Using the Rajan index to fix allocations will distort states' incentives

During the course of his maiden speech as RBI governor, Raghuram Rajan mentioned that he was not seeking Facebook "likes". He actually received quite a few. The RBI's mid-term policy review on September 20 must have given his admirers much heartburn and possibly earned him some "dislikes". The spotlight has turned on him again, with the release of the Rajan committee report on evolving a composite development index of states. If he has a Facebook page, it must be full of either angry or sarcastic comments. Only a handful of people like Nitish Kumar, whose demand for the backward status tag for Bihar is now going to be conceded, or staunch opponents of Narendra Modi, who are delighted that the committee has declared that Gujarat is not highly developed, are happy with the report. All others find a plethora of defects in it.

The general sense of dissatisfaction felt by a majority about the Rajan committee's index of backwardness is not surprising at all. If ten people are asked to define a "backward" state, they are very likely to give ten quite different definitions. This is because it is impossible to be very precise about what we mean by backwardness. Any attempt to make an imprecise or inexact concept too precise must inevitably invite criticism, because there cannot be any unique way of doing so. One can even argue that exercises of this kind are actually quite harmful when they have important policy implications. Unfortunately, this committee's report may well play a significant role in the future, by influencing Centre-state resource transfers.

The first attempt to define some notion of backwardness in India was pretty straightforward. Three states (Assam, Jammu and Kashmir and Nagaland) were put in a "special category" under the Gadgil formula in 1969. The list soon expanded to contain 11 states. A common feature of these states was that they were all handicapped by adverse geographical characteristics such as hilly terrain or locations far away from large population centres. These features increased the cost of delivering public services. Moreover, these states were less than ideal locations for entrepreneurs, both because of poor infrastructural facilities as well as large distances from major sources of demand.

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