Sources of divergence in income in Indian states, 2001–2015

Abstract

Motivation: Empirical studies on income convergence for India indicate that Indian states exhibit divergence in income. The literature, however, has neglected the convergence dynamics of the main sources of output. A pertinent question is whether divergence in income is due to divergence in factor inputs (capital and labour) and/or in total factor productivity (TFP) in India, a low middle-income country with high dispersion of per capita income across its states. Purpose: This article examines the sources of income divergence in Indian states by analysing convergence in TFP, labour, and capital. Methods and approach: We test for stochastic convergence hypothesis by employing state-level data for 19 Indian states during the period 2001–2015. Given the small sample dimension of the Indian state-level income data, we benefit from the recent developments in non-stationary panel data literature; and conduct novel panel stationarity and unit root tests with a fixed time dimension. We further carry out a robustness analysis to account for cross-section dependency across the states. Findings: TFP as well as the factor inputs (labour and capital) exhibit divergence, implying persistence in income inequality across Indian states. Divergence in labour across the states reflects the fact that migration is primarily an intra-district phenomenon. Poor investment climate in low-income states acts as a barrier for convergence in capital. TFP and capital stock are found to be correlated, and thereby lower investment in poorer states may be responsible for divergence in TFP across the states. Policy implications: Migration in India is primarily an intra-district phenomenon. There is a need to study the reasons which are discouraging inter-district and inter-state migration for better utilization of the labour resource. Government intervention has not been adequate to improve the infrastructure position and encourage capital inflows to low-income states. Low-income states should improve their business climate and create support infrastructure to earn the confidence of investors. Increasing investment in low-income states would help to increase their TFP and catch up with the high-income states. © 2021 Overseas Development Institute.