Chapter 11 – One Economic India – Highlights of Economic Survey 2016-17

This chapter of the Economic Survey 2016-17 is an attempt to assess the extent to which India can bring the idea of “ONE ECONOMIC INDIA“, similar in tune to the affirmed political “idea of India,”. The assessment is based primarily on data based and juridical analysis of Indian economy and laws and thus, definitely makes an interesting and equally important study for civil services aspirants. An understanding of this chapter will help the aspirant in understanding the relation between inter state trade dynamics, effect of tax system and also legal position in relation to inter state trade and commerce. The idea here is to make out a strong case for an internally integrated one economic India, about which the CEA seems optimistic.

This chapter of the Economic Survey 2016-17 is broadly divided into two sets :

Section One:- One India: Internal Trade in Goods

Section Two :- One India: Before the Law

So, lets begin with the factual analysis of Internal trade in goods by understanding the significance of the idea of One Economic India as described in the Economic Survey 2016-17

Why One Economic India?

India is highly integrated internally, with considerable flows of both people and goods and statistics and data further strengthen this.

1. Cross-border (between the States) exchanges between and within firms amount to at least 54 per cent of GDP, implying that interstate trade is 1.7 times larger than international trade.
2. A non conclusive evidence also points out that language barriers does not seem to be a demonstrable barrier to the flow of goods.
3. The current system of indirect taxes perversely favours interstate trade over intra-state trade, especially in the cases of final consumption items, exempted goods, or goods that are input tax credit ineligible. However, the GST by ironing out these oddities may normalise interstate trade.
4. Intra firm trade across states is surprisingly large than Arms-length interstate trade (that is trade between firms), despite being affected by trade costs to a greater extent than interfirm trade.
5. The Constitution favours preserving state sovereignty over one market.

Does India Trade Internally More Than Other Countries?

To understand this, lets compare our inter state trade, international trade and its ratio with other countries. Please look at the table below.

The data according Economic Survey 2016-17 shows that India’s aggregate inter State trade is not as high as that of the United States, but “greater than provincial trade within Canada and greater than trade between Europe Union (EU) countries“.  Further, EU countries are governed by the “four freedoms”: allowing unfettered movement of goods, services, capital, and people.

Lets look at another table, this one in reference to measuring the magnitude of trade by comparing countries’ internal trade with their international trade.

This table brings out country specific understanding of its inter state trade vis-a-vis International trade.

Analysing these data, one finds that India’s trade profile is more similar to that of China, whose internal trade is 1.6 times its international trade but less than the United States whose internal trade is 2.5 times its international. The conclusion derivable is that the large countries trade more within their own borders than beyond them because of the size of their domestic markets.

How does interstate trade take place?

Inter State trades take place in two ways:

1. Intra firm and
2. Arms Length Trade

What is Arms Length Trade?

The concept of an arms length transaction allows the market to ensure that both parties in the deal are acting in their own self-interest and are not subject to any pressure or duress from the other party.

Source: investopedia

However, it must be understood that comparing intrafirm and armslength trade for analysis of state pairs indicates that there is no discernible correlation between the two types of trades – a state open to arms length trade may not be equally amenable to intrafirm trade. Madhya Pradesh stands out as having much higher intrafirm trade than interfirm trade, possibly owing to its central location in the country, making it ideally suited to logistics supply chains.

(P.S.: How are the estimates for interstate trade values and trade balances calculated?)

The Government has used the TINXSYS dataset, administered and hosted by the Goods and Services Tax Network (GSTN).)

What is TINXSYS?

~ Tax Information Exchange System

What explains India’s Pro – Internal Trade Bias!

Analysis from Economic Survey reflect upon a pro internal trade bias in India. The reason for this is relatable to :

1. Area-based tax exemptions.
2. The current structure of domestic taxes

Area-based exemptions

Eg: The Central Excise Act exempts manufacturing in certain states from excise duty, including all the North-eastern states, Sikkim, Jammu and Kashmir, Uttarakhand, Himachal Pradesh and Kutch in Gujarat.

This exemption creates a strong incentive to shift real or reported production to these areas.

Such exemptions out weigh other factors such as trade costs and other traditional determinants of trade and firm location.

Current structure of domestic taxes- CST/VAT

Under the current system, states levy a value-added tax on most goods sold within the state, the centre levies a near VATable excise tax at the production stage. Sales of goods across states fall outside the VAT system and are subjected to an origin-based non-VATable tax (the Central Sales Tax, CST).  It turns out that the CST – far from acting as a tariff on interstate trade – may actually provide an arbitrage opportunity away from a higher VAT rate on intra-state sales in some cases. This represents a case for tax distortion. It is not possible to measure to what extent interstate trade in these goods is suppressed by the tax distortion.

 The relatively low elasticity of trade in India with respect to distance and the comparability of India’s trade to international norms seems to suggest that the pro-trade bias wins over the disincentives to trade.

What can GST do here?

GST when implemented would effectively eliminate such tax distortions and it “will actually lead to a normalisation in internal trade”.

Concluding remarks

There is enormous variation across states in their internal trade patterns.  Smaller states tend to trade more, while the manufacturing states of Tamil Nadu, Maharashtra and Gujarat tend to have trade surpluses (exporting more than importing).  Belying their status as agricultural and/or less developed, Haryana and Uttar Pradesh appear to be manufacturing powerhouses because of their proximity to NCR.

The analysis does leave open the possibility that some proportion of India’s internal trade could be a consequence of current tax distortions, which are likely to be normalised under the GST. One market and greater tax policy integration but less actual trade is an intriguing future prospect.

Coming to the second portion of the Chapter based solely on assessment of legal position, the constitutional position and comparative legal position, it helps derive some interesting analysis directing in favour of One Economic India.

Section 2: One India : Before the Law

India’s Constitutional Provisions and Jurisprudence

What are the constitutional provisions that relate to trade and commerce in India?

Part XIII of the Constitution covers Articles 301-304 which provide a layered set of rights and obligations in reference to Trade and Commerce.  While Article 301, sets the principle, 302-304 elaborate upon it. A brief note on these Articles are mentioned below.

The gist of these provisions is that both the Centre and the States have considerable freedom to restrict trade and commerce that hinder the creation of one India.

(One can expect  question for Prelims 2017 based on these Articles of the Constitution of India.)

The Evolving Jurisprudence:

Over and above the constitutional provisions which strengthens the idea of Freedom of Trade and Commerce within India, the jurisprudence has unsurprisingly come down in favor of even more permissiveness.

While the purpose of Part XIII was to ensure free trade in the entire territory of India, this is far from how its practical operation has panned out.

What has led to the difference in the Constitutional ideology and practise?

Financial levies as well as non-financial barriers imposed by the States have become a major impediment to a common market.

Financial levies in the nature of :

• motor vehicles taxes,
• taxes at the point of entry of goods into specified local areas,
• sales tax on manufacturers of goods from outside a particular State,

have always existed between States.

The existence of these levies have been constitutionally held valid and have been upheld, in principle, by the Supreme Court.

In several cases where entry taxes have been challenged, the Supreme Court has upheld their validity on the ground that these taxes are ‘compensatory’ in nature, which means that the proceeds from the taxes are used for facilitating trade in the charging State.

Why such a trend developed?

In looking to achieve free trade, while protecting the sovereignty of states to raise revenue, would always have led to trade-offs.  The experience of past 70 years of Indian trade, thus, effectively cripples the idea of a common market.

This view of the Court is entirely consonant with the constitutional scheme of Part XIII, which when read as a whole, seeks economic integration while ensuring considerable leeway for states to differentiate their own products from those from other states.

LEGAL POSITION IN USA

1. In countries like USA, the states are constitutionally barred from regulating interstate trade and commerce as it was felt that such power would fundamentally hamper free trade and movement.
2. A liberal interpretation is accorded in foreign jurisdictions as regards the Art. 300’s counterpart.
3. The approach has been to liberally view the Commerce Clauses and make efforts to maintain one common US market, with restrictions applied as a matter of exceptions.

LEGAL POSITION IN EUROPE

In the Europe, Maastricht Treaty that created the common market, it is now accepted that countries within the EU must not, except under narrow circumstances, restrict the four freedoms of movement: of goods, services, capital, and people.

For Prelims:

What is Maastricht Treaty related to:

It created a common market in Europe!

Should we follow US and EU model?

This is not necessarily important for the UPSC Mains exam. However, to make your thought process go a little deeper few arguments can definitely be laid here.

There are arguments in favour and against.

It could be argued that both the US and EU are very different from India

1. long and particular histories of nationhood
2. Indian states are more diverse than states within the US and hence require greater freedom of tax and regulatory maneuver.

The counter-argument would be that

1. The American states were always fiercely jealous of their sovereignty and that the Constitution embodies that.
2. The strong interstate commerce clause exists despite strong states.
3. The states within India should have more regulatory freedom than sovereign countries within Europe.

Indian position with the developments in WTO Law

The WTO imposes a most favoured-nation and national treatment requirement just as the Constitution does.

But the key difference with the Constitution is the freedom provided to depart from these anti-protectionism requirements. The contrast is really between Articles 302 and 304 (b) of the Constitution and Article XX of the General Agreement On Tariff and Trade (GATT) WTO. It can be understood from the following:

1. Idea of “public interest” in Constitution

The reasons for invoking departures from free trade/ common market principles are more clearly and narrowly specified in the WTO than in the Constitution which instead refers to an open-ended “public interest.”

2. Criteria for departure from norms

In the WTO, the measure must not constitute arbitrary discrimination; must not be a form of disguised protectionism; and above all must be “necessary.”

The key point is that in the WTO the departures from a common market across widely varying countries is quite heavily circumscribed whereas similar departures between states within India is easily condoned by the Constitution and consequent constitutional jurisprudence.

For Prelims:

Know about:

~ WTO

~ GATT

Quotes useful for Mains – on WTO (GS2/GS3)

The WTO has a membership of 164 countries with widely varying income levels and political systems.

The ratio of per capita GDP of the richest countries is more than 60 times that of the poorest, while the corresponding ratio within India is less than 5.

The WTO has democracies like the US and Europe and non-democracies like China whereas all Indian states are democratic. So, it cannot possibly be argued that the Indian states should have greater freedom than countries in the WTO on the issue of creating a common market

One thing becomes simple from the above analysis.

1. India cannot embrace the strong standards of a common market prevalent in the US and EU, due to practical complexities.
2. It would be in the nation’s interest to “at least aspire to the weak standards of a common international market embraced by countries around the world“.

Concluding remarks

The context has changed today. At the time of the drafting of the Constitution, and given the considerable anxieties of holding together a large and disparate nation, the demands for respecting states’ sovereignty were understandably strong. Nearly 70 years on, the sense of nationhood and unity is strong, and anxieties about territorial integrity have faded.  Cooperative federalism is becoming an increasingly important governance dynamic. Reflecting this, the country has unanimously passed a landmark Constitutional amendment to implement the GST which should result in a common market.

Can we go ahead with this idea of One Economic India?

The evidence of this chapter and a review of Indian history suggests that on the question of creating one economic India, technology, economics, and politics have been surging ahead. Perhaps, it is time for the Constitution to catch up to further facilitate this surging internal integration.