Economic Survey 2025-26 has done well to stir up a debate on state capacity: Here’s what it misses

In an international environment marked by geopolitical fragmentation and contested trade regimes, the ability of the state to act coherently, credibly and predictably has become a binding constraint on development.

It emphasizes implementation, institutional incentives, regulatory credibility, organisational design and the ability to learn under uncertainty.

Its discussion of bureaucratic risk aversion, hysteresis, retrospective scrutiny and distinction between good-faith error and malfeasance reflects a sophisticated understanding of why states fail—not because of bad policies, but because of how decisions are processed and used as punishment.

The emphasis on deregulation and compliance reduction as instruments of capacity-building is particularly valuable. Yet precisely because the survey raises the right question, it invites a sharper interrogation of how comprehensively it answers it.

A useful benchmark as the canonical definition of state capacity could be that it is the sustained ability of the state to raise resources, make and enforce credible rules and implement collective decisions through information-rich administrative systems—at scale, across territory and over time—while retaining the ability to adapt under uncertainty without losing legitimacy or control.

Read against this definition, the survey offers a sophisticated but uneven diagnosis. It captures higher-order dimensions of capacity with clarity, but underweighs the foundational components that make capacity observable, binding and scalable in practice.

One way to see this imbalance is through a tiered view of the state. The federal system operates at three levels. Regulatory and administrative capacity tends to decline as one moves down this hierarchy, even as citizen interaction with the state increases.

The survey is strongest at the top tier. Its analysis of regulatory design, central coordination, accountability architecture and the functioning of national regulators is detailed and analytically sound.

It also engages, to a degree, with state-level reform through discussions of deregulation, federal coordination and best practices. Earlier chapters do touch on municipal finance and service delivery.

However, the chapter on state capacity remains primarily oriented toward the Union and higher-capacity state institutions. Local governments, where citizens and firms most frequently encounter the state, appear largely as background actors rather than as the central sites of capacity failure.

This is a significant omission. Property taxation, building permissions, water and sanitation, street-level enforcement, local environmental regulation and grievance redress are precisely where regulatory discretion is most personalised, enforcement most uneven and legitimacy most fragile.

There are a few other areas where the survey’s ideas on state capacity could have further been fleshed out.

First, the survey devotes substantial attention to incentives, organisational design and behaviour, but fiscal capacity does not serve as an organising pillar. States that tax effectively build administrative systems, information infrastructure and enforcement capability as a by-product.

Weak capacity at local levels in India is inseparable from narrow tax bases, poor property taxation and limited own-source revenues.

Second, the survey places strong emphasis on entrepreneurial governance, reversibility and learning under uncertainty. In Mariana Mazzucato’s framework, ‘state entrepreneurship’ addresses mission-led innovation under deep uncertainty. India’s binding constraints are more mundane: contract enforcement, land and municipal systems, regulatory churn and personnel management. These are failures of predictability, not experimentation.

What India lacks are not only safe spaces for innovation, but boring forms of regular state capacity: stable rules, consistent enforcement and credible adjudication. The survey has alluded to it.

While entrepreneurial governance is valuable (and much needed) at the frontier, without mundane administrative reliability, it risks becoming a substitute narrative rather than a solution.

Third, the survey increasingly frames legitimacy as arising from citizen behaviour—delayed gratification, civic discipline and voluntary compliance—thereby treating norms as causal inputs of state capacity.

Much of institutional theory, however, posits the opposite causal direction. Predictable rules, credible enforcement and fair adjudication generate compliance by making it rational rather than virtuous. In this view, legitimacy is not a moral precondition of effective institutions, but their cumulative by-product.

Finally, the survey strongly advocates tolerance for failure, institutional forgiveness and adaptation under uncertainty as general virtues of an entrepreneurial state. This is theoretically valid but institutionally conditional.

Forgiveness is not a starting point but an outcome of strong enforcement, legal clarity and political legitimacy. High-capacity states can afford to forgive because rules are predictable and sanctions credible. Where these foundations are weak, tolerance risks sliding into permissiveness, blurring the line between learning and arbitrariness.

That said, this is among the Economic Survey’s most serious and valuable chapters. The chief economic advisor and his team have done something that is too often neglected in India’s reform debates, reminding us that policy design is meaningless without institutional ability.

The author writes on macroeconomic and geopolitical issues.