Undergraduate Economist

Perspectives of an economics student

The Political Economy of GST

Posted by Alex M Thomas on September 6th, 2017

India welcomed the Goods and Services Tax (GST) on 1st July 2017, sixty-three years after France first adopted it. In his parliament speech, Prime Minister Narendra Modi said that “GST marks the economic integration of India.” It is expected to unify India through the creation of a single market for goods and services as the GST slogan aptly captures: ‘one nation, one market, one tax’. Moreover, it is expected to increase the tax base in India where less than 1 per cent of people pay income tax and close to 90 per cent of the workers are in the informal sector. Both these perceived benefits, according to the government, are expected to accelerate India’s economic growth by making it easier to do business and increasing public investment (financed through increased tax revenue).

The second volume of Economic Survey 2016-17 released earlier last month – another first for India – argues that the introduction of GST partly contributed to “optimism about the medium term”. One hopes that the optimism is well founded and not ‘irrational exuberance’, to borrow Robert Shiller’s phrase. Was the introduction of GST aimed at raising tax compliance by simplifying the indirect tax structure with the aid of information technology? Or, did it aim to structurally reform the Indian economy with a view of increasing employment and reducing inequalities? There is also another important question to pose: is a uniform tax a good policy move in an economy like India where the intra-state and inter-state differences are significant?

Amidst his discussion on inequality, Thomas Piketty rightly writes in Capital that “Taxation is not a technical matter. It is preeminently a political and philosophical issue, perhaps the most important of all political issues.” Hence, it is important that the political economy of GST is rendered transparent. After the introduction of GST, several Indian states have lost their autonomy in public policy owing to a reduction in their tax revenue because the GST subsumes state taxes such as the value added tax (VAT), sales tax, and luxury tax. [The service tax belonged to the centre.] In fact, as GST is a destination tax, Tamil Nadu, a manufacturing state, had opposed it because of a potential revenue loss of around Rs. 9,270 crore. Additional reforms are necessary to ensure that the state’s economic policies are not throttled.

If simplification of the tax structure was a central goal, the four tax slabs of 5%, 12%, 18%, and 28% do not make sense. However, if the government has an additional goal of influencing consumer choices, different tax slabs make sense. Yet, our current GST tax structure eludes easy interpretation. For instance, why should pens be taxed at 18% and now cost more? And why should sanitary napkins be taxed at 18% and now cost more? There appears to be no obvious economic or social logic behind this classification.

On looking closer, the GST classification for goods and services appears to be based on the ‘ability to pay’ principle and therefore progressive in spirit. Hence, non-AC train travel is GST exempt while AC train travel is taxed at 5%. Similarly, while non-AC hotel services are taxed at 12%, the services in AC hotels attract a tax of 18%. From the perspective of the consumer, it is indeed the case that those who consume ‘luxuries’ (e.g., services in Five-star hotels and restaurants) have to pay a higher GST than those who consume ‘necessaries’ such as education and health services. But how are the producers affected?

During the VAT regime, handmade products were tax exempt but they are now taxed at different rates in the GST regime. If one adopts the sole principle of ‘ability to pay’ in the matter of taxation, taxing handmade products might not seem to economically unjust. As a government official put it, “a machine-made shawl is priced at Rs 500 and a handmade one at Rs 5,000. If a person can shell out so much for a handmade item, they might as well pay a higher tax on it.” This is a good example of myopic thinking because we need to ask what happens to the handloom sector (employment and wages) once the market price rises.

As I write this, a meeting has been organised to protest the taxing of handmade products. The problem is aptly captured in this statement by one of its organisers: “Handmade products such as khadi saris are already expensive as compared to machine-made products. With imposition of GST, a khadi sari has become costlier.” It is elementary economics that this can lower demand for handmade goods and negatively affect employment in this sector. India’s recycling sector has also been adversely affected due to GST implementation.

Economic policies or reforms cannot afford to be short-sighted either intentionally or out of ignorance. The second volume of the Economic Survey proudly states that the GST regime has formalised the informal textile and clothing sector. But at what cost?

It is true that the big firms will benefit from lowered transaction costs and will be able to enjoy an increased volume of inter-state business. Small firms mostly buy their inputs and sell their output within their own state. In short, the lower transaction costs benefit big firms.

While around 160 countries have implemented GST, its effects have been varied. In Malaysia, household consumption reduced after the implementation of GST; in Australia, the burden of GST was more on the poor than the rich; whereas the weaker sections of the populace benefited from GST in Ethiopia, Pakistan, and Vietnam.

To conclude, while ‘one nation, one market, one tax’ sounds alluring, it presupposes an economically homogenous nation and a uniform market for commodities and labour. Is one tax justified in India, which has several many different labour markets, each with its own ‘equilibrium’ price? Or do our policy makers think that imposing ‘one tax’ can transform India into a single market? Just like demonetisation, the GST is yet another bad economic ‘reform’ with detrimental impacts on India’s poor and vulnerable.

Acknowledgement

This is a condensed version of a talk I gave at National Public School, Indira Nagar, Bengaluru on August 11th. I thank the students for posing interesting questions. 

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The Broken Headlights of the Union Budget 2017

Posted by Alex M Thomas on February 28th, 2017

The union budget is an annual planning document of the central government, which lays bare its economic priorities for the upcoming year. Since it outlines expenditure plans and revenue expectations (from tax proceeds), it has a significant impact on everyone, directly or indirectly, in the Indian economy. The consensus on the current union budget is largely that it is a ‘positive and progressive’ budget. Although seemingly it looks like a good budget, it suffers from a deeper malaise – of lacking a robust economic vision.

A government that is committed to economic development cannot not focus on employment generation and reduction of income and wealth inequalities. Further, employment generation has to happen in conjunction with decent wages. The former is an outcome of (both private and public) investment. It needs to be noted that the National Rural Employment Guarantee Scheme (NREGS) is only an employment safety net and not an engine of employment; one must be very careful not to conflate the two. Decent wages call for worker-friendly labour laws and adequate minimum wages. The inequalities of wealth (notably land and financial assets) keep rising unless structural reforms are undertaken, such as land reforms, wealth tax, and capital tax. (To formulate such reforms, information on the personal ownership of assets as well as their social distribution is required. Hence, the publishing of the caste census becomes a socio-economic necessity.)

With respect to wage policy, the variable of socio-economic significance is the real wage and not the market wage. The real wage tells us how much goods and services that a unit of the market wage buys. The real wage is therefore dependent on inflation and the capacity of the worker to access transportation, health services, and a clean environment. The class of economists who ignored real variables at the expense of the apparent ones were labelled as ‘vulgar’ by the economist–philosopher Karl Marx.

In addition, a piecemeal reading of the budget, while appropriate from the standpoint of individuals and firms, is inappropriate from a macroeconomic perspective. This is because the economy is an interconnected system, and one sector’s gain can lead to another’s loss, and multiple sectors can gain simultaneously. More generally, both private and public economic actions have unintended consequences; for instance, while the increased budgetary allocation for physical infrastructure is welcome, what are its effects on the natural environment?

The Indian economy is facing aggregate demand deficiency because of damp rural incomes, stagnant manufacturing, self-imposed fiscal austerity, and weak external demand. Tax cuts (for low-income individuals and MSMEs) and increase in public expenditure (on railways, roads, and the small increase in NREGS allocation) positively affect the aggregate demand, whereas demonetization-induced low activity levels, fiscal consolidation, volatile external conditions, agricultural distress, low real wages, and stagnant manufacturing sector all negatively affect aggregate demand.

On the aggregate supply front, the Indian economy is constrained by low agricultural productivity, poor working conditions for the majority of the population, inadequate physical infrastructure (access to drinking water, electricity, and roads), and environmental degradation. In short, India fares badly in terms of both physical and human capital. While the current budget gives some importance to physical capital, the allocations to human capital are deplorable. Moreover, the negative consequences of physical infrastructure creation on the natural environment and on the displacement of people must be accounted for in the balance sheet of economic development. Therefore, the paltry allocations to improve aggregate supply give us nothing to cheer. And on balance, the current budget significantly falls short of its intended goal of economic development.

Lastly, in his budget speech, the Finance Minister Arun Jaitley repeats the rationale for the demonetisation move of November 2016. He states that post-demonetisation, ‘GDP would be bigger and cleaner’. Moreover, he asserts (without any argumentation) that the demonetisation-induced fall in economic activity is a ‘transient effect’ and that this ‘is not expected to spill over into next year’ (contradicting the more cautious prognosis contained in the current Economic Survey). It seems that the FM is unaware of the concept of hysteresis: the short-term equilibrium can permanently affect the long-term equilibrium. This is part of the reason why mature democracies are extremely intolerant of labour unemployment. However, it is highly unlikely that official data will reflect the long-run adverse effects of demonetisation, because of its inability to adequately capture the economics of the informal sector.

In sum, there is no cause for any celebration but many reasons to be very worried for the economic present and future of India.

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English for Economists: Sowvendra’s ‘The Adivasi Will Not Dance’

Posted by Alex M Thomas on July 31st, 2016

Economists spend time studying mathematics because it enables them to formulate questions in a precise manner and provides solutions to economic problems expressed mathematically. This blog post, the first one in the series, finds socioeconomic issues articulated clearly in the short story ‘The Adivasi Will Not Dance’ by Hansda Sowvendra Sekhar in his 2015 book with the same title. Likewise, subsequent posts in this series – English for Economists – will examine socioeconomic issues in the Indian context as found in novels and short stories (within the genre of Indian Writing in English).

Sowvendra’s story questions the current model of economic development which displaces adivasis from their home-land. The ensuing commentary follows the news about the setting up of a thermal power plant in Godda by a businessman.

The businessman, in fact, needed electricity for the iron and steel plants he was planning to set up in Jharkhand. The plant was to be set up for his own selfish needs; but if he were to be believed, the whole of Jharkhand would receive electricity from his plant. Whole towns would be lit up non-stop, factories would never stop working for lack of power. There would be development and jobs and happiness all over. (pp. 183-4)

The rhetoric of economic development rests on its supposed ability to create well-paying jobs. Displacement is seen as unavoidable within this rhetoric and is therefore compensated for in varying proportions. Of course, hardly is the compensation ever economically just.

All very happy with the progress, the development. The Santhal Pargana would now fly to the moon. The Santhal Pargana would now turn into Dilli and Bombay. The businessman was grinning widely. Patriotic songs in Hindi were playing from the loudspeakers placed at all corners of the field. ‘Bharat mahaan,’ someone was shouting from the stage, trying to rouse the audience, his voice amplified by numerous loudspeakers. What mahaan? I wondered. Which great nation displaces thousands of its people from their homes and livelihoods to produce electricity for cities and factories? And jobs? What jobs? An Adivasi farmer’s job is to farm. Which other job should he be made to do? Become a servant in some billionaire’s factory built on land that used to belong to that very Adivasi just a week earlier? (p. 185)

The above excerpt questions the current notion of development/progress. Who are the ones progressing? Who are the ones regressing? Mainstream economic theory is still obsessed with the fruit of ‘free’ markets – the trickle-down of incomes.

Land displacement happens in the name of economic ‘reforms’ and those who protest are seen as enemies of ‘development’. What is the state of the farmland?

Only a few of us still have farmland; most of it has been acquired by a mining company. It is a rich company. (p. 171)

The struggle to eke a livelihood is visible in the following passage. It is also a passage describing, what may be called, a class struggle (a la Marx).

This coal company and these quarry owners, they earn so much money from our land. They have built big houses for themselves in town; they wear nice clothes; they send their children to good schools in faraway places; when sick, they get themselves treated by the best doctors in Ranchi, Patna, Bhagalpur, Malda, Bardhaman, Kolkata. What do we Santhals get in return? Tatters to wear. Barely enough food. Such diseases that we can’t breathe properly, we cough blood and forever remain bare bones. (p. 172)

Socioeconomically, the current and previous owners of the land are highly unequal. The latter has lost a permanent means of livelihood and a physical asset, a provider of economic security. On the other hand, the former group – the current owners – live prosperously. Santhals are denied access to good education and health. Access to communication is difficult for the protagonist because the “big post office in Pakur [is] more than twenty kilometres away” (p. 180).

We come across two interesting passages on markets and pricing in this story.

Our music, our dance, our songs are sacred to us Santhals. But hunger and poverty has driven us to sell what is sacred to us. (p. 179)

Santhals don’t understand business. We get the coal easy yet we don’t charge much for it; only enough for food, clothes and drink. (p. 175)

Firstly, forcible commodification needs to be resisted. Secondly, the notion of value and prices varies in capitalistic and non-capitalistic societies.

The protagonist of the story asks: “What do we Santhals get? We Santhals can sing and dance, and we are good at our art. Yet, what has our art given us? Displacement, tuberculosis. (p. 178)” Indeed, one wonders what ‘development’ and ‘reforms’ really mean. Owing to poor economic conditions due to ‘development’ and ‘reforms’, many Santhals “have migrated, or migrate seasonally” (p. 178) – a form of distress migration. Economic distress is not an isolated event but has adverse moral and political consequences: “We are losing our Sarna faith, our identities, and our roots. We are becoming people from nowhere” (p. 173).

Sowvendra’s short story is a real story about real people who are economically, socially and politically disadvantaged. The disadvantages have exacerbated because of economic policies undertaken in the name of ‘development’ and ‘reforms’. I think that such ‘stories’ disseminate contemporary socioeconomic issues to a wide audience in a lucid yet poignant manner. Insofar as they do that, they add to the existing vault of socioeconomic data. Moreover, such short stories can be used in schools and universities while teaching economics.

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60 Years after the 2nd Five-Year Plan: On Economic Theory, Planning & Policy

Posted by Alex M Thomas on June 18th, 2016

Picking up Ajit Dasgupta’s A History of Indian Economic Thought (1993) motivated me to revisit India’s 2nd Five Year plan (1956-61) and the Mahalanobis model in light of the structural changes in India’s economy and developments in economic theory, particularly of demand-led growth theory. Although 60 years have passed since the inception of the 2nd Five Year plan, the ‘Approach to the Second Five Year Plan’ contains ideas which are particularly important today, especially after the closure of the Planning Commission. In its place, we now have the NITI (National Institution for Transforming India) Aayog which assumes that Indian manufacturing and service sectors are currently operating ‘on a global scale’ and what is now needed is ‘an administration paradigm in which the government is an “enabler” rather than a “provider of first and last resort”’ (see Cabinet Secretariat resolution, 1 January 2015).

Why economics?

Economics is the study of commodities – its production, distribution and consumption. Economics provides us with the determinants of aggregate production (GDP), employment, and income distribution. This allows us to understand our economic surroundings better and consequently enables us to improve existing economic conditions. This may be carried out through general economic policies (for example, progressive taxation to reduce income and wealth inequalities and monetary policy to combat inflation) or through targeted economic policies (for example, fertilizer subsidies to improve agricultural productivity and tax concessions to foreign investors). Ultimately, economic interventions are made based on an assumption and several aims. The assumption is that economic theory tells us how economies function. The interventions are carried out to satisfy certain normative aims (for example, equity and freedom). This distinction is made in textbooks by distinguishing between positive and normative economics. For instance, if a particular society is not uncomfortable with unemployment its economic policies would not be aimed at reducing unemployment.

Objectives of the 2nd Five Year Plan

In this section, the economic objectives of the 2nd Five Year Plan are presented. All excerpts from the 2nd Five Year Plan are taken from here.

“The current levels of living in India are very low. Production is insufficient even for satisfying the minimum essential needs of the population….” Therefore, it was imperative to increase aggregate production. But, the economic architects of the plan did not visualize money as an end in itself.

“A rising standard of life, or material welfare as it is sometimes called, is of course not an end in itself. Essentially, it is a means to a better intellectual and cultural life. A society which has to devote the bulk of its working force or its working hours to the production of the bare wherewithals of life is to that extent limited in its pursuit of higher ends.”

Moreover, economic policy was aimed at an increase in activity levels and “also in greater equality in incomes and wealth.”

The Plan Document clearly favours social gain over private gain. In other words, private enterprise was regulated such that the economic yields benefitted all. To put it differently, a recognition of negative externalities was present.

“The private sector has to play its part within the framework of the comprehensive plan accepted by the community. … Private enterprise, free pricing, private management are all devices to further what are truly social ends; they can only be justified in terms of social results.”

More clearly,

“Economic objectives cannot be divorced from social objectives and means and objectives go together. It is only in the context of a plan which satisfies the legitimate urges of the people that a democratic society can put forward its best effort.”

The Plan Document also recognized the dual nature of urbanization – that economies of scale have both positive economic externalities and negative environmental externalities.

The 2nd Five Year Plan on economic inequality

The 2nd Five Year Plan clearly recognized that the gains from economic development are skewed and trickle down is not automatic. For the gains from economic development to be inclusive, two institutions have to be strong: trade unions and the democratic state.

“The gains of development accrue in the early stages to a small class of businessmen and manufacturers, whereas the immediate impact of the application of new techniques in agriculture and in traditional industry has often meant growing unemployment or under-employment among large numbers of people. In course of time this trend gets corrected partly through the development of countervailing power of trade unions and partly through state action undertaken in response to the growth of democratic ideas.”

There is a passage similar to Thomas Piketty’s view on wealth inequalities and the role of progressive taxation in reducing such inequalities in the document.

“The most important single factor responsible for inequalities of income and wealth is the ownership of property. Incomes from work are by no means equal, but in part at any rate, they have some justification in terms of productivity or relative scarcity. Some types of work are, however, remunerated more liberally than others for reasons which are not directly connected with productivity. Differential monetary rewards are often a matter of tradition an existing psychological or social rigidities. It has also to be borne in mind that capacity to work effectively at higher levels depends on a person’s education and training, and these are a matter of the accident of birth or circumstances. A large expansion of general and technical education for all classes of people irrespective of their paying capacity is over a period a potent equaliser. The point is that while inequalities in incomes from work have to be corrected, the case for taxation based specifically on wealth or property needs to be carefully examined.”

India needs to seriously consider a tax on wealth given the wide disparities of income and wealth. The connection between ‘productivity’ and ‘social rigidities’ is noteworthy and requires to be addressed through labour laws, education policy, food policy, employment policy and so on.

The core of the 2nd Five Year Plan: the Mahalanobis model

From the previous paragraphs, we can state the following as the normative economic aims of the 2nd Five Year Plan: (1) expansion of output and employment opportunities, (2) reduction of income inequalities, and (3) inclusive economic growth and development. The economic core of the 2nd Five Year Plan is constituted by the Mahalanobis model. As Ajit Dasgupta writes in A History of Indian Economic Thought, “The purpose of the model was to determine the optimal allocation of investment between different productive sectors so as to maximise long-run economic growth in India” (p. 164). In other words, the aim of this model is to increase the pace of aggregate economic activity in India.

The Mahalanobis model is a two-sector model with a capital goods and a consumption goods sector. The model tells us how the resources are to be distributed between these two sectors such that maximum economic growth is achieved. Note that the then production was insufficient to meet the basic needs of the Indian populace. There are inter-sectoral relations due to which one sector cannot exist (or grow) without the other. To produce consumption goods, capital goods are required. For the workers and capitalists in both sectors, consumption goods are needed. Employing the Mahalanobis model is to some extent vindicated because the model assumes “capital to be the effective constraint on output” and India lacked good physical infrastructure.

Note also that this model assumes that there are no demand constraints. As Dasgupta writes, “The higher the proportion of investment (i.e. of the current output of capital goods) that is allocated to the further production of capital goods, the higher the long-run growth rate of output” (p. 165). The dual character of investment is not clearly understood for investment creates productive capacity and is a component of aggregate demand. Logically, a solution can be found such that the addition to capacity is validated by the demand generated but it is a knife-edge equilibrium as in Harrod.

Dasgupta points out that the Mahalanobis model has been criticized “for being concerned exclusively with investment and for identifying investment with the production of capital goods” (p. 165). Yes, demand constraints and human capital investment are ignored. Another criticism of the model has been its neglect of foreign trade (p. 166). However, the model could be modified easily to account for foreign investment and consumption whereas the incorporation of demand constrains and human capital would not be easy.

Conclusion: the relevance of economic planning

Since the 2nd Five Year Plan, much time has passed and the Indian economy has undergone several changes. Developments have taken place in economic theory too, particularly in the areas of economic growth and development. While the Mahalanobis model has its limitations, the normative aims of the 2nd Five Year Plan are still valuable today. The expansion of employment opportunities needs to be at the forefront of any macroeconomic or growth strategy. As written in the 2nd Five Year Plan, “From the economic as well as from the larger social view point, expansion of employment opportunities is an objective which claims high priority”. However, NITI Aayog, the successor to the Planning Commission works within ‘an administration paradigm in which the government is an “enabler” rather than a “provider of first and last resort”’. The market cannot be expected to provide accessible and good quality education, health, housing and living environments to all. With existing economic and social inequalities, the need for economic planning is even more. Social costs require to be assessed and not ignored in the name of economic efficiency and economic growth.

An economic planner ought to know the implicit assumptions and scope of economic theories and be knowledgeable about legal and institutional constraints of policy implementation. The economic planner must therefore be an excellent economist and an experienced bureaucrat.

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Posted in Development Economics, Economic Growth, Economic Thought, Economics, Employment, GDP, India, Indian Plan Models, Macroeconomics | No Comments »