The recent passage of the Goods and Services Tax (GST) Bill, which will put in place a uniform indirect tax regime in India, is a landmark achievement for the Narendra Modi government.
The GST council, which will oversee the GST regime, is currently in deliberations over its own procedures and over the appropriate tax rate to prevent revenue shortfalls. It is already clear, however, that GST, once implemented, will, for the first time in India’s history, unify the nation into a common economic market, obviating the need for goods to be taxed each time they cross a state border. GST will affect all aspects of business in India, from decisions on investment location and product pricing to logistics and supply chain optimization; it is being widely applauded as a crucial reform that will facilitate India’s development trajectory.
Less well appreciated, but perhaps no less important, will be the impact that GST will likely have on India’s international trade and on its trade strategy.
GST is a development that comes at a challenging time in the external environment for India. Global growth has slowed. Many major economies in the world face economic and political challenges with uncertain resolution. With the British vote to exit the European Union, the EU now confronts the possibility of a disintegration, with a larger collapse of the Eurozone in the coming years remaining a real, even if unlikely, possibility. Japan, once a driver of global growth, now lies dormant and is struggling to revive itself. China, after two decades of extraordinary growth, appears to be slowing down. The US is going through a divisive presidential election that has seen its candidates adopt threatening postures towards international trade, especially with lower-income countries, and towards the world trade system more generally. To achieve improvements in trade performance in this environment will clearly be difficult.
How can GST help? While India herself undertook substantial market-oriented reforms starting in the early 1990s, major impediments, both internal and external, that have kept the economy below its productive potential clearly remain.
Consider for instance, the electronics sector in which global trade is estimated to be around $1.5 trillion annually and which employs around 20 million people globally (more than any other manufacturing sector). An important feature of the sector is that production is highly fragmented, with intermediate inputs from a variety of countries being assembled together before being sold as final goods to consumers. Over time, the ability of corporations to shift part of the value chain to low-cost locations has created opportunities for developing countries in these production networks; electronics companies from the developed world first started relocating to Malaysia, Singapore, Taiwan and Thailand during the 1970s and early 1980s, followed by China, Indonesia and the Philippines.
While these economies have benefited from their participation in production networks in the electronics sector, and while India has many of the prerequisites that have attracted the electronics industry to these other locations—including low wages and a sufficiently skilled labour force—India’s contribution to the electronics sector has been depressingly low. It produces just 1.5% of global output, trailing far behind China, but also behind much smaller countries such as Vietnam and Indonesia.
India has also not been able to grow its export share, contributing merely 0.5% to global exports. India’s relative inefficiency as a production platform is clearly to blame. In the electronics industry where there is a significant distribution chain across the country, electronics products pass through different states, making the journey from producer to consumer, and get taxed at each border, raising production costs. The warehousing requirements, red tape, delays and corruption involved in this process can be easily imagined.
Indian producers have also complained about the problems created by an inverted duty structure where domestic producers pay high costs on taxed intermediate inputs made elsewhere in the country, making them under-competitive relative to imports which land at lower cost. GST, which is expected to eliminate these distortions, is being rightly seen as a “once in a lifetime” opportunity to improve industry competitiveness and enable much larger participation in global markets.
Such benefits won’t accrue to the electronics sector alone. Recent studies examining the gains from reduction of internal and external barriers to trade in India, suggest that the combined benefits will be of a very significant scale—roughly a 20% increase in economic welfare, with reduction in internal barriers to trade accounting for over half that number.
India’s transition away from agriculture will require productive opportunities for workers and firms in manufacturing and services. This evolution will be greatly helped if India could take advantage of the global market. For its “Make in India” campaign and in helping India to become an efficient export platform, the Modi government has just scored its game-changing goal with GST. If the economy evolves as is hoped, the GST council can rest easy over its revenue concerns—a policy reform of this magnitude and reach will surely deliver the necessary growth and, quite likely, a good bit more.
Pravin Krishna is the Chung Ju Yung distinguished professor of international economics at Johns Hopkins University.
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