Decentralisation and Competitive Federalism: A Pathway to Economic Resurgence
India’s federalism debate has long revolved around the tug-of-war between cooperative and competitive models. Competitive federalism, when executed effectively, fosters innovation, efficiency, and growth. However, its pitfalls—such as reckless bidding wars among states—often lead to a race to the bottom. Meanwhile, China’s growth model demonstrates a counterintuitive reality: despite being a one-party authoritarian state, it is far more decentralised than India. This decentralisation has been a key driver of China’s economic success, allowing cities to experiment, innovate, and compete globally.
By learning from China’s decentralised ecosystem, India can address the limitations of competitive federalism and build a governance structure that empowers its states and cities to drive economic progress.
The Strengths and Pitfalls of Competitive Federalism
Competitive federalism is designed to encourage states to compete for investment, talent, and economic growth by implementing policies that attract businesses and improve governance. Empirical research highlights four key benefits of the concept; firstly it significantly enhances economic efficiency by empowering states to tailor policies specific to their local needs and conditions. When states have greater autonomy, they can implement targeted initiatives that directly address their unique economic challenges, leading to more efficient resource allocation. This approach attracts increased investments, boosts economic growth, and generates employment opportunities, as policies become finely tuned to local industries and workforce demands, thereby maximising overall productivity and reducing inefficiencies that often result from generalised, centrally-imposed solutions.
Secondly, competitive federalism fosters innovation and policy reforms among states, as each strives to develop and test new governance models, regulatory frameworks, and public service delivery systems to stay ahead of their peers. This competitive dynamic encourages states to become laboratories of policy innovation, experimenting with approaches that can streamline bureaucratic processes, reduce regulatory hurdles, and promote transparency. Consequently, successful reforms from one state can serve as benchmarks or inspirations for others, leading to a widespread improvement in administrative practices and enhancing national competitiveness as a whole.
Thirdly, in the realm of fiscal management, competitive federalism incentivises states to maintain strict fiscal discipline. Since investor confidence and economic stability are crucial to attracting private capital, states face pressure to manage their finances responsibly, reduce unnecessary expenditures, and maintain balanced budgets. Adhering to prudent financial policies enhances the credibility and creditworthiness of states, reassuring both domestic and foreign investors that their investments will remain safe and profitable, thus contributing to a stable economic environment conducive to sustained development.
Finally, competitive federalism significantly contributes to improved service quality across states, particularly in critical areas such as infrastructure, education, and healthcare. Competition among states to attract talent, investments, and residents motivates governments to invest proactively in high-quality public infrastructure, better educational institutions, and advanced healthcare facilities. This competition ensures continual improvement and innovation in public services, directly benefiting residents who experience enhanced quality of life, increased employability, and greater opportunities for socioeconomic advancement.
However, India’s competitive federalism often turns into a zero-sum game, where states undercut each other with subsidies, tax breaks, and regulatory relaxations without long-term planning. The case of Gujarat and Maharashtra engaging in a tax war for auto manufacturers in the early 2000s exemplifies this. Moreover, political incentives often prioritise short-term gains over sustainable development.
Decentralisation: Learning from China’s Model
China’s rapid economic rise is often attributed to central policymaking. However, a closer analysis reveals that much of its success stems from decentralised governance. Unlike India, where city governments account for less than 3% of total government spending, China allocates 51% of government spending at sub-provincial levels. This allows local governments to tailor policies to their unique economic conditions.
China’s decentralised governance model has several key features that have been instrumental in driving its rapid economic growth and global competitiveness. Fiscal autonomy stands out prominently, as seen in Shanghai’s municipal government launching a substantial $1.4 billion investment fund in 2024 specifically designed to nurture cutting-edge sectors such as artificial intelligence, biotechnology, and semiconductors. This financial independence contrasts sharply with Indian metropolitan cities, which largely remain dependent on central grants, limiting their flexibility and responsiveness to local economic priorities.
Another defining feature is the strong emphasis on institutional competition among local leaders through China’s unique “appointocracy” system, introduced during Deng Xiaoping’s era. Under this framework, local officials competed directly for career advancement, with promotions explicitly tied to their ability to deliver measurable economic results. This fostered a culture of proactive governance, incentivizing local officials to continually strive for higher economic performance and innovation.
Moreover, China’s decentralised structure encourages cities to implement targeted, sector-specific policies tailored precisely to local strengths and global ambitions. For example, Chongqing has established a dedicated foreign affairs office focusing exclusively on economic diplomacy, effectively leveraging international relationships to attract investment and trade. Similarly, Shanghai directly owns and guides major corporations such as SAIC Motor Corporation and Semiconductor Manufacturing International Corporation (SMIC), strategically steering them towards global competitiveness through direct municipal oversight and support.
Lastly, China’s decentralisation model allows substantial scope for policy experimentation and flexibility at the city level. Cities have actively tested various governance and economic models, such as the promotion of Township and Village Enterprises (TVEs) in some regions and the establishment of Special Economic Zones (SEZs) in others. This policy flexibility has enabled rapid identification of successful strategies, scaling them effectively nationwide, thus significantly contributing to China’s extraordinary economic transformation and resilience.
India’s Urban Governance Deficit
Despite urban areas contributing significantly—around 60%—to India’s GDP, municipal revenues remain remarkably low at merely 0.4% of the national GDP, as highlighted by RBI data from 2025. In states such as Tamil Nadu, municipal tax revenue constitutes just 1.8% of the total state tax collections. Even Maharashtra, which is regarded as India’s most decentralised large state, sees municipal revenue accounting for only 10% of state-level tax collections. This severe over-centralisation significantly hampers cities’ ability to compete effectively on a global scale, limiting their fiscal autonomy and strategic responsiveness. To counteract this, India urgently needs to recalibrate its decentralisation strategy by empowering city governments with direct taxation powers, thereby reducing their excessive reliance on state governments. Additionally, substantial investment is required in building local governance capacity, including the establishment of independent regulatory bodies for urban planning modelled after China’s National Development and Reform Commission (NDRC). Furthermore, sector-specific city strategies must be encouraged, enabling metropolitan cities like Bengaluru and Hyderabad to set up dedicated industry-focused investment funds, similar to Shanghai’s recent initiative—a $1.4 billion municipal fund launched in 2024 aimed at nurturing strategic industries such as artificial intelligence, biotechnology, and semiconductors. This targeted approach would greatly enhance India’s cities’ ability to develop specialized expertise, thereby boosting their global economic competitiveness.
A Hybrid Approach for India: Competitive Federalism with Decentralisation – A robust policy framework that thoughtfully combines competitive federalism with decentralised decision-making holds immense potential to accelerate India’s economic growth. Among the critical initiatives to achieve this is the Investment Friendliness Index of States (IFI), introduced in Budget 2025, which aims to provide measurable benchmarks for assessing state competitiveness. The success of IFI, however, depends crucially on aligning state-level incentives with overarching national economic priorities. Complementing this is the National Manufacturing Mission, strategically designed to institutionalise sector-specific expertise within states, reflecting the successful city-driven industrial strategies employed by China. Another significant initiative is the Decentralised Digital Infrastructure Initiative, which promotes greater autonomy for cities and states to develop their own smart city projects, data centres, and digital governance frameworks. Such localised autonomy encourages innovation tailored specifically to regional economic strengths, similar to Estonia’s acclaimed decentralised e-Governance model, Barcelona’s Smart City Model—characterised by neighbourhood-level urban planning and data-driven public services—and China’s city-led tech strategies, exemplified by Shenzhen and Hangzhou independently advancing digital innovations in AI, 5G, and governance. Additionally, facilitating robust PPP Project Pipelines for Cities encourages private-sector involvement in urban infrastructure, thus reducing the fiscal burdens on state and central governments.
Ultimately, India must acknowledge that its economic competition is not merely with China at a national level but directly with highly competitive Chinese cities. If Shanghai can articulate its economic priorities and strategic vision up to 2035, cities like Mumbai, Bengaluru, or Hyderabad should similarly adopt long-term strategic planning and execution. Importantly, decentralisation does not imply weakening the union government; instead, it advocates the creation of a powerful, bottom-up growth engine that harmonises national and state interests while enabling urban centres the autonomy required for localised innovation. By embracing this decentralised model—learning from China’s successes while preserving the distinctive strengths of competitive federalism—India can effectively unlock its true economic potential.
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https://www.degruyter.com/document/doi/10.7591/9781501705854/html