is also relatively low, and prodctivity is constrained by the general lack of infrastrctre, land holding patterns, and other environmental factors. Some of these are explained frther below: Water control and flooding. Bihar s gross sown irrigated area of arond 50% is relatively low as compared to 95% in Pnjab, 67% in Uttar Pradesh, and 60% for India as a whole. The average grond water exploitation is 39%, indicating a large nexploited potential. Annal flooding has exacerbated land degradation and created a host of related economic and social problems (see Box 2.2). In 2000, annal floods in Bihar affected 8.2 million people and 7,80,000 hectares of land, over half of which were nder crops, amonting to an estimated Rs.28 billion loss to pblic property. Several districts along or near the border with Nepal have more than half their gross cropped area exposed to damage by floods. Lack of rral power spplies. Power generation and tilization rates are among the lowest in India, with only 10% of hoseholds with electric lighting, as compared with 56% nationally. Where available, highly irreglar spplies are exacerbated by annal flooding. This adversely affects the main lines, and the aging radial transmission lines reslting in high transmission losses and load shedding. The effect on agricltre has been the very low se of electric power pmpsets for grond irrigation and other prposes. As compared with Andhra Bihar: Towards a Development Strategy

5 Pradesh, for example, Bihar has approximately one-fifth the nmber of power sbstations and length of transmission lines. Fragmentation of land holdings. Land holdings in Bihar consist predominantly of small farms and holdings with a high degree of fragmentation. The average size of holdings is declining, having fallen to arond 0.6 hectares, and over for-fifths of farmers have less than one hectare each. High poplation density has pshed p the intensity of cltivation: the total cltivated area is arond 60% compared with 47% nationally. With the average size of land holdings shrinking as a reslt of increasing fragmentation, many marginal farms are becoming economically non-viable and oriented towards sbsistence. This has slowed the diversification into commercial crops from low vale-added cereals that contine to dominate cropping. Connectivity and market access. Bihar s state road system, as well as the national highways that rn throgh the state, are poorly developed and are in major need of repair and better annal maintenance. Many villages lack all-weather road access, restricting crop movement to the market and componding storage difficlties. Ineffective land reform. Althogh Bihar was one of the first states to enact land reform legislation, its implementation has been poor and only a small share of potential srpls land has been redistribted and taken possession of, de to varios loopholes and difficlties with enforcement. Land records and land tenancy. As in many states, the maintenance of land records is a problem. Compterization of land records is being introdced in some districts with encoraging reslts, bt it is a slow process. The procedre of obtaining the Record of Rights is cmbersome, and typically involves significant transaction costs. Problems with land tenancy, which is illegal, are also well known. Althogh official records sggest that less than 4% of the cltivated land area is nder tenancy, field stdies indicate a far higher rate of arond 25%. Unrecorded oral tenancy is prevalent, with very weak tenant secrity. These constraints have led to relatively low crop yields despite fairly rapid growth in the se of highyielding varieties (HYVs) dring the 1990s. HYVs of rice grew particlarly rapidly dring the 1990s in Bihar, with the coverage increasing from 38% to 68% by HYVs of wheat and maize were introdced earlier, and now cover approximately 91% and 75% respectively of cropped area. However, despite favorable endowments and widespread se of HYVs in cereal crops, the constraints mentioned above, and the relatively low average fertilizer se (82kg/ha as compared to 108 kg/ha in Uttar Pradesh, 152 kg/ha in Tamil Nad and 153 kg/ha in Andhra Pradesh) have all contribted to fairly low prodctivity levels in agricltre in Bihar. Bihar s agricltral yield as compared with potential yield (estimated by yield achieved in national and state-specific demonstration plots) reveals a large yield gap across several crops. The gap is particlarly large in the case of rice and maize, where Bihar s crrent yield is less than half the potential yield. Wheat yields in Bihar show a mch lower gap, as do many non-cereal crops sch as gram, rapeseed, sgarcane, etc. It is also noteworthy that prodctivity levels of maize and several non-cereal crops rose above the national average, althogh still falling short of their potential. Thogh Bihar has a significant yield gap in crops like potato, sgarcane and rice, this cold be constred as encoraging for the state s ftre growth potential. Crrently horticltral crops accont for arond 4% of cropped area and show strong promise for growth in several districts. It is clear from cropping patterns that a shift towards nonfoodgrain crops is already taking place. Litchi cltivation is one sch sccess story. There is potential for frther expansion if the right investment climate for agro-bsiness is established (see Box 2.3). Bihar prodces 70% of India s litchi crop, which is high in terms of both qality and yield per acre. In addition to litchis, the prodction of mangoes, pomegranates, lots seeds (makhana), spices, and other crops show great promise. Exploiting Bihar s growth potential reqires a comprehensive development strategy, and there is also need for national-level attention in problematic areas that go beyond the state s fiscal and instittional management capacity. For example, Bihar s massive long-term annal flooding problem needs investment in infrastrctre and cross-border agreements backed by central government intervention. The effort so far has been piecemeal and inade- 27

6 BOX 2.2 ANNUAL FLOODS: SETTING BACK THE DEVELOPMENT CLOCK The annal pattern of flooding which inndates Bihar's districts along the Gangetic plains has enormos hman and environmental cost. Sown area is washed away, taking with it the top soil and seeds. Cost of cltivation increases, restricting cropping patterns and technological innovation. Farmers tend to become strongly risk averse. Roads and bridges are damaged, reqiring greater maintenance and repair. Marketing of agricltral prodcts becomes more costly and difficlt. Electricity lines are broken, leading to increased maintenance costs and irreglar power spply. Broken tbewell pmpsets reqire annal repairs. Hman settlements along the river systems are displaced leading to seasonal nemployment, and health and social problems. Irrigation canal systems reqire expensive maintenance. Sorce: WB mission interviews with farmers. 28 qate. National spport for major infrastrctre development to improve connectivity with national markets and to strengthen interstate power transmission is also essential and is gradally getting nderway. Greater market access and growth potential will in general also benefit from a liberalized national food procrement, stockpiling and distribtion system. Bihar has a natral comparative advantage in agricltre bt cannot expand its share within controlled national markets. However, these isses are complex and go beyond the immediate scope of this report. The state has a large agenda for improving pblic spport to agricltral prodction and improving the economic climate for growth. These shold form part of comprehensive reforms aimed at the many constraints to agricltre otlined above. The focs shold lie in providing assistance to smaller holdings that constitte the blk of Bihar s prodcers. More specifically, reform is needed to improve: (a) the se and allocation of pblic finances for enhancing effective pblic investment in rral infrastrctre (Chapter 3); and (b) pblic administration and governance for providing high-qality pblic services to rral commnities (Chapter 4). Besides, improvement in pblic service delivery is vital for agricltral extension services to reach intended beneficiaries, expanding access to new and highqality seed varieties and other inpts, improving land registration, and tackling the problem of land fragmentation and tenancy. At the local level, experimentation in innovative commnity approaches to service delivery has shown very TABLE 2.3 YIELD GAPS FOR VARIOUS CROPS IN BIHAR (KG/HA) Crops State average Potential Yield gap Yield at all India yield yield** average Rice 1,218 3,026 1,818 1,940 Wheat 1,816 3,052 1,236 2,703 Maize 1,844 4,056 2,212 1,810 Gram 1,017 1, Arhar 1,379 1, Rape-Mstard 1,360 1, ,002 Jte 1,409 2, ,823 Sgarcane 48,856 62,780 13,924 70,578 Potato 9,060 23,500 14,440 18,161 Mango* 1,000 1, Litchi* 1,000 1, Banana* 5,000 8,000 3,000 - Notes: *Yield nmbers per tree; **Yield achieved in national demonstration and other demonstrations; Yield gap is compted from these figres. Sorce: Yadav et al (2000), in J. Prasad (ed.), Export Potential of Indian Agricltre, New Delhi. Bihar: Towards a Development Strategy

7 promising reslts. In irrigation, for example, Bihar s participatory irrigation management approach has shown that irrigation services can be significantly expanded and yields increased at lower nit cost to commnities and lower cost to the government (see Box 5.6). Many of these measres also fall nder the broad aspect of investment climate improvement, which is as pertinent to agricltre and agrobsiness as it is to improving the growth performance of indstry and services. Bihar s Investment Climate Investment climate (IC) refers to the instittional, economic, political and infrastrctral environment that shapes the manfactring sector s operations and expectations (see Box 2.4). Comparative srveys, condcted by the Confederation of Indian Indstry in collaboration with the World Bank (CII - WB), have examined several IC indicators to compare 11 Indian states and identify the main challenges in improving the IC. The comparative srvey analyses the main differences in good and bad state investment climates. Costs to bsinesses of a poor investment climate for example, an nreliable power spply, oneros reglations, and intrsive and disrptive visits from government officials were fond to be high. The states ranged from Uttar Pradesh (ranked as the worst IC in the srvey) to Maharashtra (ranked as the best). The analysis highlights the impact of three main factors, which in particlar affect small-and medim-sized enterprises: BOX 2.3 LITCHI CULTIVATION IN MUZAFFARPUR India is the second largest prodcer of litchis in the world after China and prodces approximately 450,000 metric tons annally. Abot 70% of India s litchi prodction comes from Bihar, the traditional sorce of the frit in the contry, where the increase in cltivation in the last decade has been impressive particlarly in Mzaffarpr. Significantly, this change seems to have occrred almost entirely de to market forces, with no concerted effort or planning by either the government or any organized instittional mechanism. Abot 2000 farmers in Mzaffarpr grow litchis; the average size of a litchi orchard is 1.2 hectares, with trees per hectare. For most farmers, the main income is from cash crops sch as paddy and maize, and litchi cltivation is an additional activity; only abot 200 orchards grow high-qality exportable litchi varieties. Limited formal credit facilities and a long gestation period have meant that most farmers have gradally increased their orchard sizes. There are no litchi cooperatives in the district, and while some milk cooperatives do market litchis grown by their members, this is rare. The growth of the litchi indstry has been driven by two major factors: first, an increase in demand from external non-traditional markets, which has sparked off the interest of local traders and entrepreners looking for export opportnities. Second, fairly stable prices and income potential has made investment in litchis attractive to local farmers. As a reslt there has been a change in litchi cltivation and marketing with as mch as 50% of the farmers now selling their crop to traders before the harvest for half the prchase price p front. For an estimated 10% to 15% of farmers the relationship extends to contract farming where the middleman finances inpts - seeds, fertilizer, pesticides, and credit. Traders have an incentive to provide farmers with new information and technologies, helping farmers toincrease their prodctivity. The two main problems facing litchi cltivators are the short harvest season and an even shorter post-harvest shelf life, which makes it essential to have a high qality and responsive logistical system for getting the crop to market qickly. A shortage of cold storage processing and canning facilities has led to post-harvest losses of as mch as 50 %, particlarly dring bmper seasons. Poor road conditions and transport bottlenecks, inclding nreglated trck prices, compel farmers to sell their prodce at cheap rates in the local markets, and an absence of refrigerated transport has meant that very little of the prodce can be marketed otside Bihar or exported. Lack of information on (and shortage of) qality seeds, efficient prodction techniqes, limited availability of finance the long gestation period of the litchi tree (7 years to fll matrity) frther constrain expansion. The strong potential for the indstry is evident from the rapid growth in otpt that has taken place in the absence of pblic or instittional spport. Well targeted spport cold accelerate growth and prodctivity throgh improved infrastrctre, and an improved investment climate. 29

8 Reglatory brden. The reglatory brden appears higher in the poor climate states. For example, SMEs receive factory inspections twice as freqently in the poor climate states (9.5 visits per year on average) as in the best climate ones (5.2 visits). srveyed firms indicated overstaffing de to labor reglations and political pressre not to lay off workers. In good IC states over-manning was less severe, and in some instances related to hoarding labor in anticipation of growth in ftre otpt demand. 30 Power infrastrctre. In the poor climate states, 73% of SMEs have captive (self-owned) power generators, whereas in the best climate states the figre is 31%, reflecting more severe power spply problems in the poor climate states. For SMEs the cost of own power generation is twice that of power from the pblic grid. Indstrial relations and reglations. Problems with having more workers than firms want is widespread, and reflects heavy reglation of labor markets. In poor IC states (UP) all These differences have real conseqences for the costs firms face and their bsiness competitiveness. Firms in Uttar Pradesh, for example, are estimated to face an additional cost brden of arond 30% arising from higher infrastrctre and reglatory costs as compared with good IC states. One conseqence is that states with a weak IC enjoy less growth and have seen less poverty redction than those with a good IC. Unified Bihar had a long history of state-sponsored indstrial development spported by the Government of India in the mineral rich sothern BOX 2.4 FACTORS INFLUENCING THE INVESTMENT CLIMATE Evidence based on standardized srveys sggests that the investment climate helps to explain differences in investment and growth performance across contries and regions. China, Thailand, Malaysia and India have been able to benefit tremendosly from greater openness to trade and investment flows. The qantity and qality of investment flows to a contry or state depends pon the retrns that investors expect and the ncertainties arond those retrns. Three interrelated components shape investor expectations: 1. Macro level isses concerning economic and political stability and national policy towards foreign trade and investment - fiscal, monetary, exchange rate policies. 2. The efficacy of the reglatory framework related to the isses of entry or starting a bsiness, labor relations and flexibility in labor se, efficiency and transparency of financing and taxation, and efficiency of reglations concerning the environment, safety, health, and other legitimate pblic interests. 3. The qality and qantity of physical and financial infrastrctre, sch as power, transport, telecommnications, and banking and finance. Entrepreners often cite infrastrctre bottlenecks power reliability, transport time / cost, and access and efficiency of finance as key determinants of competitiveness and profitability. Srvey reslts in India point to several factors that enhance or harm the competitive position in international markets. India's large market size, low labor costs, and abndance of skilled and edcated workers are major strengths, and clearly it is potentially competitive in a range of labor intensive indstries. Bt in practice this advantage is partially offset by infrastrctre bottlenecks, and India s foreign investment flows are low compared to China, Brazil, or Thailand. Three elements of India s IC drive this reslt: (i) the lack of smooth operating labor and capital markets to facilitate firm entry and exit procedres;(ii) the lack of availability of qality infrastrctre services to redce per nit costs of prodction and transport; and (iii) the brden of the reglatory environment and corrption on firms. Excessive reglation of firm entry and exit, throgh higher reqirements on the nmber of permits and clearances, means firms face more time and expense to start a firm. Bankrptcy procedres are otdated and ineffective, making them very cmbersome and lengthy. Excessive reglations over indstry hiring and firing of workers, and on the se and transfer of land are other factors. Sorce: World Bank, Improving the Investment Climate in India, Bihar: Towards a Development Strategy

9 part of the state. Good transport linkages and abndant raw materials led to the development of the iron and steel indstries, other private investors located there, technology instittes were fonded, and sothern towns, sch as Ranchi and Jamshedpr, became the indstrial centers of Bihar as well as India (see Box 5.2). However, very little of this affected north Bihar and one reslt is that no major state-sponsored indstries or instittes are to be fond in Bihar today. Althogh Bihar was not inclded in the CII-WB sample srvey, some of its conclsions seem relevant for Bihar which also shares certain characteristics with neighboring Uttar Pradesh. Besides, frther srvey evidence illstrates Bihar s comparative circmstances. The 55th NSS rond in inclded a srvey of private sector perceptions of the main impediments to bsiness operations in Bihar, from which some indicators can be drawn. Thereafter, a comparative stdy pblished in 2002 inclded all states and nion territories, covering a broad range of social, economic, environmental and instittional conditions. 4 To this can be spplemented anecdotal evidence from discssions with bsinessmen in Bihar to facilitate comprehension of the main IC problems and isses. In terms of the physical and instittional environment, Bihar ranks the lowest among all of India s states and nion territories, even below Orissa and Jharkhand. For most other IC indicators sch as penetration of infrastrctre, financial systems, and workforce qality, Bihar is ranked at or close to the bottom. While this cold be partly attribted to historical reasons, which have been aggravated by the state s bifrcation, the fact is that even in its ndivided form, Bihar has tended to be ranked at the bottom. There are several explanatory factors, with important policy implications, that fall into three main categories infrastrctre, factor markets and governance: Inadeqate infrastrctre to spport indstry and commercial services Power. High nit costs, large T&D losses, and low collection rates have created high nit costs of power spply in Bihar. The spply qality is also poor and irreglar, with freqent breakdowns and heavy flctation. Hence, the majority of indstrial nits in Bihar have captive power (as in Uttar Pradesh) which is not only costlier bt also redces cost competitiveness. Road connectivity. Bihar has relatively low road penetration despite its high poplation density, with only 77 km total road length per 100 sq km, compared with 169 km in Orissa, 118 km in Tamil Nad, and 97 km in Uttar Pradesh. A small proportion of Bihar s poorly maintained roads are srfaced 50% verss Gjarat (90%), Tamil Nad (77%), and the national average (60%). Nearly 70% of inhabited areas are not connected by motorable roads, which is the highest percentage in the contry. Ths firms operating in Bihar incr delays and significantly higher transport costs, compared to other states, in some cases making it prohibitively expensive to access markets otside Bihar. Telecommnications. Bihar has the lowest telephone density in India, with 0.93 telephones per 100 persons; for times lower than the national average. Only 2.2% of all hoseholds in Bihar have a telephone (compared to the national average of 9%), and only 40% of villages in Bihar have pblic telephone access. Internet facilities are highly limited. Weakness of local factor markets Financial services and capital markets. Bihar appears to have one of the contry s least developed financial sectors, de to both demand and spply factors. The NSS srvey of private sector perceptions identified weak capital markets as the major impediment (31% of respondents). Additionally, there is considerably low hosehold accont sage: only 21% of all hoseholds se banking services, as compared to 73% nationally. A high incidence of poverty and a predominantly rral poplation clearly contribte to this. Bt banks in Bihar also have higher depositor nmbers per branch and exceptionally low credit to deposit ratios despite fairly high savings rates, thereby reflecting the banks perception of high risk and a general lack of qality lending opportnities in the state. 5 Hence, financial services in Bihar are relatively nderdeveloped, more expensive, and often navailable, particlarly in rral areas. One conseqence is that India s poorest state is a net exporter of capital. Labor markets. Bihar has abndant nskilled manpower which it spplies to many other states throgh ot-migration, inclding season- 31

10 BOX 2.5 STATE-SPONSORED INDUSTRIAL DEVELOPMENT IN BIHAR Prime Minister Nehr's indstrial policies after independence called for the development of large-scale indstries aimed at establishing heavy indstries near raw material spply centers, and developing an effective national infrastrctre network to transfer materials to other indstrial areas. The Chhotanagpr platea in soth Bihar was identified as an important investment destination de to its rich mineral resorces and existing transport links to indstrialized Calctta. Large indstrial nits, sch as the Tata Iron and Steel Company, were already operational in this area and India's indstrial policy led to frther state-sponsored and private indstrial development. Technology instittes were also fonded there, and sothern towns like Ranchi and Jamshedpr became the indstrial centers of Bihar. A distinct indstrial pattern ths emerged in Bihar in the 1950s, which had far-reaching conseqences for the process of indstrialization in the state. First, indstrial nits and infrastrctral facilities were mainly concentrated in the mineral rich areas of sothern Bihar. Second, as a reslt of emphasis on investment in heavy indstries, state-sponsored agro-indstries did not develop in the Gangetic region of north Bihar. Finally, the indstrial centers of soth Bihar remained isolated pockets of indstrial growth, and had little impact on developing links to indstry in north Bihar, which was not as well endowed with mineral resorces. The bifrcation of Bihar and Jharkhand has ths left the new Bihar state with virtally no major state-sponsored indstries or instittes. 32 al and long-term labor movement to Haryana and Pnjab. Moreover, labor costs are relatively low: average annal money income of factory workers in 1998 was 25-35% lower than most other states. However, skilled manpower is relatively scarce, and is becoming more so with persistent low literacy rates, ot-migration of skilled labor, and stdents seeking qality edcation otside the state. Labor disptes also contribte to the risks and qality of labor in Bihar: the state recorded the forth highest nmber of man-day losses de to disptes in India in Governance Law and order. Official crime statistics sggest that Bihar does not rank far above the other states. Thogh recording the third highest nmber of kidnappings, abdctions and dacoities, it is still below India s per capita average in For factors sggest that law and order isses are far more serios than what these statistics reveal. First, the national and local perception of criminality in Bihar appears to be very different. Many people qestion the veracity of official statistics, and perceive abdction in Bihar to be a thriving indstry. Second, extortion and abdctions appear to be disproportionately directed at professionals doctors, bsinessmen, traders, althogh this cannot be statistically verified. Third, srveys indicate that concern over law and order isses in Bihar is a significant deterrent to investment. Finally, informal discssions in the state sggest that secrity costs incrred by bsinesses in Bihar for secrity personnel, protective strctres, and protection money are higher than those paid elsewhere, and have been rising as a proportion of total costs over time. Political spport for private investment. Bihar has not been proactive in corting private investment or articlating a development strategy and vision. Ths, the government does not have an investment promotion concil, conveying a lack of concern abot fostering and protecting private investment. Despite these serios constraints to private sector activity and investment, there are some instances of sccess in Bihar which demonstrate that, given the right opportnity and bsiness environment, entrepreners in Bihar can be sccessfl and generate thriving bsinesses. The Bihar State Cooperative Milk Prodcers Federation (COMFED) is one example, and the litchi indstry, discssed earlier (see Box 2.3), is another. A closer examination of sch sccesses will explain the factors responsible for their strong performance. COMFED has developed into a profitable and growing bsiness since its creation in It has a horizontally and vertically integrated strctre, ndertaking a fll range of dairy activities for its members, inclding pgradation of milk prodction technology, animal health, procrement, storage and processing, and basic information on dairy farming techniqes. COMFED has diversi- Bihar: Towards a Development Strategy

11 fied its prodct portfolio, and its marketing network now extends beyond Bihar and Jharkhand to Assam and West Bengal. Its membership has risen from 66,000 hoseholds in to 213,000 hoseholds in , with cooperative clsters in two-thirds of Bihar s districts. The annal trnover has reached arond Rs. 90 crore. The sccess of COMFED against the backdrop of Bihar s challenging IC provides some lessons that may yield sefl policy insights. These inclde: Professional management was allowed to focs on viability and long-term profitability. The new management, with a clear tenre, placed the company on a solid growth path, bringing in technology and know-how from dairy cooperatives elsewhere in India. Absence of political interference and independence from the secretariat in day-to-day fnctioning allowed the company to focs on bsiness reqirements withot diverting time, energy, and resorces to an overbearing reglatory athority. This reqired both political leadership to deflect interference, and strong professional management to minimize these costs. The horizontal prodction base and vertical integration of activities spported broad membership and participation, withot being top heavy and overbrdened by an apex organization. 7 Priority was placed on sstaining the financial incentives of members with timely and reglar payments to prodcers, and attractive procrement prices, even dring the lean months. COMFED s procrement prices are at par with the federations in Pnjab and Uttar Pradesh. The social composition of the membership is diverse and has grown withot being hindered by caste, focsing on services, work cltre and incomes rather than on narrow social and political interests. A large proportion of members consist of women, over half of whom belong to the backward castes, and another 9% to schedled castes. These factors reaffirm important elements in the IC srvey reslts. COMFED was able to overcome infrastrctre constraints and bild on Bihar s comparative advantage in primary prodction throgh prodction nodes where low-cost private infrastrctre cold sffice, sch as milk storage facilities and mobile cold storage for artificial insemination services. COMFED s technology was bilt on available labor skills (althogh otside management was broght in), and members credit reqirements were kept low throgh prompt payment. Perhaps most importantly, COMFED had political spport, and a minimm of breacratic or political interference, which facilitated entreprenerial talent to take root and thrive. Strengthening Economic Performance 8 Bihar faces challenges that are more severe than those in many other states de to its history, geography, weak infrastrctre, politics and instittional limitations. The resltant costs of sch constraints have been low growth performance and a high incidence of poverty. Improving growth performance is a long-term challenge that will reqire spport from the central government, particlarly in areas where Bihar s own capacity is severely limited. Annal flood control and interstate infrastrctre are needed to improve connectivity to national markets. The state government can do a great deal to improve growth prospects in the near and medim term. Bilding on the above analysis, the most critical featre the state needs to strengthen in order to improve growth is the delivery of core pblic services. Chief among these is basic infrastrctre, particlarly in rral areas, and the provision of basic law and order. The key infrastrctre services in which the private sector cannot sbstitte pblic delivery inclde road and water management, especially for boosting investment and otpt in agricltre, agro-indstry, and related services sch as transport, storage, marketing, etc. The pblic sector has an important role in basic capital investment and maintenance of large-and medim-scale water management systems. Private and commnity management of small-scale and feeder systems has been effective where commnities have organized themselves with low breacratic or political interference. Similarly, pblic initiatives in road constrction and maintenance have yielded large social and commercial benefits. Of corse, effective water management and road transport services reqire efficient resorce appropriation, allocation, and spervision, backed by strong administration 33

12 34 BOX 2.6 POWER SECTOR IN BIHAR P oor qality of spply and high levels of technical and commercial losses characterize the power sector in Bihar. Losing most of its generating capacity after bifrcation, Bihar now generates only 10% of its power reqirement and nearly 90% is prchased from the National Thermal Power Corporation (NTPC) and the National Hydro Power Corporation (NHPC). Among the states, the Bihar State Electricity Board (BSEB) owes the largest amont to the central power tilities. The performance of BSEB is frther complicated by transmission and distribtion losses estimated at 45-50%. Dal line systems do not exist in the state; hence a point breakdown collapses the entire grid. BSEB's commercial losses are estimated at 20-25%, mainly de to the problems of billing, metering and classification of consmers. Only 20-25%of domestic and commercial consmers are metered, and of these, only abot 25% of the meters fnction. The average tariff is abot 200 paise/kwh, far below the average cost to the BSEB of abot 351 paise/kwh, with high sbsidies to agricltre and commercial sers, bt higher tariffs for indstrial sers. Arond one-forth of BSEB's consmers are indstrial, of whom abot 90% are metered. The GoB and the BSEB plan several reform measres. A Tripartite Agreement has been signed between GoB, GoI and the RBI for a settlement of BSEB des. A Memorandm of Understanding (MoU) was also signed in September 2001 between GoI and GoB nder the Accelerated Power Development Reform Programme (APDRP). The MoU sets ot general policy and reform gidelines. Under the GoI's special spport package for Bihar, Rs. 330 crore is to be granted to the Power Grid Corporation (PGC) for improvement of transmission network in Bihar over the next few years. and project implementation. Chapters 3 and 4 focs on strengthening fiscal performance and pblic administration. One implication of this for Bihar is the need to redce government activities in non-essential areas, improve the management of pblic resorces, and focs service delivery on core areas where government leadership is essential. This means withdrawing the government s involvement in low-priority activities, especially those where the private sector can deliver more efficiently. The government s role in Bihar shold be primarily to identify essential pblic services and to prioritize activities. In agricltre, for example, this cold inclde dereglating seed distribtion to improve farmers access to high-qality and reliable spply of seeds and agricltral inpts throgh competitively priced private channels. On the other hand, the government needs to provide greater spport to agricltral research and extension services; it mst identify appropriate reglatory norms and ensre that market growth and necessary restrctring are not impeded. There shold also be efforts to redce labor market reglations that bind employers to neconomic practices and adversely affect small and medim enterprises. Similar efforts are needed to identify the main constraints in the capital markets and improve their fnctioning. In the power sector, new delivery models cold effectively expand service provision to rral and rban areas throgh private providers or cooperative arrangements. This cold eliminate spply bottlenecks and redce the very high losses and sbsidy costs crrently being incrred by the Bihar State Electricity Board (BSEB). The state (and national) government needs to ndertake instittional, reglatory, sbsidy and tariff reforms to facilitate new modes of service delivery, drawing on a range of technologies and organizational arrangements that engage new players ranging from reforming the BSEB and privatized distribtion entities to new private entrants, cooperatives, and non-governmental service providers. There has been some promising experience with low-cost delivery mechanisms for rral power in India and elsewhere in the world. This has inclded decentralized models with considerable commnity-level involvement, sch as in the rral electricity cooperatives established in Bangladesh. These cold prove effective in Bihar and merit consideration. 9 It is also necessary to rgently improve the delivery of essential social services and to strengthen investment in basic hman capital for Bihar s long-term growth and economic well-being. There is considerable evidence to sggest that nder-investment and weak service delivery in edcation and health is detrimental to economic development. This isse is examined in depth in Chapter 5. The other basic pblic service needed for improving growth and investment in Bihar is strengthening of governance, more specifically garanteeing law and order. This fndamental role in garantee- Bihar: Towards a Development Strategy

13 ing secrity is essential for markets to fnction, commerce to take place, and bsiness contracts to be enforced. While the problems of governance occr everywhere in India and internationally, their scale in Bihar warrant mch stronger government leadership in giding convergent effort, together with civil society, to identify ways for improving law and order, as well as bringing greater transparency in the government itself. There is mch to be learnt from elsewhere in India abot efforts to improve law and order, and to redce corrption. For demonstrating pblic priority in reform efforts, and for fresh strategic thinking, an empowered committee wold be an important mechanism towards strengthening law and order, formlating policy options, examining national and international experience, and engaging commnity leaders and civil society in open pblic discssion. A final recommendation for strengthening the IC in Bihar is to ensre that the government is flly committed to creating an enabling environment for private enterprise and entreprenership. This cold start with articlation of a strategy for strengthening the IC, spporting private enterprise and economic development in the state. This reqires strong political spport for private investment. As an example, one step wold be to establish an Investment Promotion Concil, as most other states in India have done. Other means to develop investor otreach and ways to demonstrate responsiveness to investor concerns can inclde establishing a grop of experts from arond India to examine and develop Bihar s indstrial policy and investment regime with a view to pdating them, making them more investor friendly, and drawing on best practices from elsewhere in India and abroad. n 35 Notes 1 The data shold be treated catiosly: growth is seen from a very low base and has been highly irreglar, with qestions of data consistency, sggesting statistical nreliability. 2 Similarly low levels are reflected in data on the total nmber of projects (both private and pblic) that have been completed (i.e. which have started commercial prodction) from 1990 till May Unified Bihar acconted for 3.5% of the total and most of this appears to have been in Jharkhand, as data on the nmber of Indstrial Entreprener Memoranda (IEMs) sggests. Between 1990 and 2000, 78% of the vale of IEMs were for projects in Jharkhand, and since 2000 IEMs for Bihar have declined to virtally zero. 3 This section draws primarily on World Bank consltants and analysis prepared for the Planning Commission sponsored Bihar Development Report (2003). 4 Bibek Debroy and Laveesh Bhandari (2002), How are States Doing? 2002, by Indics for the Confederation of Indian Indstry. 5 Bihar s credit deposit ratio with commercial banks was 21% in 2001, as compared with UP (28%), Orissa (40%) or more developed states sch as Maharashtra (86%) and Tamil Nad (91%). (Sorce : Reserve Bank of India). 6 Statistics on IPC crimes also show that per 100,000 people Bihar is well below the national average, and less than half the rate of Delhi, Rajasthan, Kerala, Gjarat and Madhya Pradesh. Left wing extremist grops are active in Bihar, bt case mch less damage to property than most other states with active insrgencies. 7 Cooperatives have generally had a checkered history in Bihar, failing in the past nder large apex organizations that were nresponsive to base membership needs. 8 This chapter does not rigorosly examine sectoral growth strategies (e.g. indstrial priorities, torism potential, agro-processing potential, etc.), bt focses on basic pblic service priorities in strengthening the environment for growth. The Planning Commission sponsored Bihar Development Report offers more sector-specific analysis. 9 See India: Rral Access to Electricity, Soth Asia Energy and Infrastrctre Unit, The World Bank, 2003, for a discssion of rral electrification policies and experience internationally, and their relevance in the Indian context.