Following is the Summary of ECONOMIC SURVEY 2016-17 – Chapter 11 – One Economic India: For Goods and in the Eyes of the Constitution
On the basis of a new “Big Data” set available from the Goods and Service Tax Network (GSTN- invoice level data on interstate movement of goods), it seems (Contrary to perception) that India is highly integrated internally, with considerable flows of both people and goods.
The headline findings are:
- The first-ever estimates for interstate trade flows indicate that cross-border exchanges between and within firms amount to at least 54 per cent of GDP, implying that interstate trade is 1.7 times larger than international trade.
- A potentially exciting finding for which we have tentative not conclusive evidence is that while political borders impede the flow of people, language (Hindi specifically) does not seem to be a demonstrable barrier to the flow of goods.
- On trade as a per cent of GSDP, smaller states like Uttarakhand, Himachal Pradesh and Goa trade more; the net exporters are the manufacturing powerhouses of Tamil Nadu and Gujarat but otherwise agricultural Haryana and Uttar Pradesh are also powerhouses because of Gurugram and NOIDA, respectively which have become part of the great Delhi urban agglomeration.
- The costs of moving are about twice as great for people as they are for goods.
There is a potential dampener on our finding that trade in goods is high within India. This may be a consequence of the current system of indirect taxes which perversely favours interstate trade over intra-state trade.
Does India Trade More Than Other Countries?
- India’s aggregate interstate trade (54 per cent of GDP) is not as high as that of the United States (78 per cent of GDP) or China (74 per cent of GDP) but substantially greater than provincial trade within Canada and greater than trade between Europe Union (EU) countries.
- This is all the more striking given that the data here covers mainly manufactured goods, excludes agricultural products, and is therefore an underestimate of total internal trade in goods.
- India’s internal trade is about 1.7 times its international trade of 32 per cent of GDP. China- 1.6 times and US- 2.5 times.
- The intuition from standard gravity models of trade is that large countries trade more within their own borders than beyond them because of the size of their domestic markets.
Patterns of Interstate Trade: Arms-Length Trade
Openness to Interstate Trade (Exports + Imports)
- The most open states by this measure are Uttarakhand, Goa, Himachal Pradesh and Gujarat with Assam, Bihar and Uttar Pradesh bringing up the rear.
- High GSDP states such as Maharashtra and Tamil Nadu are conspicuous in their absence from the top of the list – though their trade to GSDP ratio is still substantial at 33 per cent and 24 per cent, respectively.
- This is the first of many indications that while India’s borders seem porous, this might be because of its complex regulations rather than inspite of it.
- Himachal Pradesh and Uttarakhand’s, exceptional trade volumes might be explained by the exemption from central excise tax for manufacturing in these states.
- The outliers on the under-performing side are Assam (5.3 per cent), Bihar (9.9 per cent) and Kerala (17.9 per cent), who have much lower trade openness than what their size would predict.
- It is because these states have small manufacturing share in their GSDP. The other possibility is the exclusion of north-eastern states that may be important trading partners for Assam and Bihar.
Balance of Interstate Trade: Net exporters and net importers
- If the sum of exports and imports measures how open a jurisdiction is, the balance of trade is a useful, if imperfect, measure of that jurisdiction’s manufacturing competitiveness.
- The large manufacturing states – Gujarat, Maharashtra and Tamil Nadu have a positive balance of trade highlighting their competitive manufacturing capabilities. This positive balance is also a feature of Delhi (7.4 per cent), Haryana (26.1 per cent) and UP (4.2 per cent).
- Uttarakhand, Himachal Pradesh and Goa (seen earlier to possess the highest trade to GSDP ratios) are predominantly trade balance deficient. This may be because we do not observe import side intrafirm trade flows.
- It is likely that these states’ special status (in terms of tax exemptions) would encourage firms to allocate some intermediate stages of their production process there, followed by intrafirm exports.
Is Indian Interstate Trade Unusual? Formal Evidence from a Gravity Model
- The evidence shown so far suggests that contrary to the received wisdom, India’s internal trade does not seem unusually low.
- The basic intuition is that trade between two jurisdictions will be greater: the richer they are, the closer together they are, and fewer the policy and other cultural barriers between them.
- Data shows that richer states trade more with each other; states that are closer together trade more; contiguity matters as does the distance between economic agents.
The results from various models can be interpreted as follows:
- Distance – The most remarkable finding is that India’s elasticity of trade flows with respect to distance is much lower than one might have expected – a 10 percentage point increase in distances between economic capitals results in a fall in trade of only 5.65 percentage points.
- State GDP coefficients – The elasticity of trade with respect to income is positively correlated with trade flows: a 10 percentage point increase in GDP of an importing or exporting state is associated with an 8.2 and 9.6 percentage points increase in trade, respectively.
- Proximity coefficient – Adjoining states in India tend to trade with each other about 90 per cent16 more than other states.
- Language coefficient – In the international trade literature, the language dummy has been found to be persistently positive and significant, implying that countries with shared languages tend to trade with each other more than with others. There is insufficient evidence for this to be true within India; the Hindi dummy is insignificant for interfirm interstate trade but positive and weakly significant for intrafirm trade.
Explaining the puzzle: Why Does India Trade so Much?
- Contrary to priors, it seems that India may have a pro-trade bias. One plausible answer is that the current structure of domestic taxes as well as area-based tax exemptions might actually bias economic activity towards more internal trade.
- Since our data is derived from declarations filed for tax purposes, this is particularly pertinent. The Central Excise Act exempts manufacturing in certain states from excise duty and this exemption creates a strong incentive to shift real or reported production to these areas.
The CST and VAT
- Under the current system, states levy a value-added tax on most goods sold within the state, the centre levies a near VATable excise tax at the production stage. Sales of goods across states fall outside the VAT system and are subjected to an origin-based non-VATable tax (the Central Sales Tax, CST). It turns out that the CST – far from acting as a tariff on interstate trade – may actually provide an arbitrage opportunity away from a higher VAT rate on intra-state sales in some cases.
- Contrary to the caricature, India’s internal trade in goods seems surprisingly robust. This is true whether it is compared to India’s external trade, internal trade of other countries, or gravity-based trade patterns in the United States. For example, the effect of distance on trade seems lower in India than in the US. Hearteningly, it seems that language is not a serious barrier to trade.
- The analysis does leave open the possibility that some proportion of India’s internal trade could be a consequence of current tax distortions, which are likely to be normalised under the GST.
Section 2- One India: Before the Law
- The GST was justly touted as leading to the creation of One Tax, One Market, One India. But it is worth reflecting how far India is from that ideal. Indian states have levied any number of charges on goods that hinder free trade in India—octroi duties, entry taxes,Central Sales Tax (CST) to name a few. Others are cross-state power surcharge and Agriculture Produce Market Committee (APMCs).
India’s Constitutional Provisions and Jurisprudence
- Articles 301-304 provide a layered set of rights and obligations. Article 301 establishes the fundamental principle that India must be a common market:
- Article 301: Subject to the other provisions of this Part, trade, commerce and intercourse throughout the territory of India shall be free.
- Article 302 gives Parliament the power to restrict free trade between and within states on grounds of public interest.’
- Article 303 (a) then imposes a most-favored nation type obligation on both Parliament and state legislatures; that is no law or regulation by either can favor one state over another.
- Article 304 (a) then imposes a national treatment-type obligation on state legislatures (apparently not on Parliament); that is, no taxes can be applied to the goods originating in another state that are also not applied on goods produced within a state. This Article refers only to taxes and not to regulations more broadly.
- But then Article 304 (b) allows state legislatures to restrict trade and commerce on grounds of public interest.
Interestingly, this freedom to the states in Article 304 (b) is only different from that provided to Parliament in Article 302 in that states have to impose “reasonable restrictions” whereas Parliament may impose “restrictions.” Of course, states can only impose restrictions in areas that are either on the state or concurrent list.
The gist of these provisions is that both the Centre and the States have considerable freedom to restrict trade and commerce that hinder the creation of one India.
While the purpose of Part XIII was to ensure free trade in the entire territory of India, this is far from how its practical operation has panned out. Financial levies as well as non-financial barriers imposed by the States have become a major impediment to a common market.
Many of such levies are constitutionally valid and have been upheld, in principle, by the Supreme Court.
In several cases where entry taxes have been challenged, the Supreme Court has upheld their validity on the ground that these taxes are ‘compensatory’ in nature, which means that the proceeds from the taxes are used for facilitating trade in the charging State.
Provisions in Other Countries
- The United States has a very strong interstate commerce clause in the Constitution. It vests Congress with the power: “to regulate commerce with foreign nations, and among the several states, and with the Indian tribes.
- Also the US Supreme Court has largely interpreted the Commerce Clause liberally, ensuring that the power of Congress to regulate interstate commerce is not excessively curtailed, thereby leading to protectionist legislation from particular states.
- On the other hand since the Maastricht Treaty that created the common market in Europe, it is now accepted that countries within the EU must not, except under narrow circumstances, restrict the four freedoms of movement: of goods, services, capital, and people.
- Now, it could be argued that both the US and EU are very different from India because of their long and particular histories of nationhood.
Comparable WTO Law
- The WTO has a membership of 164 countries with widely varying income levels and political systems: for example, the ratio of per capita GDP of the richest countries is more than 60 times that of the poorest, while the corresponding ratio within India is less than 5. Also, the WTO has democracies like the US and Europe and non-democracies like China whereas all Indian states are democratic. So, it cannot possibly be argued that the Indian states should have greater freedom than countries in the WTO on the issue of creating a common market.
- If that is reasonable, then the comparison between WTO rules and the provisions of the Constitution is not inappropriate. That is, it is reasonable to compare the common-market/regulatory freedom balance provided for countries in the WTO with the same provided for states in the Constitution.
- The two striking differences between the two are:-
- The reasons for invoking departures from free trade/common market principles are more clearly and narrowly specified in the WTO than in the Constitution which instead refers to an open-ended “public interest.”
- The criteria that have to be met before the departure can be justified. In the WTO, the measure must not constitute arbitrary discrimination; must not be a form of disguised protectionism; and above all must be “necessary.”
- WTO jurisprudence has over the years elaborated on all these three criteria and others. For example, the burden of proof is on the party invoking the exception provision (i.e. invoking the right to depart from a common market).
- The key point is that in the WTO the departures from a common market across widely varying countries is quite heavily circumscribed whereas similar departures between states within India is easily condoned by the Constitution and consequent constitutional jurisprudence.
- At the time of the drafting of the Constitution, and given the considerable anxieties of holding together a large and disparate nation, the demands for respecting states’ sovereignty were understandably strong. Nearly 70 years on, the sense of nationhood and unity is strong, and anxieties about territorial integrity have faded. Cooperative federalism is becoming increasingly important governance dynamic. Reflecting this, the country has unanimously passed a landmark Constitutional amendment to implement the GST which should result in a common market for domestic indirect taxes.
Building on this, the country can go further and extend this principle of one economic India to other spheres.