Creating Fiscal Space In Today's India
In this special column, which first appeared in Swarajya, Prof Mukul Asher explains what fiscal space has come to mean in modern economics, why creating it is more complex than it seems at first, and how it can be done in India.
This article presents and explains a possible framework for generating fiscal space. It can be adapted for a specific context by a city, a state, a region, or a country to enhance fiscal sustainability and to address present and future fiscal risks. It is thus intended to facilitate a systemic and integrated approach for addressing fiscal challenges.
Such a framework is particularly relevant for India due to the evolving dynamics of Union- State fiscal relations which portends availability of larger unconditional resource transfers and responsibilities for the provision of public amenities from the Union government towards the States.
Increased resources and responsibilities however must be matched by significantly improved institutional and technical capabilities in public financial management by the States if the cooperative federalism paradigm being pursued is to improve governance, and make India’s development process more broad-based and resilient. State-level leadership and willingness to organize needed skill-sets will be key aspects in managing fiscal risks, and therefore affect the extent to which a state addresses its development challenges. This is a medium duration process, but its beginning must be made urgently.
There has been several developments globally (these also apply to India) which have contributed to heightened anxiety about ensuring fiscal sustainability and managing fiscal risks.
Fragile macroeconomic environment: First, the 2008 global crisis and its aftermath, being manifested in the ongoing crisis centering on tough conditions imposed by the Euro Zone countries on highly indebted Greece, has sharply underscored the consequences of unsustainable fiscal and public debt policies. The Greek Parliament has had to approve these conditions in return for assistance in debt management and in maintaining economic linkages with the outside world.
Fragility of international macroeconomic environment is reflected in subdued growth projections. Thus, OECD’s June 2015 projections are, that as compared to the annual average of 3.9 percent for the 2002-2011 period, global GDP is projected to grow at 3.2 percent during the 2012-2015 period. A similar subdued trend in the world real trade growth is also projected, suggesting challenging trading environment for using external trade as an engine of growth.
Constrained Autonomy of Tax Policy: Second, constraints on tax policy autonomy, including limited results from measures designed to moderate shifting of tax bases to countries with greater ability and willingness to practice “fiscal dumping” (i.e. luring of tax bases by certain tax jurisdictions without underlying commensurate real economic activities in that jurisdiction); due to globalization and associated technological changes; and the proliferation of preferential trade agreements (PTAs), have made raising revenues from conventional income, sales, excise, and customs taxes much more difficult for any single country. A review of entering into PTAs without adequate preparations and strategic considerations therefore merits considerations, including by the Indian policymakers.
Funding good governance: Third, several factors, including rising incomes and expectations of the populations concerning public amenities; growing aspirations for better quality of living and quality of life, growing urbanization, demographic trends portending ageing populations, and changing patterns increasing the share of GDP devoted to health care, are likely to lead to higher level of government expenditure in this area. This expenditure will need to be funded, i.e. greater proportion of nation’s GDP will need to be devoted to them. Both public and private sectors will need to contribute to funding. The issue of funding is separate from the financing mix used, such as taxes, insurance premiums, mandatory and voluntary saving and others.
The above three broad developments have hastened the urgency of understanding how to generate fiscal space in a manner which improves public financial management practices, preserves fiscal sustainability, and enables addressing the current and future fiscal risks.
Before analyzing the suggested framework, it may be useful to briefly review the manner in which fiscal space has been defined in the literature.
The Concept of Fiscal Space: A Brief Overview
Heller (2005) has defined fiscal space as ‘the availability of budgetary room that allows government to provide resources for a desired purpose without any prejudice to the sustainability of government’s financial position.’ This is a broad and rather vague definition, with varying interpretations possible.
The World Bank Group (2015, Chapter 3), in discussing how to generate fiscal space and use it in the developing countries, adopts the definition of fiscal space as the “…availability of budgetary resources for a specific purpose…without jeopardizing the sustainability of the government’s financial position or sustainability of the economy”. The focus of the World Bank Group (2015, Chapter 3) study is on fiscal space generation and use among a cross-section of countries for short-term counter cyclical fiscal policy to cope with macro-economic shocks, such as those generated by the 1997-98 East Asian financial crisis, and by the 2008 global crisis.
The above study identifies fiscal rules imposing specified numerical targets on budgetary aggregates; stabilization and reserve funds which involve setting aside revenue from commodity booms or fiscal and balance of payments surpluses; and medium term expenditure frameworks (MTEFs) designed to link budgetary plans and allocations on the one hand and growth and other strategic objectives on the other in a multi-year flexible framework.
Some studies (e.g. Ortiz et al 2015) approach the concept of fiscal space from the advocacy perspective for significantly expanding social sector programs, without considering design, implementation, and actual outcomes of the ongoing social sector programs. Such studies simply enumerate various sources from which government can obtain higher revenue, and assert that government expenditure be re-allocated, usually from defense sector, expenditure on which is inappropriately asserted to be without merit, towards social sector, inappropriately asserted to be of “investment nature”.
There are three important questions missing from such studies, which is not surprising as their intention is advocacy not analysis.
The first missing question is that whether society’s resources devoted to current social sector (and other) programs bring commensurate benefits to the society. The success of a typical subsidy program is when conditions giving rise to its need are substantially mitigated, and therefore over time subsidy expenditure and beneficiaries exhibit downward trend. Instead, the usual assumption is that more expenditure on areas of advocacy and more beneficiaries are by definition desirable. Thus, requisite rigorous analysis of the current social sector programs and current social sector organizations is usually precluded. In many subsidy programs, entry is encouraged by the beneficiaries, but exit often necessitates difficult political choices.
The second missing question is the need for trade- offs among different sources of government revenue generation. Thus, foreign assistance, which is not sustainable or desirable in the long run, is advocated in such studies as one of the options for generating fiscal space.
The third is the neglect of context- specific factors, including political economy of reform in particular countries, as well as globally. This is illustrated by advocacy of shifting defense expenditure to social sector programs; significantly reducing fiscal incentives, and proposals for eliminating shifting of tax bases to low tax jurisdictions.
Analysts concerned with broader development issues focus on how additional fiscal revenue and expenditure can be generated from such avenues as reprioritization and efficiency enhancing of expenditures, domestic revenue mobilization, budgetary deficits, and in selected countries, in the short-run from development assistance.
These analysts also emphasize on how these additional resources are used for obtaining better societal outcomes from specific government spending such as on education or health; and how government spending can help in enhancing broad-based economic growth. This suggests that developmental aspects rather than short term stabilization aspects are emphasized in such definitions of fiscal space.
Thus, Roy, Heauty, and Letouze (2007) adopt the following definition of fiscal space: “Fiscal space is the financing that is available to the government as a result of concrete policy actions for enhancing resource mobilization, and the reforms necessary to secure the enabling governance, institutional and economic environments for these policy actions to be effective, for a specified set of development objectives.”
Some analysts such as Asher (2005) have argued that greater competence and willingness in generating non-conventional revenue resources can help generate fiscal space. Such sources include using state assets, both physical and financial, more productively; revenue from state-created property rights in a transparent and economically desirable manner; and willingness to use non-tax revenue, including appropriate cost recovery and user charges, and surpluses of regulatory bodies. State assets involve such areas as land owned by the state, mining, telecommunication spectrum, and other rights, air-space above and area within and below public sector properties, including railways and bus stations, and accumulated balances in various funds, including pension funds.
Willingness to charge for publicly organized (not necessarily produced) goods and services (such as water and electricity) also involves taking responsibility for effectiveness in delivering these goods and services, increasing accountability of the government. This is perhaps one of the factors constraining many authorities to use cost recovery and user charges more expensively. For those who may require assistance, use of utility vouchers, combined with block pricing, where per unit pricing increases with usage, merits serious considerations. Progress on pre-conditions necessary for using such methods, including installing of effective metering systems,is essential if fiscal costs are to be managed.
In analyzing fiscal space generated for use in any one area, such as age-related expenditure, the opportunities foregone for using the space for other purposes should also be considered in public policy discussions. Some analysts have argued that addressing curbing of activities resulting in collection of benefits of government programs by those not targeted by such programs, essentially curbing benefit cheating, could also help improve fiscal space.
Thus, the specific instruments and avenues for generating and for using fiscal space will vary among countries, and among regions within the same country.
Fiscal Space Framework
A Suggested Framework in Figure 1 has three distinct yet interrelated components. Strategies for generating fiscal space should view them in a systemic manner, with context specific initiatives, appropriate for eliciting desired responses from all relevant stakeholders.
Three main components are enhancing rate of growth and broadening its base; improving revenue generation from conventional and unconventional sources; and better expenditure management for obtaining value for money.
A detailed analysis of each is not attempted here. But illustrative examples are given which would strongly suggest that generation of fiscal space is not a mechanical exercise of simply raising taxes (or ceases), or reducing expenditure, but requires understanding of linkages between a variety of economic and social policies, bureaucratic incentive structures, and social and political norms.
Using insights the literature on behavioral studies to nudge social and political norms and behavior in the desired direction is the main theme of the World Bank’s 2015 World Development Report.
Analysis of mind, society and behavior in the above Report is relevant as several initiatives of the current government, such as Swacch Bharat, Smart Cities, Beti Bachao Beti Padhao ( save and educate girl children) involve altering social norms, while others such as insistence on accountability of government employees and organizations involve bureaucratic behavior.
At a broader level, shifting public discussion and debates from “Poverty and Personality-centered” politics to Development and Policy oriented” politics also involves altering Social and Political norms in India.
Enhancing Growth Rate
In the Indian context, improving current low rate of participation of women in labour force has the potential to enhance growth rate, broaden economic opportunities, and generate fiscal space. Thus, according to the ILO’s Global Employment Trends 2013 Report, India’s labour force participation rate for women fell from just over 37 per cent in 2004-05 to 29 per cent in 2009-10. It is in this context that such initiatives such as Beti Bachao Beti Padhao (Save and educate girl child) could not only improve gender equality, but also enhance growth rate and generate fiscal space.
Another recent initiative of setting up an online national agriculture market to improve efficiency of logistics and supply chains for farmers and other stakeholders could also serve as an illustration in helping to enhance growth broaden economic and fiscal base, and help generate fiscal space. Some estimates suggest that improved agricultural logistics and supply chains could raise India’s GDP growth rate by around 0.5 percentage points annually.
Improving Revenue Performance
There are opportunities for generating fiscal space from conventional and non-conventional sources at Union State and local government levels. The key challenge is to create proficiencies and capabilities in generating such revenue.
In taxes, “broadening base-lowering nominal rate” strategy has much to commend it from theoretical and policy perspectives. As an example, tendency to raise income tax limits below which the tax is not applied, and to also add to number and amount of exemptions for specific purposes has led to significant erosion of the individual income tax base. The number of individual income taxpayers in India is only around 35 million. This is widely regarded as much below the number (estimate range from 70 to 100 million) which should be in the income tax registry under current laws.
It is reported that the Income Tax Department (ITD) is to initiate measures to add 10 million persons to the individual income tax registry by 2016. There are also significant numbers of current income tax payers who are reporting incomes significantly below their legally required income, thereby resulting in revenue erosion.
Similar conditions are also prevalent concerning corporate income tax. Thus, ‘broadening- the- base-lowering nominal rate’ strategy, effectively implemented, could generate fiscal space, while preserving fairness and not adversely impacting economic growth. It is on these criteria that the income tax administration should be evaluated.
The above analysis applies to other taxes as well at all levels of government. The strategy suggested requires willingness on the part of the policymakers and the executive to acquire capacities to broaden tax base. This will be also relevant for the GST (goods and services tax) when it is implemented.
There are several opportunities for revenue generation from non-conventional sources. The Union Government has already raised equivalent of 2.5 percent of 2013 GDP from coal, spectrum and related auctions, with most of the revenue from coal auctions accruing to the States where such mines are located. More such revenue is likely to accrue as additional coal mines are auctioned.
THE MINES AND MINERALS (DEVELOPMENT AND REGULATION, AMENDMENT ACT, 2015 under which States can generate revenue from their own mining resources would require proficiency in organizing transparent, accountable, and effective auctions (and other appropriate instruments) to generate fiscal space. Such proficiency should also be consistently exhibited by the Union government as role of auctions in allocating state assets increases.
Better Expenditure Management
One of areas of better expenditure management worth noting is the potentially large savings from better procurement practices. Thus, in India, in 2013-14, combined government expenditure of The Union and the State governments was nearly 30 percent of GDP, of which between 12 and 15 percent comprised procurement of current and capital goods and services. Even a saving of 10 percent as compared to current procurement practices could potentially generate fiscal space of between 1.2 and 1.5 percent of GDP. This is non-trivial.
It is no coincidence that the Ministries of the Union government with large spending and procurement such as Railways and Defense has been focusing on procurement reforms to generate resources for their modernization programs. There is however substantial scope in improving procurement practices, particularly in the States, and in the Urban and local bodies.
India’s recent initiatives towards direct benefit transfers (DTBs) in bank accounts, combined with Aadhar card or similar instruments for identification, and better design of benefit programs could create fiscal space. Thus, official estimates of savings from DTBs for LPG subsidy are around INR 120 Billion, a non-trivial amount. The DTBs however should be used only where pre-conditions for its effectiveness are present.
Speeding up project implementation, such as for road construction, could also generate fiscal space by lowering effective project costs.
Many of India’s current arrangements, such as indexing civil service wages and pensions to not only prices but also to wages through establishing Pay Commission at regular intervals also need to be reviewed if generating fiscal space is to be consistent with fairness and with broad-based growth requiring business competitiveness.
The above analysis strongly suggests that generating fiscal space in a systemic and integrated manner is a complex exercise. It involves not only flows of receipts and expenditure, but also balance sheet items. Thus, preparing asset registry, and accounting for accrued and contingent liabilities have become essential.
Setting up fiscal risk management office in the Union Government, and in each of the States merits serious consideration. Such office should have the requisite authority, access to technical and professional expertise. There is potential for sharing such expertise between the Union and the State governments, for example with revenue forecasting and estimation of contingent liabilities provided by the designated agency of the Union government.
It is evident that current practices and organizational structures at the Union, the States and in the Urban and Local bodies are inadequate to undertake the exercise involving such complexity. A shift towards much greater professionalism, accountability, and organizational effectiveness in public financial management are needed.
Asher, Mukul G. (2005), Mobilizing non-conventional budgetary resources in Asia in the 21st century, Journal of Asian Economics, 16,6, pp.947-955.
Heller, P (2005), “Back to Basics – Fiscal Space: What is it and How to Get it”. Finance and Development. 42(2),p.3.
Ortiz, I., M.Cummins, and K., K karunanethy (2015), “ Fiscal Space for Social Protection: Options to Expend Social Investments in 187 countries”, Geneva: International Labor Office, Extension of Social Security Series No.48,
Roy, R., A. Heuty, and E. Letouze (2007). Fiscal Space for What? Analytical Issues from a Human Development Perspective. UNDP Paper for the G-20 Workshop on Fiscal Policy. Istanbul, 30 June – 2 July. Available at:
World Bank, (2015). Global Economic Prospects: Having Fiscal Space and Using It, The World Bank, Washington D. C.
Rationale & Key Requirements For Implementing GST in Indian States
This paper originally appeared in Swarajya on July 5, 2015
The time has come to align tax administration in the States with the aspirations of the citizen for a modern, and technologically enabled, and service-oriented tax administration. What are the key requirements and focus areas for an effective roll-out of the GST?
The GST (Goods and Service Tax) Constitutional Amendment Bill (representing 122nd such amendment) was passed by the Lok Sabha on May 6, 2015. It permits the Union government to levy sales tax on goods, and States to levy sales tax on services, both barred in the original constitution.
The GST, when ultimately implemented (as of end June 2015, the Bill is still awaiting passage by the Rajya Sabha, but the official target is to implement GST by April 1, 2016), will facilitate a coherent and unified approach to taxing goods and services by both the Union and the State governments for the first time since independence.
While India became a politically unified country in 1947, inappropriate and counterproductive economic policies, exhibiting insufficient understanding of how a combination of market and government can address India’s public policy and development challenges, led overtime to a severe fragmentation of India’s domestic market. As a result, the country has had to bear huge costs in terms of much lower quality of life, significant constraining of economic and social opportunities, and reduced resilience of the economy and society. It has also adversely impacted India’s competitiveness, generation of productive livelihoods, and inflation management.
Low level of economic literacy exhibited by large section of the policymakers, political class, media, and others is also continuing to adversely impact India’s rapid progress from a low-middle income country to a high-middle income country.
The GST Bill, along with complementary reforms is focusing on reducing cost of doing business, and creation of new enterprises, particularly small and medium enterprises (SMEs), expected to facilitate India’s emergence as a single market, an outcome which is long overdue.
A single unified national market has the potential to significantly reduce logistics, supply chain and other transaction costs to businesses; compliance costs for the taxpayers, and potentially improve tax administration, while enhancing prospects for better realization of economies of scale and scope in production and distribution activities.
Without rapidly progressing towards a single market, India’s prospects for emerging as a major economic
power with commensurate economic and strategic space globally would be severely undermined. Therefore impediments put in the GST implementation do not serve the nation’s strategic interest, and must be portrayed in the media and perceived by the electorate in this manner.
The GST in India will be implemented under a dual rate structure (GST at the Union Government, and GST at the State level, with some interim arrangements for inter- state transactions, which it is hoped will be eliminated over time).
There is no prior experience globally of a federal country (29 states, 7 union Territories), with a population of 1.25 billion implementing such an ambitious tax reform. So India needs to device its own context-specific solutions in designing and implementing GST. This is an added reason for exhibiting responsibility and seriousness of purpose, as well in ensuring careful preparations in implementing GST by all the Stakeholders.
Combined Union and State Expenditure and Tax Composition and Its Implications
This section provides a brief overview of aggregative data on India’s expenditure and tax composition for Union and State governments combined for the year 2013-14. All data are actual nominal amounts officially recorded.
The relevant data are obtained from the Indian Public Finance Statistics and the Hand book of Statistics on India’ Economy of the Reserve Bank of India
On the basis of the 2013-14 composition of combined Union and State government expenditure and taxes, the following observations may be made.
- The combined expenditure and tax revenue to GDP ratios were 28.2 percent and 17.9 percent of GDP respectively, while the combined operating revenue to GDP ratio was 20.4 percent of GDP.
The key economic question arising from these ratios are the following. First, is the quality and quantity of public services and amenities, and of governance commensurate with the government sector transferring resources from the Indian citizen’s equivalent to nearly 30 percent of India’s GDP?
Broad consensus is likely to be that they are not, and therefore the focus should be on how to improve the outcomes from government spending rather than relying on higher and higher outlays. This does not prevent reallocation of existing outlays among different uses.
While detailed balance sheet data of the Union and State government are not available, a case can be made that the government entities also disproportionately use nation’s and therefore Indian citizen’s assets (e.g. land mining ,wealth, air space and other property rights etc), without sufficient commensurate benefits. Economic and societal value generated from these assets has been low. Potential for generating such value is illustrated from the revenue generation equivalent to 2.5 percent of GDP from coal mining auctions of some of the mines which has so far been undertaken. India needs to develop competence in using balance sheet of the government to generate revenue rather than relying on income flows alone.
Taxes are financing less than two-third of total expenditure, corresponding ratio for the operating revenue being 72 percent. There is therefore scope for improving revenue performance, but by broadening tax bases and more rational use of cost recovery and user charges, rather than through including through tax rate increases inappropriate use of various causes and through use of monopoly pricing by government.
- Taxes on Income generated revenue equivalent to 5.7 percent of GDP (with corporate income tax contributing nearly two-third, implying rather narrow individual income tax base); customs duties were 1.6 percent of GDP (this share is unlikely to increase significantly due to many Preferential Trade Agreement, PTAs, which India has entered into), while excise, service tax, and state sales tax combined generated 8.6 percent of GDP. States generated additional 0.7% of GDP from taxes on goods, passenger’s entertainment tax and other taxes and levies.
The above are taxes which are deposited with the government. However, it is essential that the term “taxes” should henceforth be used analytically, as meaning “all compulsory transfer of recourses, including money, from citizen and businesses to government functionaries, even when such transfers do not reach government treasury. When measured appropriately, India’s tax burden is much higher than reported. This is an area meriting empirical research on a disaggregated basis, by location, activity, type of compulsory transfer generated, etc..
- The Services Tax generated 1.6 percent of GDP while services share in GDP is around 55 percent. In contrast, the tax generated from goods (sales and excise taxes) at 7 percent of GDP is disproportionate to the share of manufacturing in GDP of less than one-fifth.
As the share of household income spent on service increases with income, the current tax composition is inherently regressive, one of the unfortunate legacies of insufficient emphasis on rigorous economic reasoning in formulating Public Policies.
- When goods and services are taxed separately, some at the Union government level, some at the level of States, and inter-state transactions taxes separately, the effective tax rate, as measured by the tax burden to retail price ratio, and by distribution of tax burden between consumers and producers are likely to exhibit large variability. This affects both efficient resource allocation and fairness of the tax system. Moreover each state levying its own sales and other taxes (such as entry tax, and excises) increases businesses and compliance costs, and more pertinently discourages formation of small and medium enterprises. Their importance in generating, income and employment should not be underestimated.
If competently and coherently designed and implemented, the GST is expected to significantly, but not
fully, address severity of the above constraints. Some of the reported design of GST design provisions (such as not including petroleum and alcohol in the GST), and continuing tax on intra-state trade, are however likely to prevent realization of full benefits. But a more appropriate stage to analyze these aspects would be when the final decisions on GST design, including tax rate, tax base, and the various Union and State taxes subsumed under it, and operational details, are finalized.
Implementation of GST thus will be a good step forward. A mind-set that recognizes that “let the best not be the enemy of the good” is needed in taking the GST initiative forward.
- International experience suggests that in 2014, standard rate of Value Added Tax (VAT), equivalent to the proposed GST in India, was 19.1 percent in OECD (Organization for Economic Cooperation and Development), and 21.7 percent in the European Union countries. In Asian members of the OECD, such as Japan (8 percent), and Korea (10 Percent), the VAT rates are much lower. The revenue from VAT to GDP ratio in OECD averaged 6.6 percent of GDP in 2012. These comparative figures are relevant as India competes with these countries.
Requirements for Effective GST Implementation in the Indian States:
A major area which could prevent fuller realization of GST benefits is inadequate planning and preparation. It is this aspect, particularly concerning the States, that is discussed in this section
The current tax composition has become even more untenable as India’s economy and therefore tax revenue increases. In 2013-14, India’s GDP at market prices was INR 114 trillion. If India’s nominal GDP manages to grow at an annual rate of 12 percent, in six years (by 2019-20), India’s GDP will be INR 228 trillion by 2025-26. Even if the current revenue to sales, services, and excise taxes at 8.6 percent of GDP is maintained, this will generate INR 48 trillion from GST (and excises outside GST) alone.
The current sales and excise administration at the Union and in the States government level will need to undergo a qualitative transformation to effectively implement the GST.
The process of such a transformation can begin even as the design details, (tax rate and tax base definitions, and tax to be subsumed under GST registration requirements for GST etc.) are being worked out. International experience suggests that about fifteen to eighteen months are needed to prepare for implementing a GST type of tax even in countries with a reasonable level of tax administration expertise and use of technology. In many States in India, these requirements are insufficiently met. Thus, in several States computerization and IT infrastructure for sales tax administration is at a very early stage. This lands even greater urgency to begin the process of preparing for GST implementation.
The following represent key areas where the States are urged to focus as they prepare for the GST.
1. IT Infrastructure and Computerization
The States need to strengthen their IT infrastructure and computerization readiness for administering sales, excise, and related taxes. States which give insufficient emphasis to this aspect will find generating realizable revenue from GST difficult, and in an era of co-operative but competitive federalism, will find erosion in their competitiveness in retaining and attracting new business.
As GST implies a shift from Sales tax on the basis of “origin” (where consumption occurs), the States with relatively strong “origin” of production (such as Haryana, Tamil Nadu, Maharashtra, and Gujarat) would need to particularly focus on their IT infrastructure readiness.
2. Initiate Preparation of Service Tax Registry at State Levels
GST will be levied on both goods and services. States do have experience on levying taxes on goods, but not on services. So it is essential that process is begun to build a registry of service tax payers.
The current practice by the CBEC (Central Board of Excise and Customs) is to organize services tax data of the union Government by Commissioners and Chief Commissioners in each state.
The first step in initiating service tax registry at the individual state level is to make the relevant data available to each State. This will be a good starting point for the States. Each State can further refine the service tax registry.
Transaction costs of this exercise can be minimized if the proposed GST council takes the initiative for such transfer of information from the Union to the individual State governments
The individual governments could also take initiative to familiarize their tax officials about the operational requirements of the services tax. Such knowledge-transfer with the different levels of governments is vital as effective implementation of GST requires it.
3. Explore How Best to Use GSTN (Goods and Services Tax Network)
The Union government has set up GSTN as a statutory company to create a common IT infrastructure to serve the needs of various stakeholders, including the individual States. Registration, Returns, and Challans (Payment instruments) represent three of the critical work processes of the GST.
The individual States could consider exploring with GSTN how its services could be best utilized by the concerne State to facilitation transition from the current VAT to GST. Capacity building component for this area can also be considered to facilitate GST implementation. GSTN requires considerable capital expenditure and investment in technical and professional expertise which individual States can utilize.
Finally, individual States need to review their human resource policies and practices for tax administration. Transition to and subsequent implementation of GST will require different and higher levels of skill-sets than what is currently exhibited by almost all States.
In this area as well, States could consider co-operating with Union government, through its agencies, to developing requisite human resources, and skill-sets.
Focusing on the above four areas to prepare for GST implementation would make genuine interests and
needs of the Union government, States, taxpayers, administration and other stakeholders more compatible with nation’s interests. Those benefiting from current inefficient, insufficient transparent and accountable tax administration may resist the needed reforms. But their short-term interest should no longer be permitted to detract from the overall public and national interest.
There is considerable merit in individual States viewing transition to and implementation of GST as a high priority project, with clear demarcation of benchmarks to be achieved and setting of accountability for the outcomes. The time has come to align tax administration in the States with the aspirations of the citizen for a modern,
and technologically enabled, and service-oriented tax administration.
India Compares Well in External Trade Integration in Asia Pacific
Mukul Asher and Keya Chaturvedi
An in-depth analysis of India’s trade with the Asia-Pacific region which leads to some intriguing conclusions and sound recommendations. This paper originally appeared in Swarajya on June 20, 2015
The current government has initiated the process of energising India’s external economic relations in general, and external trade in particular, to facilitate higher and more regionally balanced economic growth, and to enhance livelihood opportunities. This has led to better economic coherence and coordination among agencies in India’s commercial diplomacy, and in foreign relations, auguring well for India’s economic and other engagements with the rest of the world.
There appears to be a perception, both domestically and globally, that India’s global integration as measured by its external trade is low in relation to the Asia-Pacific region, which is of vital importance for expanding India’s economic and strategic space. Empirical evidence presented below however strongly suggests that such a perception is unwarranted, and those holding it are likely to forego beneficial economic opportunities.
India on its part will need to continue to enhance its economic and strategic space in a global environment in which the relationship between growth in global trade in goods and services on the one hand, and global economic growth on the other appears to be weakening. For example, in volume terms, global trade during the 2000-2008 period expanded at an annual average rate of 6.8 per cent (equivalent to 1.6 times the growth in global GDP), but during the 2011-15 period, the corresponding growth rate is expected to be 4.0 per cent (1.1 times the growth in global GDP). Projections for the next several years portend subdued global GDP as well as global trade growth.
On a more positive note, according to data from World Trade Organization, (WTO) the share of developing countries in world exports has been increasing, from 24 per cent in 1990 to 45 per cent in 2014. Deeper and wider external trade integration globally could therefore enable India to more fully utilize this channel for sustaining high broad-based and regionally balanced growth, and provide livelihoods for its relatively young population.
India’s Ministry of Commerce reports that about a third of India’s total merchandise trade was with the Asia-Pacific region in 2014-15. If trade in services, investment, tourism, manpower flows and other components of economic interactions are included, the importance of Asia-Pacific region for India would be even more significant. According to the World Bank projections, India’s real GDP is expected to grow around 7 per cent over next several years. If these projections materialize, India’s 2014 GDP at current exchange rates of around USD 2.2 trillion is expected to approach around USD 4.5 trillion, providing considerable opportunities to its trading partners.
Conceptual and Statistical Aspects
Before analysing India’s external trade indicators with the rest of Asia-Pacific, some conceptual and statistical aspects in conducting such an analysis may be briefly noted. First, both external merchandise trade, i.e. trade in goods, and trade in services need to be analysed for more complete understanding of external trade integration. With the proliferation of information technology intensive product innovations, traditional distinction between goods (manufacturing) and services is becoming less useful, as many goods (such as mobile phones) derive their value primarily from other services (such as software applications) incorporated in them. Similar trends are increasingly manifesting themselves in consumer durable goods, such as refrigerators and cars. Disruptive technologies, which may permit leapfrogging of stages (such as some Indian consumers may shift directly from Kirana or neighbourhood stores to buying on-line, bypassing supermarket stage), also are often based on informational technology platforms.
External trade analysis usually focuses on trade in goods thus neglecting trade in international service transactions. A primary reason for this emphasis is due to lack of comprehensive data on external trade in services. Disaggregation of total trade in services by trading partners is not usually published. This is also the case for India, a gap that must be addressed urgently.
Second, the analysis should focus not only on the value of external trade in relation to Gross National Income (GNI) but also on absolute value of trade and share in global exports and imports. This is because the extent to which a country has the potential to be an important trading partner depends on absolute value of trade and on its relevant share globally.
The kind of commodities traded (key minerals and other resources), and the position in global value chain for a particular commodity sector (such as electronics and motor vehicles) are also relevant. But such analysis should cover both goods and services, and not just goods alone, as is usually the practice in most such studies and debates. As an example, for the electronics industry, software production and micro-chips design and tests are essential parts of creating value. Both these are services, and not included in the analysis of production networks. Such omission therefore leads to incomplete analysis of production networks. This is another reason why India should urgently consider regularly collecting and publishing data on its international services trade where it has global competitive advantage.
Ideally, external trade integration should be analysed by value-added per country in trade in goods and in services, and not on the basis of gross trade data as is routinely done currently. With elaborate production networks and global supply chains, value-added by a country is likely to be only a fraction of the gross value of trade. This suggests that India should increase value-addition occurring within India of its gross external trade. It is hoped that India’s recently announced Foreign Trade Policy (FTP) for 2015-2020 would be monitored not just from the perspective of trends in gross trade, but also on the basis of trends in value addition within India. Such estimates, relevant for both exports and imports of goods and services, should be a high priority for researchers on external sector both within and outside the government.
This section compares India’s external trade for 2013 with the Asia-Pacific region. The region is divided into South Asian Association for Regional Cooperation (SAARC), Association of Southeast Asian Nations (ASEAN), and rest of selected countries of Asia-Pacific. SAARC, formed in 1985, comprises Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. ASEAN, established in 1967, comprises Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vitenam.
The main aggregate indicators used are absolute value of external trade, total trade in goods and services to GDP ratio, share in global trade, and trade per capita (Table 1)
Notes: Data in bracket represent percentage share in world trade. Table 1: Selected indicators of external trade of India and other selected Asia-Pacific countries
Source: Constructed by the authors from WTO (World Trade Organization) Country Profiles; World Bank Database and other sources.
- India’s total external trade in goods and services in 2013 was USD 1054.8 billion. It ranks fourth after China (USD 4,693.1 billion), Japan (USD 1855.9 billion), and Korea (USD 1292.9 billion). India thus has comparatively large potential to provide markets for its trading partners. This potential will increase as India’s 2015-2020 FTP aims to double its current level of exports of goods and services by 2020, with corresponding increases in its imports.
- The importance of absolute value of external trade is often overlooked when the focus is on external trade ratio in relation to GDP. Even when this ratio is used, India with a value of 54.2 per cent compares favourably with other Asia-Pacific countries with relatively large populations such as China (51.9), Japan (33.6), Bangladesh (55.9), Indonesia (48.6), and Pakistan (33.8).
- In 2013, India’s share in world exports (goods) was 1.66 per cent, which was moderate as compared to other Asia Pacific countries, such as China (11.7), Japan (3.8), Korea (2.97), and Singapore (2.18).
- As compared to exports, India’s share in world imports (goods) was much higher at 2.47 per cent, compared to other Asia Pacific countries such as Indonesia (0.99), the Philippines (0.34), and Thailand (1.33).
- India however ranks more favourably with other Asia Pacific countries with respect to share in world export and import of services, with shares of 3.25 per cent; and 2.84 per cent respectively. Preponderant share of India’s external trade in services exports is accounted for by “Other Commercial Services” (75.3 per cent), while transport and travel services account for only around 10 per cent each. In sharp contrast, “Travel Services” account for about a quarter of China’s exports of services. The shares for Thailand (71.3 per cent), Malaysia (54.0 per cent), and Indonesia (42 per cent) are much higher. India has also neglected the transport sector.
Thus, India exhibits relatively high global export share in services in spite of its relatively low exports of transport and tourism services. India’s focus on infrastructure for much improved connectivity among India’s different regions and with India’s neighbours, such as ports, railways, roads, electricity, and its focus on improving its ranking in ‘ease of doing business’ and facilitating tourism are expected to improve its competitiveness in these areas. Tourism could be a major growth node and livelihood generator for the economy, as Prime Minister Modi has repeatedly emphasized.
A substantial proportion of the other commercial services are provided to the electronics sector. India is therefore an integral part of the electronic production networks, when production is defined appropriately to include trade in service transactions.
- India’s trade per capita (USD 820) is quite low when compared to other middle income countries in Asia-Pacific. The corresponding figures for China (USD 3175), Indonesia (USD 1699), Vitenam (USD 2757), the Philippines (USD 1440), and Malaysia (USD 16510), and Sri Lanka (USD 1744) are much higher. India’s challenge therefore is to increase trade per capita through diversification of its trade basket, through broader geographical coverage, and by improving trade capabilities of some of its States.
There are four broad policy implications arising from the above analysis. First, there is a strong case for India to compile and regularly publish data on bilateral trade in goods and services with its trading partners. India should also encourage policy relevant and strategic research on ways to expand and diversify India’s services trade. The Cooperative federalism initiative of the Union government provides ample scope for the individual States to play a vital role in promoting connectivity, and encouraging travel related services.
Second, the government’s current Make-In-India policy is subtle and requires an integrated and systemic approach for increasing India’s exports in goods and services. Improvements in value-addition within India could occur when capabilities are developed to supply some of the services currently being imported. As an example, currently a substantial share of financial services for projects, investment managements, and front-end work is being performed abroad, constituting India’s import of services. If an International Financial Services Centre (IFSC) within India, such as Gujarat International Finance Tech-City (GIFT) succeeds in having some of the international financial services being supplied from within India, value-addition in the finance sector will positively impact India’s external trade. The benefits would be greater if GIFT can supply financial services from India to countries other than those involved in the bilateral trade.
Third, the traditional distinction between trade in goods and trade in services is becoming less useful as an analytical framework. This is also the case with traditional distinction between agriculture, manufacturing, and services. Greater disaggregation of these sectors and understanding of inter-connectedness among them in creating economic value for the society are needed. India’s efforts must therefore be focused on increasing total value of trade, and capturing larger share of value-added generated by external trade to serve India’s economic priorities, and strategic interests.
Fourth, there is a strong case to monitor trade per capita and the geographical variations in it across India. Those parts of India, such as East and North-east regions, which currently exhibit lower physical and digital connectivity, are likely to have lower external trade per capita, reducing India’s national average. The government’s current efforts to increase connectivity among States, as well with the neighbouring countries such as Bangladesh, Bhutan, Nepal, and Myanmar will help improve trade per capita, and therefore help improve livelihoods in the region.
Finally, the above analysis strongly suggests that smoothening India’s continuing deeper integration with the Asia Pacific (and indeed with the global economy) is in the interest of India’s trading partners. Both India and its trading partners need to deepen and broaden interactions with each other, and explore mutually beneficial opportunities, while discarding current misconceptions.
Mukul Asher is a Professorial Fellow, National University of Singapore and Councillor, Takshashila Institution. Keya Chaturvedi is an Independent Researcher.
GST: small reform, big impact
Published August 31, 2014 in Pragati - The National Interest Review as part of a series from the Takshashila Institute and the Hudson Institute's August 2014 conference, Shaping India's Growth Agenda: Implications for the World
Implementing GST will be one small step for the legislature but a giant step for the benefit of the country.
Ad man Rory Sutherland of Ogilvy and Mather in a TED talk entitled “Sweating the small stuff”, refers to a strange disproportionality where the response of a target audience is inversely proportional to the force applied. While inflation, the revenue deficit, labour reform and subsides remain important macroeconomic issues that the government should focus on, economic reform should now be about the small stuff. The list of such ‘plumbing’ reforms is long. Each item, in turn, requires a laundry list of enabling actions. These small-ticket reforms range from getting the corporate bond market off the ground; to establishing a workable bankruptcy regime; to cleaning up public sector banks; to implementing a nation-wide goods and services tax (GST).
Of these, GST is the ‘small’ reform with potentially the biggest impact. GST is little understood by the average citizen. In simple terms, GST is a Value Added Tax (VAT), which means that each supplier in the supply chain of the product or service pays to the government the difference between the tax they charge their downstream customer and the tax they paid for the input. The only entity that does not get this offset is the final consumer of the product or service. This is the reason why GST is called a consumer tax. France was the first country to adopt this in 1954 and now derives over 50 percent of its total tax collection from this system. Twenty-nine of the thirty Organisation for Economic Co-operation and Development countries levy a value added tax. The only exception is the US. GST rates in these countries vary from a low of 5 percent in Japan to a high of 25 percent in Denmark.
India has moved beyond the debate on whether to have a VAT regime. The widely applicable federal service tax framework already operates on a VAT basis and is charged at 12.36 percent. Manufactured products operate under a VAT regime that is either 4-5 percent or 12.5-15 percent. Yet, many indirect taxes remain outside a national VAT framework and in the hand of the states. Of these, entry tax, octroi, stamp duties, entertainment and luxury taxes are the most important. These tax rates vary widely among states and substantially impact not merely the profitability of services but often their very viability. For instance, Maharashtra taxes cinema tickets at nearly 50 percent whereas Goa does at 25 percent and Tamil Nadu levies 15 percent (though prices are capped). Similarly, expensive hotel rooms are taxed at 12 percent in Karnataka, 15 percent in Maharashtra, and 25 percent in Tamil Nadu.
GST combines all these value added taxes into one framework and attempts to apply understandable and easy to follow rates and processes. This unified framework will reduce the friction in transport and delivery of goods and services across states in India. Much of this framework has already been hammered out in discussion between the central government and states over the last five years.
Some sticking points have prevented the consensus required to pass a required constitutional amendment. The main points of departure relate to the exempt list, those items to be exempted from the GST framework; the issue of compensation for taxes lost by states in the initial period and a somewhat technical point about dual centre/state control on small businesses. Pundits have proposed two general solutions. One set has suggested a compromised birth—do whatever it takes to get it done is their mantra. The other set has suggested that it is better to take sometime and do it ‘right’ rather than compromise at the start.
I suggest that both approaches be adopted though for different issues. On the matter of exempt items, I think it is important that the drafters of the Bill draw a hard line and ensure that the state and central lists are identical. In addition, only liquor (which has previously been agreed) should be exempt from the framework altogether whereas items such as petroleum products which have been reintroduced in the exempt discussion should not be allowed. In legislative matters, India has too often compromised at the get go resulting in great difficulty later. On the matter of compensation, I think the central government should be more accommodative and protect state revenues for longer. This is a tactical decision and should not be made part of the constitutional amendment. The arcana surrounding the issue of dual control should be demystified; states should have both administrative and legal jurisdiction for small firms.
With more and more states being governed by Bharatiya Janata Party (BJP) governments, there is every likelihood that the winter session of Parliament will allow passage of the constitutional amendment Bill for GST. It will be one small step for the legislature but a giant step for the benefit of the country.
(Based on remarks presented in a Trade and Investment panel at the Takshashila-Hudson Conference held in Bangalore on 2 August on Shaping India’s New Growth Agenda.)
This piece was first published in Mint on August 24, 2014
Narayan Ramachandran is fellow for Economics, Inclusion & Governance at the Takshashila Institution
Global economy: a zero-sum game
Published September 7, 2014 in Pragati - The National Interest as part of a series from the Takshashila Institute and the Hudson Institute's August 2014 conference, Shaping India's Growth Agenda: Implications for the World
In the name of free trade in services and financial liberalisation, the US should not try to rob sovereigns of their policy space.
This article is being written in the backdrop of the disclosure that the previous Indian government might have left itself with no escape clause when it signed the trade agreement in Bali. Instead of a four-year window being given to the World Trade Organization (WTO) to come up with an acceptable formula for calculating reference prices, the agreement appeared to have put the onus on the subsidising governments to find a solution by 2017, failing which they would be found guilty of violating their international commitments on agriculture and food subsidy.
It is clear that developed nations are playing hardball. Economic growth is history in much of the developed world. Hence, developed nations would try to extract as much growth as possible through international trade because their attempt to gain market share is not based on improved competitiveness of their products.
Share of manufacturing has not picked up materially in the US economy. It has perhaps not even stopped declining. Employment generation in manufacturing is conspicuous by its absence. In any case, a manufacturing revival is possible only if businesses are prepared to invest in real assets, in equipment. Even in the headline grabbing second-quarter gross domestic product growth in the US of an annual rate of 4 percent, the share of equipment investment was just 10 percent.
Further, much has been written about the recent improvement in US trade deficit due to declining imports of crude oil and petroleum products. The improvement is marginal so far. Second, excluding petroleum, there is no improvement in its trade deficit. If anything, it has worsened despite record low interest rates aimed ostensibly at boosting investment spending and enhancing domestic production.
In real terms (2009 dollars), the US is on course to record one of its highest trade deficits (excluding petroleum) in 2014. Therefore, the US is trying to bludgeon its way through other markets in services, including financial services. Financial services include banking, insurance and asset management. The baggage of global capital flows comes along with financial services. The Financial Services Annexure to the draft Trade in Services Agreement (TISA) document, released by WikiLeaks, leaves the potential signatories to the agreement with no scope to regulate the entry of Western financial firms into their countries and to restrict their product offerings.
While the US lost its manufacturing competitiveness earlier, it lost its alleged competitive advantage in Services with the onset of the economic crisis of 2008. The weaknesses of the largely unregulated financial system and its inherent instability were brutally exposed. Yet, it is not clear if all policymakers in the US have learnt the right lessons from it. Moreover, the ethical transgressions of the banking sector continue to this day.
Despite this backdrop, the US insists on aggressive opening up of financial markets in the developing world. Notwithstanding the experience of the global financial crisis, provisions on capital flows proposed in the Trans-Pacific Partnership severely crimp the ability of sovereign nations to restrict inflow and outflow of capital in an emergency for a reasonable period.
Further, the spillover from easy money policies of the West stoke credit booms and asset bubbles in the developing world. Their institutions and regulatory framework are not fully adequate to handle these and their fallout. That is not a surprise since even the US seems to be at a loss to handle the political economy of the financialisation. Financialisation reflects the disproportionate influence of the interests of the financial sector in policy decisions. Consequently, financial asset prices influence economic outcomes (instead of asset prices reflecting economic fundamentals) and financial market outcomes heavily household and corporate income and in balance sheets.
The US has to put the genie of financialisation back into the bottle and accept the short-term growth consequences that would arise consequently. It has to recognise the global spillover of its monetary policies. The privilege of being the issuer of the world’s reserve currency and the benefits that accrue from that status come with the obligation of maintaining international financial stability.
Global capital flows, especially of the financial variety, on balance, are more short-term and add little to economic welfare when they enter emerging nations but cause damage when they leave. Hence, emerging economies need all the policy space they can get to deal with them. In the name of free trade in services and financial liberalisation, the US should not try to rob sovereigns of their policy space. The US should come good on the promise made in the April 2009 meeting of the G-20 to reform the governance of international financial institutions.
If it refuses to as much as acknowledge these issues, let alone act on them, then the world will find a way to conduct the bulk of its transactions in another currency.
(Based on remarks presented in the session on Trade and Investment at the Takshashila-Hudson Conference held in Bangalore on 2 August)
This piece was first published in Mint on August 11, 2014
V Anantha Nageswaran is the Fellow for Geo-economics at the Takshashila Institution
Make for India, not just in India
Published October 18, 2014 in The Hindu as part of a series from the Takshashila Institute and the Hudson Institute's August 2014 conference, Shaping India's Growth Agenda: Implications for the World
The government’s policies have unwittingly tilted the balance in favour of innovating for the world rather than creating conditions that encourage innovations for India’s own needs
With a large engineering workforce and links with the English language, India already has some natural advantages in providing knowledge workers to global corporations. In addition, government policies that have made foreign investment increasingly easy, coupled with tax holidays in Special Economic Zones that only large corporations can afford to move into, have provided excellent incentives for setting up export-oriented captives in India.
In the last 10 years, the number of global research and development (R&D) captives in India has been progressively increasing. A recent study by Zinnov Consulting found that nearly half of the top 500 global R&D spenders have set up shop in India. These captives and their service providers together have created a globally exposed and competent workforce in India in addition to a new wealthy class of a few white collared professionals. The positive impact that this has made to the country is significant and real, even if it is limited to a small percentage of the population. To replicate this success in manufacturing seems a worthy objective, but with lessons from the past, we can and should aim higher.
Innovation has two beneficiaries — producers and consumers. For example, creating the light bulb was a profitable venture for Thomas Alva Edison but it also benefitted millions of consumers with the innovation.
In most cases, the knowledge workers seem to be pursuing problems of their employers in western countries. The output of their work often tends to be irrelevant in India. Thus in this increasingly interconnected world, one can effectively create islands of producers and consumers that are far removed from each other. The value created is shared by a few producers in India and a lot of consumers in western countries. The recent ‘Make in India’ campaign is trying to extend this trend into manufacturing from services.
There is a silver lining to this approach. While the output of what workers create is removed from the needs of their country of residence, the skills and capacity that they develop in the process are transferable. For example, workers from the very same pool, using similar tools and processes, created the first of its kind Unique Identification project in India. Aadhar aims to give a billion unique biometric IDs to Indian residents and has already achieved half of its target within a few years.
However, where government policies in attracting more FDI and in encouraging the Indian outsourcing industry have been a success, the track record in encouraging companies to innovate and make in India and for India has been poor. With a dismal rank in the ease of doing business index, there is a systemic advantage that existing businesses enjoy versus the problems that new innovative companies seeking to disrupt them have to face. However, improving the country’s rank on this well-established score doesn’t seem to be an important priority for the Indian government. Apart from the many sound bites, no concrete action is forthcoming.
The initiative of implementing a uniform Goods and Services Tax will do more to create an integrated domestic market than anything else. Equally important is to be able to move goods across state borders without being subjected to harassment.
However, an export-oriented manufacturing policy sidesteps this issue since the goods produced will mostly go out. Another key issue in India is a broken credit system that makes it difficult for new businesses to raise debt. The ‘Make in India’ initiative will even further tilt the balance in favour of large domestic firms that hog all credit and can also tap international markets or foreign firms that have better access to capital in their home country. These are barely two in a long list of reforms that India awaits.
Software as a service
We can already see examples that frustrate businesses trying to make for India in the software sector. The recent trend of delivering software as a service has proved to be an ideal solution for a capital-scarce country where consumers and small businesses are happier with a pay-as-you-go system rather than investing upfront for using software tools. However, the one thing that such businesses need — an ability to easily collect recurring payments online — is tedious in India. This makes it is easier for an Indian company to serve customers in the U.S. than in India. This is tragic, apart from being strange.
The collateral advantage of learning from exposure to western markets also comes with the inherent bias for creating products and services more relevant for the richer countries. Innovations perfected in India on that scale would also find relevance in emerging economies all over the world.
However, that is an unlikely scenario given the current policies we are pursuing. Right now, we are trying to encourage creation of figurative islands in India with a red carpet for setting up factories and exporting those goods. We have done that successfully in services and seen the limitations. A focus on ‘Make for India’ will spur ‘Make in India’ export-oriented businesses too but the reverse doesn’t happen automatically. We have the opportunity to get it right this time.
Saurabh Chandra is a Bangalore-based tech entrepreneur and an adjunct faculty fellow at the Takshashila Institution.
Soft power, hard choices
Published October 20, 2014 in The Hindu as part of a series from the Takshashila Institute and the Hudson Institute's August 2014 conference, Shaping India's Growth Agenda: Implications for the World
Substantive policy changes and not speeches alone would determine the success of Narendra Modi’s desire to bolster investment and encourage tourism and manufacturing
Prime Minister Narendra Modi has to move on several fronts simultaneously to fulfil expectations he has generated in various constituencies. Through his foreign trips, especially the high-profile U.S. visit, and his interaction with foreign dignitaries, Mr. Modi has declared economic issues to be the focus of his foreign policy. But substantive policy changes, not speeches alone, would determine the success of his stated desire to bolster investment and encourage tourism and manufacturing.
Mr. Modi’s recent trip to the U.S. was the first time that an Indian Prime Minister pitched India’s case not only at the United Nations or the White House, but also at broader constituencies including the general American public at a concert in New York’s Central Park and the Indian diaspora through a rally in Madison Square Garden. Mr. Modi spoke to CEOs of multinational corporations at breakfast, held several one-on-one meetings with corporate heads, and made a pitch for his ‘Make in India’ idea through an op-ed in The Washington Post. After pitching his case to three constituencies — the Indian-American diaspora, the American business community and his voters back home — Mr. Modi must now deliver. The laundry list of his promises, both explicit and implicit, is not short and might require bureaucratic as well as legislative action. To the Indian American diaspora he promised lifelong visas and a reduction in red tape. For the American corporate sector he has promised procedural reform and enhanced investment incentives. To the Indian voter he made appeals about reviving India’s past glory; he spoke of taking advantage of the demographic dividend, the need to improve sanitation, to provide clean water and to boost local incomes by attracting more tourist dollars.
Pursuing potential partners
Mr. Modi appealed to the Indian diaspora to not just invest in India but also encourage travel to the mother country. He promised to eliminate unnecessary rules and regulations, make the government more transparent and accountable and thus improve India’s ease of business rankings. His government now plans on repealing 287 outdated laws, most of which date back to the British colonial era, in the upcoming winter session of Parliament. If Mr. Modi pulls that off, he would be able to translate the enthusiasm of a high-profile trip into policy momentum.
Continuing in the mould of the previous National Democratic Alliance regime, Mr. Modi’s government has also promised to improve infrastructure, focus on both cities and villages and on sanitation, health and education. But specific plans have to gradually unfold for specific schemes, and each plan must then be financed. Mr. Modi appears intent on securing international partnership for his grand ventures. The concept of using external relations to fund development is not new, but he may have injected fresh vigour into an old idea.
During the Prime Minister’s trip to Japan, the Shinzo¯ Abe government renewed Japan’s commitment to help develop India’s infrastructure. Japan has already committed $1.5 billion for Delhi’s mass rapid transit system and will also assist development of the Delhi Mumbai Industrial Corridor. China has committed to investing $20 billion in India in the next few years, most of which will be in the area of manufacturing and infrastructure. Given Mr. Modi’s ambition, which now appears to have become India’s aspiration, these are still only a fraction of what the country needs. The government will now have to pursue other potential partners and investors to generate financing for infrastructure projects that are still on the shelf or the drawing board.
Growth in manufacturing
India’s economic growth since the liberalisation of the 1990s has been driven by the services industry. However, India’s large and youthful population needs jobs and expansion in manufacturing. This is essential for the country to maintain high rates of growth. India’s license-quota raj system, excessive bureaucracy, decrepit and often non-existent infrastructure, as well as power and water shortages, have hampered the manufacturing sector so far.
In addition, India’s land acquisition laws and labour rules have ensured that manufacturing has been capital-intensive, not labour-intensive, and is often aimed at land acquisition as an asset. All this must change, and change fast, if Mr. Modi expects to turn India into a global manufacturing hub — the aim of his ‘Make in India’ programme. The government needs to move forward on reforming labour laws. It must change the Land Acquisition Act passed by the previous government, in addition to finding ways to ensure regular supply of power and water and improving infrastructure.
India’s leaders have always sought to incorporate India’s ancient civilisational heritage and traditions into the country’s foreign policy to carve out its unique place in the world. Mr. Modi too has followed this policy but has sought to adapt it by honing his core domestic constituency, the youth. In his speeches in the U.S., the Prime Minister repeatedly spoke about the role that India’s youth — which is talented, innovative and yet proud of its heritage — can play in helping the country achieve the goals that it has set for itself and the expectations the world has of it. The Modi government has yet to set out an effective plan for taking advantage of India’s demographic dividend.
The Prime Minister has raised hopes and attracted international attention by outlining a vision for a market-friendly India. Non-Resident Indians appear to be enthused by the prospect of putting their money into the country of their origin. Global corporations are expanding their India research teams to look at opportunities.
The media, too, has withheld scepticism within reasonable limits. But at the end of the day, the pace at which he implements reforms will determine Mr. Modi’s success. Legal and regulatory changes must now come with the same, if not greater, efficiency as the song and dance that accompanied Mr. Modi’s triumphant New York spectacle.
Aparna Pande is Research Fellow and Director, Initiative on the Future of India and South Asia at Hudson Institute, Washington DC.
Reforming labour laws, creating livelihoods
Mukul G. Asher
Published October 30, 2014 in The Hindu as part of a series from the Takshashila Institute and the Hudson Institute's August 2014 conference, Shaping India's Growth Agenda: Implications for the World
A consensus on the outcome-based approach adopted by the Modi government to labour reforms is emerging. As the benefits become apparent, more reforms would become feasible
Prime Minister Narendra Modi’s government has exhibited competence in formulating economic reform measures that are small but likely to have substantial positive impact on reviving growth, generating productive livelihoods, and addressing price rise. The government has tended not to view reforms in a particular scheme or a programme narrowly but has tried linking them with other schemes and programs which could positively impact the desired outcomes and create an environment of trust among the various stakeholders.
These welcome initiatives are also evident in the government’s moves to make labour markets more flexible to address employability gaps effectively. The government is explicitly linking labour reforms to improvement in ease of doing business — setting up the business, operating it as a going concern, and exit norms — so that the available human and material assets can be put to more productive use.
This is evident in the phrase used by the Rajasthan Chief Minister Vasundhara Raje to explain the government’s labour reform proposals — creating “a fertile habitat for jobs creation”.
The labour reforms are also, rightly, linked to improving worker benefits — like providing for a minimum pension under Employees’ Pension Scheme; making Provident and Pension Funds portable; and increasing the maximum work hours. There is also stress on easing the compliance burden for small and medium businesses, like by permitting self-certification in some areas; restricting the powers given to labour inspectors, and by modernising labour laws. Also, various initiatives to increase the skilled manpower include the amendment to the Apprenticeship Act, 1961 which was passed by the Lok Sabha in August this year but is pending before the Rajya Sabha and steps to modernise the governance of the Industrial Training Institutes (ITIs).
Rethinking MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) to provide skills and create productive assets and perhaps linking it to apprenticeship programs in industry, plantations, and agriculture is also consistent with labour reforms, which encourages labour mobility.
The above approach builds support for the reform process, enhances trust in the government; and develops capacities and consensus for far deeper and wider reforms. It is also consistent with modern growth theory and evidence, and with sound public management principles.
The approach also enables the Union government to experiment with the concept of cooperative federalism where outcomes rather than narrow partisan political considerations govern Union-State relations. The decision to let the States retain revenue from proposed e-auctioning of coal blocks is consistent with this.
India is in a demographically favourable phase. This implies that the ratio of working age population to total population ratio is on the increase, leading to a need to provide productive livelihoods to the increasing number of young entering the workforce and also to those who are unemployed or under-employed.
India’s total labour force in 2011-12 is estimated to be about 480 million, only about 40 per cent of the total population. In particular, the participation of women is quite low at about one-third of the working age population — that in the 15-59 years category — while for men it is around four-fifth. Thus reforming labour laws to bring about moves such as permitting women to work in night shifts, as has been proposed, would improve gender equality and, potentially, the economic growth.
Shifting labour from agriculture to non- agricultural occupations is essential and so is encouraging manufacturing — through initiatives such as Make in India’. India’s employment elasticity was negative for the years 2009-10 and in 2011-12. This cannot be allowed to continue if the country’s economic progress is to be sustained and a certain social cohesion maintained.
Under the current constitutional provisions, labour is a subject in the Concurrent List. Individual States can amend labour laws. The Union government’s role is to forward them to the President. If the President assents, the States are free to implement the amended laws. This is the avenue States such as Rajasthan and Madhya Pradesh are likely to pursue to implement labour reforms. Uttar Pradesh, Himachal Pradesh, and Haryana, are reportedly considering labour reforms to attract investments. Also, with a BJP government having been elected in Maharashtra — an important State in terms of the economy as Mumbai is the financial and commercial Centre of the country — labour reforms are also likely to be initiated there.
This avenue of State initiation-Central consent-presidential acceptance permits initiation of context-specific labour reforms and allows experimentation and flexibility, making the costs of policy reversal less severe. It also encourages much needed accountability on the part of State governments in terms of livelihood outcomes.
As the BJP gets entrusted with the responsibility of governing more States, potential for constructive competition among States to produce the economic, social, and political environments necessary to generate productive livelihood increases. This will also help facilitate the passage of Union government’s labour reform legislation in the Rajya Sabha.
An alternative avenue is to amend the Constitution so that labour primarily becomes a State subject. This merits further research and debate.
A consensus on the outcome-oriented approach adopted by the Modi-led government to labour reforms is emerging. As the benefits, particularly to workers and to businesses, become apparent, greater reforms are likely to become feasible. Here it is essential not to let ‘the best’ be the enemy of ‘the good’, and to keep focus on the 500 million workers in the labour force — not on just the workers who are members of trade unions — and on ease of doing business, particularly for small and medium businesses.
Mukul G. Asher is Councillor at the Takshashila Institution and a Professorial Fellow at the Lee Kuan Yew School of Public Policy at the National University of Singapore.
Reforming labour laws to bring about moves such as permitting women to work in night shifts would improve gender equality
Bridging the innovation gap
Mark F. Schultz
Published November 5, 2014 in The Hindu as part of a series from the Takshashila Institute and the Hudson Institute's August 2014 conference, Shaping India's Growth Agenda: Implications for the World
For a country aspiring to global economic leadership, the 2014 Global Innovation Index (GII) brings bad news for India. For the Index saw the country drop 10 places compared to last year. The Index — published by Cornell University, INSEAD, and the World Intellectual Property Organisation (WIPO) — measures innovation. If the measure provided by the Index is anything to go by, then India ought to close its innovation gap. This is crucial if it is to prosper as it can and should. The world’s top economies are driven by innovation, and India is falling behind. An important part of bridging the innovation gap is for India to improve its intellectual property systems.
Importance of innovation
The other BRICS countries all gained ground on the GII. For example, while India fell to 76th, Russia jumped further ahead by 13 spots, placing 49th. The World Economic Forum’s Global Competitiveness Index tells much the same story. India’s Research and Development (R&D) spending is five times lower than that of China. It scores poorly on commercialising R&D from its universities compared to China and South Africa. The per capita number of engineers and scientists remains low, as do patents granted per million of population.
Overall, the Global Competitiveness Report rates “India’s capacity for innovation” as “lower than that of BRICS countries (Brazil, Russia, India, China and South Africa) except Russia.” Falling behind in innovation would mean falling behind as a world leader for India.
Economists agree with the importance of innovation to economic growth and productivity. They had long ago identified innovation as the key to economic leadership — even before Silicon Valley, the Internet, and the biotech revolution happened. In 1957, Nobel-Prize winning economist Robert Merton Solow credited innovation with about 90 per cent of productivity growth in the first half of the 20th Century. Similarly, William J. Baumol estimated that “nearly 90 percent” of the U.S.’s then-current “GDP was contributed by innovation carried out since 1870.”
The wealth of nations in the 21st century is intangible, in the form of knowledge assets. This point was illustrated by a 2006 World Bank study, which compared the stock of wealth among nations. The World Bank study showed that the biggest difference between wealthy countries and the BRICS was intangible capital. While the rich nations had somewhat more physical capital, the majority of their wealth was intangible capital – knowledge, goodwill, and intellectual property assets. It greatly exceeded the intangible assets of countries such as India in magnitude.
How then can India build its intangible capital to take its place among the world’s leaders? It must innovate. And it’s not a question of potential. Instead, it must live up to its potential. By some measures, India is ready to become one of the world’s global economic leaders. It has the world’s largest market in terms of population, one of the factors that helped the U.S. to build innovation industries that dominate world markets.
R&D spending; IPR
India’s large population also makes India rich in the most important modern resource — the human mind. People everywhere have the capacity to innovate and create. India’s citizens could lead the world, given the right institutional support. The good news is the World Economic Forum’s Global Competitiveness Index notes that India is top tier in terms of availability of engineers and scientists. Its scientific research institutions are top notch in quality, outscoring China, Brazil, Russia, and most other nations. And India’s R&D spending has been rising steadily in recent years. However, these factors, while positive, may not be quite enough to do the job. India’s R&D spending remains low when compared to most other countries that aspire to economic leadership.
India is not fulfilling its potential when it comes to innovation, and there seems to be a gap between its capabilities and results. One of the challenges holding India back likely is the less-than-full development of its intellectual property system. Innovators and creators need to be able to secure their investment in developing their creations — or they often simply won’t create, and they surely won’t invest in commercialising and bringing products to market.
Research shows that stronger intellectual property rights are associated with a large number of outcomes likely to help a nation bridge the innovation gap. Nations that protect intellectual property file more patents, have more researchers, invest more in R&D, and enjoy more Foreign Direct Investment.
Though India has improved its intellectual property system in recent years, much work remains to be done. Some of the resistance likely stems from the fear that intellectual property is a tool for blocking competition and withholding technology from others. These concerns are understandable in that intellectual property protection has become a bargaining chip in trade negotiations — something that the U.S. and EU demand, for India to withhold until something can be received in return.
However, intellectual property’s primary function is not to block others or promote the interests of foreign companies. Rather, it serves as a tool to spur collaboration and internal development.
It’s time that India saw intellectual property as a tool for its own development. The last month saw the launch of the ‘Make in India’ campaign, wooing both domestic and foreign entities to manufacture and create products in India. Unless this goes hand-in-hand with a relook at India’s innovation ecosystem, the gains will be marginal. With improvement in its intellectual property systems, India can bridge the innovation gap and assume its place as one of the world’s leaders.
Mark F. Schultz is a Senior Scholar at the Center for the Protection of Intellectual Property, George Mason University School of Law.
Far from sunny optimism
Kenneth R. Weinstein
Published November 11, 2014 in The Hindu as part of a series from the Takshashila Institute and the Hudson Institute's August 2014 conference, Shaping India's Growth Agenda: Implications for the World
Some of India’s labour market regulations are a legacy of Fabian Socialism and colonial rule; others are a product of postcolonial bureaucracy, disincentivising economic growth
By 2050, India’s economy could be the third largest in the world, surpassed only by China and the U.S., according to a study undertaken by Goldman Sachs. In a 2003 analysis, Goldman Sachs economists Dominic Wilson and Roopa Purushothaman painted a dramatic picture of the future international economy. By 2050, they argued, the combined Gross Domestic Product of Brazil, Russia, India and China (which economist Jim O’Neill had grouped into the acronym BRIC in 2001) could surpass the combined GDP of the current richest economies. Central to the rise of the BRIC, the two economists agreed, would be the rise of India.
Indeed, at the time, India’s trajectory seemed stratospheric. Even when buffeted by the winds of financial crisis in 2007-2008, it managed to sustain growth and helped avert global economic depression. India, many analysts noted, possessed key components of what it would take to become a global economic power: a strong civil society, favourable demographics (including a relatively young workforce), an increasingly educated populace, and vast natural resources. Noting these and other factors, on his first trip to India in 2010, U.S. President Barack Obama declared, “The United States does not just believe, as some people say, that India is a rising power; we believe that India has already risen.”
Impediments to growth
Within four years, however, the situation has changed dramatically. The pace of reform had screeched to a standstill; rather than moving the country forward, the Congress became entangled in mismanagement and a series of corruption scandals, and resorted to economic populism to sustain its rule. Economic growth slowed to below five per cent.
In turn, many of those who had envisioned India’s future as a great economic power saw their projections fail. Far from the sunny optimism of the early 2000s, the country’s turn to failed statism naturally led to large-scale corruption and sclerotic growth.
Today, an opportunity exists for India to reclaim its future. In order to achieve the economic growth its people deserve, it must seize the moment by modernising its labour market.
Some of the current labour market regulations are a legacy of Fabian Socialism and colonial rule; others are a product of postcolonial bureaucracy. Either way, they are a clear disincentive to employment and growth.
Despite a large population, labour participation in the formal economy remains low. Women still play only a disproportionately minor role in the economy, large segments of the population remain cut off from the global market, and government mandates stifle labour sector growth.
In short, the regulatory burden is incompatible with building a modern society. For example, the Industrial Employment Act requires employers to submit information such as work hours and wages to the government ahead of time for approval. Moreover, the Act’s regulations constrain employers by providing little flexibility in updating employees’ work hours, training, or pay. Similarly, the Industrial Disputes Act (IDA) requires businesses to obtain government approval before firing large numbers of employees. In many instances, the process of doing so is lengthy and features copious red tape.
Foreign companies are also discouraged from investing in Indian enterprises by laws like the IDA. As a result, they prefer to take their businesses to other labour hubs that offer greater employment flexibility and fewer regulations.
Reform under way
Yet India’s potential should not be underestimated. As Prime Minister Narendra Modi has emphasised, further reform may be on the way. Moreover, some reform has already begun at the state level, with Rajasthan leading the charge as a regional leader in labour reform. Under the leadership of Chief Minister Vasundhara Raje, the State has passed a number of measures aimed at decreasing corporate regulations that inhibit efficient business practices. This liberalising impulse will make hiring, training, and firing easier for employers.
Whereas in the past the IDA required that government be notified if more than one hundred workers were being terminated, if the Rajasthan reforms are enacted, companies in the future will be able to terminate up to 300 employees without government approval. Moreover, representative trade unions will be held to stricter standards, with worker membership requirements doubling from 15 per cent to 30 per cent. The effect should be a more productive and dynamic workforce.
Rajasthan is also pushing regulatory streamlining through reform of the Contract Labour Act, which aims to put contract labourers on a similar footing as employees; and the Factories Act, which closely regulates operations of factory businesses. In Rajasthan, smaller and mid-sized businesses will be exempt from these regulations, allowing them to compete more effectively in the marketplace.
On a national scale, Bharatiya Janata Party (BJP) leaders hope that Mr. Modi will succeed in strengthening federalism, providing individual States more opportunities for reform. Progressive States like Rajasthan, or Mr. Modi’s own Gujarat, which put in place significant changes under his leadership, will not only be free to move forward with pro-employment measures but hopefully can act as a catalyst for the rest of the country too.
The BJP’s election manifesto promised to focus on national economic reform and development, with an emphasis on manufacturing. In his 2014 Independence Day speech, Mr. Modi invited global economy players to “‘Come, make in India,’ ‘Come, manufacture in India.’ Sell in any country of the world but manufacture here.” In an attempt to capitalise on India’s vast human resources, Mr. Modi also appealed to India’s large youth population.
In order to unleash the potential of the labour force, Mr. Modi has already pushed for a number of reforms, including the doubling of the hourly overtime limit. Also, in order to keep pace with global technological advances, the government has sponsored initiatives to increase Internet access across the nation, thereby augmenting business connectivity and improving technological literacy.
Though India has not lived up to some of its more optimistic development scenarios, its economic potential remains vast. With the right kinds of reforms mobilising its relatively young workforce, it can enjoy a prosperous future.
Kenneth R. Weinstein is President and CEO of the Hudson Institute, a Washington DC-based think tank.
An Indian agenda for trade and investment reform
Michael Owen Moore
Published November 15, 2014 in Pragati - The National Interest as part of a series from the Takshashila Institute and the Hudson Institute's August 2014 conference, Shaping India's Growth Agenda: Implications for the World
India must put in all its reform effort into policies that will increase the international competitiveness of Indian firms and encourage both foreign and domestic investment.
The new Indian government led by prime minister Narendra Modi swept into power on a promise of improving economic conditions in India. A critical focus of the reform effort must be policies that will increase the international competitiveness of Indian firms and encourage both foreign and domestic investment. These decisions will have profound effects on Indian economic growth and poverty reduction in the coming decades.
The policy efforts should have two dimensions. One reinvigorate multilateral trade negotiations held under the auspices of the WTO; Two, undertake an aggressive domestic reform agenda that will be helpful regardless of the features of future trade agreements.
The former means a far different approach than recent unfortunate Indian actions surrounding adoption of the trade facilitation agreement negotiation in Bali in December 2013. Many countries share India’s concern about food security. But the vast majority of WTO members, both low-income and high-income, have taken umbrage at perceived Indian reneging.
The announcement of a preliminary deal between the U.S. and India on November 13 may cause some in India to celebrate a ‘victory’ about food security. But the reality is that India’s approach reinforces the view in Washington and elsewhere that global WTO negotiations are a waste of time. The U.S. as well as many other important economies, are already looking at fora outside the multilateral trade system to further liberalisation efforts. In short, Indian recalcitrance may result in agreements that shut out Indian trade opportunities, which one would presume was not the intention of the new government.
Regardless of the long-term status of the WTO negotiations, the Modi administration cannot afford to wait for domestic economic reform. Effective and far-reaching reform that encourages trade and investment will help renew economic growth. These reforms should not be undertaken because they might benefit foreigners but instead because they are in the long-term deep interest of India.
India has a profound interest in maintaining the rules-based multilateral trade system, which unfortunately is under unprecedented strain as a result of a moribund WTO negotiation process. The dysfunction has resulted in major economies seeking other venues for integration. For example, the U.S. has shifted almost its entire negotiating resources towards agreements with the EU (TTIP) and a separate one for countries of the Pacific Rim (TPP) and the Trade in Services Agreement, none of which include India. Completion of these and other similar agreements not only further complicate the international trade and investment system but also will lead to discrimination against Indian commercial and economic interests.
India would be best served by working to reinvigorate the WTO liberalization process rather mimicking the U.S. and EU preferential trade agreements. This would mean hard decisions by the Modi government that could be unpopular domestically but could bring new life to WTO negotiations.
India’s approach in recent years has been to drive a very hard bargain at the Doha Round. The WTO consensus-based decision-making process has given India and other emerging economies like Brazil and South Africa substantial leverage in preventing a broad multilateral agreement. Of course, high-income countries like the U.S. and EU have also played a major role in the dysfunctional WTO process. Unfortunately for emerging economies, high-income countries have alternative arrangements and agreements that they can pursue. In short, failure of the Doha Round does not mean that the world stands still and may very well leave India behind.
As a clear leader of lower-income countries, India plays a particularly important role to help maintain the WTO system. Less developed countries have the most to lose from preferential trade agreements such as TTIP and TPP. These countries would be left out of setting the rules for new trade and investment issues set by the world’s major economies.
India’s leadership would be critical to regaining WTO momentum. The recent stance by the Modi administration on implementing the trade facilitation agreement that arose in the Bali WTO ministerial is exactly the wrong way to move forward. Whatever the merits of the Indian government’s stance towards a near-term solution to issues of food security, this approach risks further undercutting the interests of major economies to spend time and resources on WTO negotiations.
Of course, India cannot by itself determine whether the WTO is recast as the primary forum for trade negotiations or whether countries move towards preferential agreements. The Indian government cannot force other WTO members to make their own politically difficult changes necessary to reach a compromise.
But the Indian government can undertake domestic policy reforms that likely will be beneficial in a host of global environments. These include reforms that affect the investment climate and increase the competitiveness of Indian firms. Moreover, research over the last two decades make clear that trade liberalisation is not a panacea; sensible and appropriate domestic reform can play at least as important a role as eliminating trade and investment barriers.
The first set of general reforms focus on improving the climate for business within India, especially for investment. The well-known World Bank “Ease of Doing Business Rankings” indicates the need for these changes. The 2014 reported ranked 189 countries and put India in position 134 (compared to 41 for South Africa, 97 for the People’s Republic of China and 116 for Brazil). There naturally are potential problems with this index and the specific numerical rankings. Moreover, India has made progress in some of the areas examined for this index. But the overall message of unhelpful impediments to business is one that found resonance within the Indian electorate in the 2014 election cycle.
The array of possible reforms is influenced by social and political realities. Nonetheless, it is useful to identify those areas that could help the Indian economy. These reforms include:
One, reductions in administrative burdens and red tape for domestic economic activity;
Two, tax reform that broadens the tax base while lowering the marginal tax rate;
Three, improving the internal market by reducing state-level regulatory and fiscal burdens;
Four, reducing judicial backlogs, especially in enforcement of contractual obligations;
Five, labour market reform, including reducing the restrictions on dismissing redundant workers;
Six improved intellectual property protections.
Significant improvements in these areas likely would lead to increased domestic and foreign investment.
The Modi administration has a golden opportunity to improve the lives of hundreds of millions of Indian citizens. Making the correct decisions on trade and investment policies will play a key role in seizing these opportunities.
Michael Owen Moore is a Professor of Economics and International Affairs at George Washington University.