India is doubling down on some of the most ambitious public investments in its recent history, but are these investments alone enough to deliver long-term, sustained growth?
In the 2025-26 budget cycle, the government allocated Rs 11.21 lakh crore (US$123 bn), with an emphasis on defence manufacturing, domestic production, and large-scale infrastructure. At first glance, these signals appear encouraging. For example, the Financial Times reported that India in 2025 secured foreign direct investment of “$50.4bn from April to September, a 16 per cent increase from the same period last year and a record high”. Yet the same data show that the net figure was only 7.7 billion, meaning that although substantial foreign capital entered the economy, almost 42.7 billion flowed out through disinvestment and repatriation. This paradox of flows raises a deeper question: what determines whether these investments and development strategies translate into sustained economic growth?
In trying to diagnose whether these strategies deliver their intended outcomes, social science researchers have been increasingly resorting to analysing the role of institutions in shaping outcomes of these interventions. Much of the debate today that is centred around policy making revolves around examining the association of institutional quality, or more specifically, the quality of government, with the effectiveness of public investment. Institutions sit at the heart of today’s regional development agenda. Whether this means context-specific local development strategies or facilitating deliberations and negotiations among local actors, both formal and informal, now drive the “new paradigm” of regional development policy. The importance of institutions is further encapsulated in the fifth cohesion report of the European Union (EU), wherein it was stated that “poor institutions can, in particular, hinder the effectiveness of regional development strategies.” In this backdrop, the essay attempts to provide a strong case in favour of how institutional quality conditions the returns to development strategies, drawing on theoretical insights and evidence from EU cohesion policy.
Using a metaphor of a bicycle to describe regional economic development, Rodríguez-Pose (2013) argues that a “well-designed and functioning development strategy” requires effective alignment between the two rounded wheels. The front wheel represents a tailor-made development strategy, with the back wheel representing efficient formal and informal institutions. Such a situation would facilitate a region to steer forward in terms of development and, in the process, minimise frictions between development strategies and institutions. Potential frictions between the two wheels would translate into three worse-off scenarios. Firstly, most regional economic development strategies rest upon a grand strategy that is reflected in the front wheel while undermining the institutional back wheel, which takes a tiny shape. This leads to regional economic development operating in a “penny farthing” (early type of bicycle popular in the 1870s that had a large front wheel and much smaller rear wheel) equilibrium. Secondly, a form of mismatch between institutional setting and development strategy can also lead to a “square wheels situation” (where development efforts are forced forward using blunt, ill-fitting governance tools that prevent smooth progress and generate friction rather than momentum, much like trying to push a square wheel along a flat road) resulting from the implementation of poor development strategies under weak institutional settings. Thirdly, poor institutions and an absence of a real development strategy result in the worst possible scenario of no development, akin to a “bicycle frame”. This provides crucial insights into the relevance of ensuring that development strategies are designed to best fit into the potential of place-specific institutions, thereby enhancing returns from development interventions.
A useful illustration of this relationship comes from the EU cohesion policy. The primary objective of the cohesion policy has been “to strengthen its economic, social and territorial cohesion” and to reduce “disparities between the levels of development of the various regions”. Despite debates over its effectiveness, the central argument in favour of the policy has been that it has enhanced the profile of regional and local actors in shaping economic development. The EU has acknowledged that weaker institutions hinder economic and social cohesion, which led the EU to Draft Agenda 2000, establishing a cap cohesion investments at 4% of national GDP due to limited absorption capacity. Despite limited empirical work on governance quality and cohesion returns, Rodríguez-Pose and Garcilazo (2015), studying 169 EU regions from 1996 to 2007, find that cohesion fund investments are positively associated with regional economic growth regardless of government quality (such as rule of law, corruption, quality of bureaucracy, and so on). However, the study also shows that government quality becomes critical once spending exceeds about €80 per person per year. This, in simple economic term means that initial cohesion funds can deliver baseline gains across regions, but sustained long-term development beyond a certain financial threshold depends on institutional quality. This reaffirms that the best development strategies operating under the climate of poor institutions will inevitably fail to generate optimal returns. Therefore, devising development strategies warrants a detailed understanding of local conditions while also assessing the viability of different forms of development interventions through the lens of existing place-based institutional conditions.
In India, the consequences of weak institutions are not abstract. They show up daily in delayed contracts, frozen credit, stalled infrastructure projects, and prolonged disputes that quietly drain economic momentum. To illustrate this, let us unpack the case of the judiciary and other legal institutions, which together play a central role in enforcing contracts, sustaining law and order, and enabling collective economic accountability. There has been a heightened focus on case pendency in every level of the Judicial system in India, with the National Judicial Data Grid indicating that as of 2024, the pendency cases stands at 5 crore (50 million) with criminal cases constituting 77% of the pending cases (NJDG, 2024).A state wise breakdown indicates that states like Uttar Pradesh and West Bengal constitutes approximately 31% of the total case backlogs in the country. A north-south categorisation would furthermore suggest that northern states like Delhi, UP, Bihar, Rajasthan and Eastern states of West Bengal have consistently registered higher number of pendency in cases, which is in the range of 3 to 12 million pending cases as of 2024, as compared with the southern states which on average report an annual pendency of 700,000 to 1.8 million case pendency. A correlation of judges vacancy (per capita) and pendency cases, suggests a strong positive correlation wherein northern states have a optimistic disproportionate correlation estimate of 0.87 (statistically significant estimate) between judges vacancy and case pendency, as compared to a lower magnitude of disproportionate correlation estimate of 0.54 (statistically significant estimate) between judges vacancy and case pendency in southern states of India. This shows that, when population is accounted for, judicial vacancies disproportionately worsen backlog problems in the north, indicating that institutional capacity constraints have more severe consequences where they are already weakest. While establishing a causal link between judicial backlogs and regional economic growth requires more sophisticated analysis, the intuition is straightforward. Persistent case delays raise transaction costs, weaken contract enforcement, constrain bank lending, and slow the resolution of commercial disputes. In effect, they place a drag on the very mechanisms that public investment and market-led strategies rely upon. This points to a simple but often overlooked conclusion. Investment in institutional capacity, particularly in the administrative and legal institutions, is not merely social expenditure, but growth-enhancing intervention that can have large multiplier effects.
Mainstream economic theory, especially the neoclassical growth model following Solow’s foundational contribution in 1956 has treated institutions (such as property rights, rule of law, and impartial judiciary ) as fixed and exogenous, meaning they are unchanging throughout the analysis and are not included as a variable to growth. Over the last two decades, the emergence of New Institutional Economics, particularly since the 1990s and further advanced in the early 2000s by scholars like Acemoglu, Johnson, and Robinson (the 2024 Nobel Laureates), has moved the role of institutions from the periphery to the core of economic analysis . While a nuanced critique of Acemoglu, Johnson, and Robinson’s colonial perspective warrants a separate discussion, the broader point remains: leading economists today no longer treat institutions as passive proxies, but as core independent variables that can be studied, nurtured, and deliberately reformed to drive regional and national development. In this view, institutions such as a credible central bank, an accountable executive and legislature, and an impartial and effective judiciary are not peripheral features but foundational pillars of a country’s development trajectory. Despite a growing body of empirical work, including within India, a country with a population over three times the size of the European Union, there remain limited studies that provide a detailed picture at the subnational level (states and districts), largely due to data resolution constraints. As a result, robust evidence on how institutions interact with development strategies across states and districts leaves regional policy design an open and pressing area for further research.
What follows from this is not simply a call for more regionally targeted investment strategies, but for parallel investments in institutional capacity, research, and governance. Development strategies without institutional strengthening risk being a strategy built for failure. Returning to the bicycle metaphor, a sophisticated front wheel of development strategy cannot carry a region forward if the institutional back wheel is weak. Without balance, the bicycle wobbles, stalls, or collapses altogether. Seen this way, India’s market-led growth has relied too heavily on the invisible hand of markets while neglecting the visible hand that steadies and steers it. A strong, visible hand of institutions is not a constraint on markets, but the condition that allows them to function. Without a robust back wheel, the promise of forward motion remains fragile, reminding us that even Adam Smith’s invisible hand needs a firm institutional grip to keep the bicycle upright and moving.
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