Have you ever wondered why eastern Indian states namely West Bengal, Bihar, Jharkhand and Odisha, which are rich in natural resources, are so backward industrially? While the underlying causes are many, in this article we will consider the role of the disastrous freight equalisation policy (FEP) in crippling the states. The FEP, introduced in 1952, was aimed at promoting equitable industrial development by subsidising long-distance freight transportation. Unfortunately, it ended up increasing income inequality and poverty in the eastern region instead.
It may be worth noting that FEP applied only to certain commodities such as iron, steel, cement, which were deemed essential for the economy but did not apply to raw materials like cotton. Hence, the states such as Maharashtra and Gujarat, which benefited from the FEP, also maintained their hegemony of raw materials such as cotton. While the manufacturing industries started moving west and south, eastern India didn’t get an opportunity to set up cotton and textile mills as cotton was not subsidised under this scheme.
This economic imbalance was initially raised by politicians and even admitted by former President and Finance Minister Pranab Mukherjee as one of the leading causes of the economic slowdown in eastern India. Mukherjee was quoted as saying, “So, despite having mineral resources and fertile land, Bihar, and now Jharkhand, too, could not make the desired progress” as a part of his inaugural address at Bihar and Jharkhand: Shared History to Shared Vision in March of 2017. Upon careful examination by economists, most of these allegations were found to be true and were backed with data, thus eventually prompting the central government to shelve this policy in 2001.
Rationale behind FEP
The thought process behind the FEP was that every state in India should have the same access to resources for manufacturing primarily iron and steel without having to pay extra money in transportation. Somehow the competitive advantage that eastern India possessed was viewed as unfair. In the heydays of Nehruvian socialism, redistribution of wealth and resources may have seemed like a good idea for the Planning Commission after its inception in 1950. The states of West Bengal and Bihar (including the part that is now Jharkhand) in 1950 accounted for 92% of the country’s steel production and 48% of all manufacturing John Firth and Ernest Liu’s Manufacturing Underdevelopment: India’s Freight Equalization Scheme, and the Long-run Effects of Distortions on the Geography of Production North East Universities Development Consortium (NEUDC) 2018. The states were rich also in coal and other natural resources. At that point in time, only two integrated steel plants (ISP) existed in India: one at Jamshedpur, Bihar, and the other at Burnpur, West Bengal. Nehru, who was influenced by Fabian Socialism, was a firm believer in industrial expansion under the central administration. He commissioned more steel plants to be set up at Rourkela in Odisha, Bhilai in Madhya Pradesh, Bokaro Steel City in Bihar and Durgapur in West Bengal.
However, the Planning Commission decided also to provide subsidies on freight transportation to industries anywhere in India, thus negating the advantage a manufacturing industry would have if they were located closer to the steel plant. The Second Five Year Plan made this goal explicit in 1956 by stating “Only by securing a balanced and coordinated development of the industrial and the agricultural economy in each region, can the entire country attain higher standards of living” John Firth and Ernest Liu’s Manufacturing Underdevelopment: India’s Freight Equalization Scheme, and the Long-run Effects of Distortions on the Geography of Production North East Universities Development Consortium (NEUDC) 2018.
Manufacturing companies prefer to minimise their transportation costs. Hence, those who use iron and steel to manufacture goods are typically located around the steel plant, thus leading to an industrial boom, a practice that has been the norm since the days of the Industrial Revolution. Following the implementation of the FEP, the decision to set up a factory was primarily influenced by the price of the land, availability of cheap labour and other benefits offered by the state government as transportation costs were no longer a factor.
Defenders of the FEP have argued that the subsidies were relatively small, but the data shows that such small amounts were enough for the industries to move away from eastern India to other parts of the country. Regions like western India and southern India flourished as manufacturing hubs at the expense of eastern India. In addition to steel, the government equalised the costs of shipping cement and fertilisers, arguing their importance for agriculture. This policy would have been perfect had it applied to all goods and resources.
Now, it is quite obvious that nature will not bless every part of a country with the same natural resources. However, the skill, knowledge and entrepreneurial spirit required to set up a modern manufacturing unit would remain constant. Hence, it is against the very nature of competition and a free and fair market to deliberately cause an artificial economic disadvantage to a region already blessed with an advantage. Hypothetically, an industrialist could choose to move out of West Bengal to Gujarat if he found cheaper labour and subsidised land to set up a wind turbine manufacturing plant. At the same time, an industrialist in the textile sector could not move out of Maharashtra and set up a cotton mill in Bihar as the cost of cotton would remain the cheapest in Maharashtra, since cotton was not covered under FEP. Thus, despite being blessed with natural resources, economically the eastern states went backwards, as was the case with Bihar and West Bengal, or did not benefit from them as was the case with Odisha.
Economists have described this phenomenon as “the resource curse” or the “paradox of plenty”John Firth and Ernest Liu’s Manufacturing Underdevelopment: India’s Freight Equalization Scheme, and the Long-run Effects of Distortions on the Geography of Production North East Universities Development Consortium (NEUDC) 2018. According to this theory, societies blessed with natural resources tend to have poorer development parameters and less democratic societies marred with violence and human conflict. While there are many factors that contribute to human conflict in India, controlling of resources is a major one. Such a situation can be observed also in eastern India, especially in Bihar and Bengal, which became playing fields of authoritarian regimes and increased violent crimes despite being resource-rich.
Case study: Steel industry
Though the FEP scheme was applicable for a number of industries, manufacturing industries in India used very little of these materials when compared to the iron and steel industry. Hence, the FEP had little to almost no effect in this sector. The iron and steel industry formed the backbone of manufacturing in India. As mentioned earlier, in 1954, it was decided that the future production of steel was to be controlled by the Union government under Hindustan Steel Limited (HSL). HSL was commissioned to set up new steel plants (Rourkela, Bhilai, Bokaro, and Durgapur). Tata and IISCO (formerly Steel Corporation of Bengal) were privately owned, with IISCO later becoming a public sector undertaking in 1972. If we take a closer look at the supply chain of the iron and steel industry, the primary raw material for steel production is iron ore, which is available only in a handful of locations. The ISPs would then convert the iron-ore to pig iron, structural steels, plates and coils. Hence, once the location of ISPs was fixed, there would be no changes to the first part of the supply chain — that is the conversion of iron ore to steel and wrought iron products.
The users of these products can broadly be classified into two categories (a) Those who make customised refined steel and alloy products as per specifications, for example, in car axles and (b) users of these specialised products such as the auto industry.
Had there been no FEP, the industries mentioned in the categories above would prefer to be located as close to the ISPs as possible to minimise their costs. In fact, the greatest subsidy would be the location as provided by nature! The Union government calculated what was termed as “factory retention price”, which depended on the transportation distance and the type of steel. An equalisation fund was set up that would calculate the difference between the factory retention price and the price of steel paid for short distances and it paid out the difference in transportation price as credits (for manufacturing units located at longer distances)Sanjay Ruparelia; Sanjay Reddy; Dr John Harriss (9 March 2011). Understanding India’s New Political Economy. Taylor & Francis. p. 68. ISBN 978-1-136-81649-9.
A joint plant committee was established specifically for the purpose of regulating these prices. Hence, any natural geographical competitive edge was successfully negated using government-controlled artificial means. Since FEP provided a uniform shipping rate, the location was no longer a consideration in the selection of setting up of a new plant and, if incentivised, older plants would move to places with better labour and land prices.
Eventual withdrawal: Damage was done
It should be noted that during this period of loss in business and earnings of the state governments of Bengal and Bihar, they were not adequately compensated by the centre. The Union government continued to defend its policy with an inter-ministerial report in 1977 suggesting the subsidies received were only a small fraction of the final price. However, the downward trend in manufacturing continued defying any assertion made by the Centre. Eventually, in 1991, the National Development Council fixed a ceiling for the subsidies, depending on the distance. The ceiling was rather high; so, the drain on the national exchequer continued till the policy was turned defunct in 2001, thus admitting its failure. When the policy was on its last days, Somnath Chatterjee, former Lok Sabha speaker and the then in charge of the West Bengal Industrial Development Corporation lamented in 1996, said, “The removal of the freight equalisation and licensing policies cannot compensate for the ill that has already been done” Aseema Sinha’s The Regional Roots Of Developmental Politics In India: A Divided Leviathan (2005); Indiana University Press. pp. 114–. ISBN 978-0-253-34404-5.
Since then, irrespective of political affiliations and despite demands of its restoration by various lobbies, the Centre has refused to bring back this policy. Distributing wealth by artificial means almost never works in the long run; the failure of FEP proves the same. Governments should respect the natural resources that a state has been endowed with and channel the same to productive uses. Short-term thinking and attempts to redistribute resources drain the exchequer and ruin economies.
|↑1, ↑2, ↑3, ↑4||John Firth and Ernest Liu’s Manufacturing Underdevelopment: India’s Freight Equalization Scheme, and the Long-run Effects of Distortions on the Geography of Production North East Universities Development Consortium (NEUDC) 2018|
|↑5||Sanjay Ruparelia; Sanjay Reddy; Dr John Harriss (9 March 2011). Understanding India’s New Political Economy. Taylor & Francis. p. 68. ISBN 978-1-136-81649-9|
|↑6||Aseema Sinha’s The Regional Roots Of Developmental Politics In India: A Divided Leviathan (2005); Indiana University Press. pp. 114–. ISBN 978-0-253-34404-5|