An economic view of state splits

Most commentators prefer to couch the Andhra Pradesh split in emotive terms – the people of Telangana thought they were being treated in an inferior manner by the people of Andhra, and hence wanted to break away to form a separate state, and that the people of the Rest-of-Andhra (RoA) did not want the split because of reasons of Telugu pride. This is wrong, and over-complicates the issue.

Insight: When something can be explained with simple economic reasoning, looking for other (emotional/psychological/social/…) reasons is futile.

Telangana is the region of Andhra Pradesh that had been part of the Hyderabad state (RoA was part of the Madras Presidency). Due to differing standards of governance in the “Provinces” and the “Princely States”, at the time of independence, Telangana was backward compared to RoA. It didn’t help matters that Telangana was at the receiving end of brutality by the Nizam’s Razakars during the year or so when Hyderabad state was not yet part of India.

Given the vastly differing levels of development in Telangana and RoA, and the differing cultural backgrounds, I’m not sure it made economic sense to unite them in the 1950s. Potti Sriramulu’s fast and subsequent death, however, turned the issue emotive, and there was no room for rational reasoning. And a united Andhra Pradesh was created in 1956. In any case, it was consistent with the mantra of the day to have linguistic states – administrative unwieldiness be damned.

Unless there is a concerted effort, in the natural order of things, when you have a rich part  and a poor part of a particular state or country, the rich part can be expected to grow faster than the poor part – no malice here, it is simple network effects. Andhra Pradesh was no exception to this rule, and soon Telangana was much more backward than RoA.

The state splits in 2000 when Uttarakhand, Jharkhand and Chhattisgarh were formed shows that richer parts of states usually don’t mind letting go of the poorer parts. This is especially true if there is a feeling that taxes collected predominantly from the richer parts are being used to disproportionately fund the poorer parts. There might be some emotional attachment, but economics usually rules. Then, why is it that there is so much opposition to hiving off the poorer parts of Andhra Pradesh?

Andhra Pradesh has this unique situation where the capital city (and by far the biggest city) Hyderabad is located in the poorer portion. Hyderabad being the capital city saw significant investments from people from all over Andhra Pradesh, including RoA. A significant portion of RoA investment in Hyderabad is in real estate. Now, with real estate regulation being a state subject, people normally don’t want to hold too much real estate investment outside of their home states – since they will have no control over the politics of those states. So RoA investors are freaking out that their long-term investments in Hyderabad will soon be in a different state.

In a situation such as this, prudent investors might want to pull out (rather than risk their capital in a neighbouring, and possibly hostile, state). However, the problem is that none of the investors want to set off a downward price spiral in Hyderabad. Think of the situation as one where investors from RoA are invested, but know other investors are wanting to pull out any time. But you don’t want to start the process of pulling out, since that can reduce the value of your other holdings. So you stay invested. And hope that the bubble will never burst.

The attempt by people of RoA to hold on to Telangana (Hyderabad, specifically, they don’t really care about the rest of Telangana), is an attempt to save their capital locked up in investments in Hyderabad. If Andhra Pradesh doesn’t split, nobody from RoA will want to pull out their capital from Hyderabad, and the drop in value won’t happen.

It must be pointed out here that the Congress Party’s solution of having Hyderabad as a joint capital for a number of years is unlikely to be much compensation, if Telangana holds jurisdiction over Hyderabad territory anyway. The capital of RoA investors in Hyderabad will still be under risk in that case. The other option proposed was to make Hyderabad a Union Territory,  but that wouldn’t help either – since the influence of RoA in the politics of Hyderabad would still be minuscule.

To summarize, the reason RoA doesn’t want to let go of Telangana is because they don’t want to lose political control over their own investments – in the city of Hyderabad. Issues such as “state pride” and “Telugu pride” are secondary – they have been drummed up just to get the support of the non-elite who may not be economically affected by the state division. In fact, if Telugu pride were so important why in the first place would the Gults of Telangana want a separate state?

From a policy standpoint, it is important to not let the discourse of language pride get into the way of forming smaller states. The only reasons that should matter should be economics and administrative efficiency.


Trying to understand the Telangana situation

Let me state at the outset that this is a dispassionate outsider’s perspective. It’s also rather abstract – I don’t really care about the emotional factor behind the split or the non-split, or how Andhra Pradesh came into being. All that, in my opinion, is secondary.

So the basic issue is this. There is the state of Andhra Pradesh. One part of the state (a minority) thinks it will be better off being a separate state. So for years now they have been clamouring for a separate state. The rest of the state doesn’t want to let them go. And so we have a deadlock.

Let us go back to 2000, when three new states were created in India, breaking up Uttar Pradesh, Madhya Pradesh and Bihar. Those three states also had long-standing demands for separation. All those states had seen “movements” to that effect. The emotional factor was high. The key point, however, is that in each of those states, the rest of the state willingly let go of the breakaway part. Each of the three assemblies passed resolutions recommending the breakaway states. So finally when those states were created the process was rather peaceful and amicable.

That is not happening in Andhra. The Rest-of-Andhra is unwilling to let go of Telangana. Politicians across parties think a breakaway Telangana is a bad idea. The Andhra Pradesh assembly is unlikely to pass a resolution recommending the split any time in the near future. Right now the central government is trying to bulldoze the split and we are seeing the chaos that we are. The question is how we can do this better.

What helped the formation of Uttarakhand, Jharkhand and Chhattisgarh is that their geography is very different from that of their parent states. More importantly, these three states have the kind of geography that makes it hard to govern them. Hilly or forested tracts, with slow transportation and underdeveloped roads meant that administering these areas was costly. Essentially if you did a cost-benefit analysis it made sense to let go of these states – it made the job of the original state government administratively easier.

The problem with the Andhra split is that the capital city Hyderabad lies in smack in the middle of the region that wants to breakaway. People from Rest-of-Andhra have invested heavily in the city, and fear for their investments in case it becomes part of a separate state. It doesn’t help matters that people from Telangana and from the Rest-of-Andhra don’t particularly trust each other. The former claim that the latter have been persecuting them, and the latter fear the same in case the former get their own state. Events over the last few months have only made this trust deficit significantly worse.

What needs to happen is that Telangana needs to assure the Rest-of-Andhra that the people in the latter won’t lose out due to the state split. One way to do this is to sweeten the deal in terms of Hyderabad. One option that had come up would have made Hyderabad a union territory, thus putting it outside the control of Telangana. Another would be for Rest-of-Andhra to be assured of an annual payment based on the state taxes raised from Hyderabad city. This, however, is unlikely to work given the lack of mutual trust.

There is a third option – which is what is being played out now. Telangana acts as a tough guy, and a bully. One who will bully its way into getting its own state. The way this is probably going to work is that by continuously rioting in Hyderabad, it will force businesses to leave the city. As things get worse, the economic value of the city of Hyderabad fall so much that Rest-of-Andhra see no value in holding on to it and vote for the resolution to split the state. Of course, this is not good for anyone since this involves value destruction, but this seems the way things are headed right now.

What might also work (destructive, but not as much as the above) is for Rest-of-Andhra to get a strong message that the state is going to be split sometime in the near future and they have no say in it (this is probably the Central Government’s message currently). Currently, people from Rest-of-Andhra are hopeful that the split won’t happen and are thus holding on to their investments in Hyderabad. As there is more conviction that the state is going to split, they will start slowly withdrawing their investments, so that at  some point in the near future, there will be enough politicians from Rest-of-Andhra that will vote in favour of the split in the state.

Note that not all legislators from Rest-of-Andhra need to support the state split. Telangana contains 119 out of the 294 seats in the Andhra Assembly. Assuming that there is bipartisan support for the split among Telangana MLAs, they need the support of only 29 more legislators to have their way. Of course there is the Anti-Defection Law and all that, but this is some food for thought.

Lastly, I don’t think the current process of the Union Government bulldozing the state split is going to work out in the long term. You don’t want to have neighbouring states that mistrust each other. Yes, Andhra Pradesh is a vast state and might be tough to administer. But no decision on its split should be taken without the resolution by its own assembly.

The Problem with Smaller States

I’m a fan of smaller states. I think our states are currently way too large and we could do with more states since that could lead to greater administrative efficiency and federalism. So yes, I’m fully in support of the Telangana movement – only because I think AP is too huge and unwieldy a state (42 parliamentary constituencies) to be managed from one place.

I have one concern, however. I was thinking of the case of Karnataka and the possible demand by areas of North Karnataka for a separate state. While I support this demand (Karnataka again I think is too huge and unwieldy to be managed from Bangalore which is in a corner of the state) I was suddenly worried about power supply.

From what I last remember, Karnataka’s biggest source of power is the Raichur Thermal Power Station in Shaktinagar. Assuming that it breaks away from “Mysore” as part of a new “north Karnataka” state, what will happen to the energy security of Mysore (the smaller southern portion)? I guess there might be some agreements and long term power supply contracts put in place, yet the loss of this massive captive power source would significantly hurt Mysore.

My concern is that if the demand for a separate North Karnataka grows, the government of undivided Karnataka would be loathe to invest much in any area that may fall under a part of the state that wants to “break away”. And this could lead to concentration of investment in areas that are close to the seat of power, and further skew the development of different parts of the state. Power supply is just one example that I took here – it could be any other massive government investment – say SEZs or large industrial plants and so forth.

There is another issue with smaller states but I think this is a problem for which a solution has been found and is under implementation. The problem with having too many states is that we will end up with too many inter-state boundaries and thus too many “checkposts”. However, the proposed Goods and Service Tax regime (if/when it were to get implemented) will ensure that India would become a common market and inter-state commerce would become more seamless. Nevertheless it is important to get the GST regime in place before we get too many more new states – for it also means less stakeholders to deal with!