A Social Contract for Economic Recovery

The case for cooperation on GST.

Two heads are better than one, right? Yes, if both work towards shared goals, and one’s gains are not the other’s losses. This is why businesses cooperate. So could the government, industry and consumers, if governments — Central and states — choose to do so. Prospects can improve provided there are overall gains, and all boats rise with the tide. Problems arise if the costs of cooperation are high, or if one participant makes net losses, or considers its share inequitable.

Economic reality and society’s economic contract (echoing Rousseau) have this triad of government, industry (products and services), and consumers, influenced by the media and the judiciary. A coordinated approach could help in resolving impediments to economic recovery. Consider as an example the goods and services tax (GST) rates on products and services. For any rate, government collections increase as product/service delivery increases. However, demand usually declines with increasing prices (including GST). The market equilibrium will be at some level of user-perceived value, at a price depending on supply and demand levels. Conversely, lower GST rates mean lower prices, and higher demand. For expensive products, the lower the rates, down to a reasonable level, the higher the government collections from GST, barring implementation problems. This is because as the tax rate increases, beyond some level sales revenues will decline, as will GST collections.

While government treasuries focus on tax collection, governments’ objective, aside from staying in power, is (or should be) to maximise public benefit. When taxes collected are (a) reasonable, and (b) contribute to the common good, they combine with the user’s perceived value of goods and services at the prices paid, as a component of public welfare flowing from government funds. There is conceivably an optimal GST rate for a product/service that maximises the public benefit for a society, given its circumstances and priorities. These tax rates influence key areas of manufacturing and essential services. Consider an example from each.

India’s capacity in manufacturing cars and automotive components has been built up systematically over many years. In 2018, exports amounted to a little over 5 per cent of total exports of $323 billion, of which components were about 2 per cent, with strong prospects. However, sales slowed for various reasons, some relating to the difficulties of transitioning to the GST system, including the technical challenges. Earlier, domestic taxes were higher, and GST on vehicles and components at 28 per cent was a reduction assumed to yield higher revenues. However, severe GST system design and implementation problems compounded by disruption because of new technologies (electric vehicles), stricter pollution controls (BSVI), confusion about diesel regulation, and a slowing economy, resulted in declining sales from July 2018 (see chart). Difficulties with the GST systems also affected exports.

There are three aspects to consider regarding GST rates:

• First, the likely effect on revenues if taxes are lowered from 28 to 12, or 5 per cent. a) The market leader Maruti Suzuki is unlikely to be affected by a high GST rate because of temporarily slowing sales, as it has installed capacity from prior investment. Major international manufacturers who have not yet established a solid manufacturing base for the domestic market and for exports, however, are likely to have different financial compulsions. Even if they expect that India will be a substantial market and a sound manufacturing base in 10 years or more, the fact that the interim period is fraught with regulatory uncertainty and infrastructural inadequacies may considerably dampen their enthusiasm, to the point of considering alternative manufacturing locations. India cannot assume that it is the alternative to China by default. Major manufacturing investments require stable policies, and low, stable tax rates help in building cash flows. b) India’s experience with telecom franchise fees after 2003-04 shows that a significant reduction in revenue share from operators, from 15 per cent to 8 per cent, along with other factors enabled explosive growth. These resulted in much higher government collections (compare Rs 20,000 crore foregone over eight years in auction fees until 2006-07, to nearly Rs 35,000 crore collected in five years from the rate reduction until 2006-07, which then increased to over Rs 1,65,000 crore by March 2015).
  
• Second, automotive exports need a sound domestic market. Slowing domestic sales and cash flows can affect export markets, compelling foreign buyers to seek alternative manufacturing sources. This can further constrain domestic parts manufacturers who rely on linkages with their customers to build their brands and order books.
  
• Third, the effect of lost sales on employment is devastating, because this sector provides direct and indirect jobs to many millions.

Similar reasoning applies to government charges on digital infrastructure for telecom services, considering these charges amount to more than the investment in networks. Misplaced policies for resource allocation and pricing, misplaced zeal in enforcing questionable interpretations of the law, as well as selective preferential/unfair treatment, have crippled these essential services. Ill-conceived litigation by successive governments have seriously constrained India’s productive capacity, and will continue to do so if pursued. Instead, well-formulated policies, and pricing in the public interest, could lead to a vibrant sector, with a more effective digital broadband network for countrywide productivity and better living conditions.

Our governments can choose to work with industry and users for better outcomes, instead of contending on the basis of outmoded mindsets, laws, and regulations. It requires a far more constructive attitude than has prevailed so far, and an honest recognition of what we lack: Institutional support for organisation and management, including a systems approach, disciplined, end-to-end processes (starting with timely government payments), professional facilitation, legal rigour,1 expert financial modelling and simulation as decision support, and so on, over considerable time.

Administrative authorities and the political leadership need to exert themselves to pull all this together systematically, with the logic of cooperation as the basis of an economic contract.

Tailpiece - added September 15, 2020

For proof of this reasoning, see "Toyota Halts India Growth, Blaming ‘We Don’t Want You’ Taxes", by Anurag Kotoky in the Bloomberg, September 15, 2020: 

https://www.bloomberg.com/news/articles/2020-09-14/toyota-halts-india-expansion-blaming-we-don-t-want-you-taxes

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Shyam (no space) Ponappa at gmail dot com

1. Details at: https://organizing-india.blogspot.com/ 2020/02/why-india-functions-way-it-does.html

Ending Suboptimal Performance

Legacy approaches need to be reconsidered...

With growth being upbeat compared with much of the world, things must be going well with us. There are indeed a number of positive attributes that lend an upward trajectory to expectations. But, there's the difficulty of "living in interesting times", as in the apocryphal "Chinese curse", while we go through this period of transition, with uncomfortable but desirable transformations.

Setting aside the hype in claims and counter claims, there is a genuine upwelling of positive developments, resulting from economic activity in sheer numbers and scale. This leads to improvements in capacity and productivity, although more slowly than we want. The roads in many parts of the country, for example, are disrupted even as they're being improved. Also, roads everywhere are dug up to lay fibre-optic cables where possible. This makes the transition distressing, but the benefits after completion are likely to be substantial, as can be experienced, for example, in driving from New Delhi to Mumbai and beyond. Once Electronic Toll Collection begins countrywide, there will be even greater benefits through more efficient and less polluting freight carriage by road. But these gains come at a cost and take time, and those hurt.

Electricity supply, however, has been negatively affected by a number of factors apart from legacy issues, such as disruptions in fuel, high variations in costs, environmental concerns, and slower economic growth. The adoption of stricter environmental norms, while desirable, has added to costs in this difficult period. Legacy issues driven by political considerations have yet to be addressed, such as under-recoveries from agricultural and residential users, overpricing to industry, and delayed government payments. On the positive side, solar power is becoming more attractive compared with more fully-loaded costs for other sources. A move towards increased use of solar power is likely to be very beneficial in the longer term.

Market access and delivery, meanwhile, is being facilitated by digital platforms, so that many activities from commerce to government services are making the transition. For instance, even for reporting forest fires and fighting them, as in the hills of Uttarakhand just now. There are impediments, of course, such as limited rural access, especially to electricity and high-speed digital networks, or access to credit. But there is increasing capacity coming on-stream, alongside the negative reality of stalled projects and NPAs (non-performing assets, ie, bank loans in arrears). Barring unexpected disruptions, this economic momentum will continue to flow and build, despite a lack of effective strategies, or of planning and coordination. This in itself will improve the NPAs in banks, provided they can weather the interim period. Wilful defaulters need separate resolution.

There are also significant threats to the momentum. Apart from disruptions from social or political discord, the NPAs are a significant hazard, as also an obstacle to other activities whose access to funding is constrained. Other major threats include judicial or environmental actions that disrupt economic activity for whatever reason. Take the automotive industry, which employs millions directly, and perhaps over 19 million indirectly. While Delhi has no major manufacturing plants, actions taken by the Delhi government, or by the courts banning registration of large diesel cars, dampen prospects for all of them, and extend through ripple effects to the sectors that serve them, such as consumer durables, food and travel. It would help if the judges and environmentalists were informed by experts with understanding of the linkages, and of the financial impact, so as to calibrate phased action.

Despite these hazards, the momentum and flow is likely to result in improved productivity and living standards. But this will happen only to the extent that the developments are real. Unrealistic claims will not help, and this is something that needs to be internalised and made manifest in our data and reportage. The quality of data is crucial for analysis and action, as well as for influencing our perception and behaviour. In areas of essential infrastructure such as energy, communications and transport, good data quality will help drive sound decisions and action for future development.

The Opportunity Costs of Underperformance

What one rues is the difference between what happens with this uncoordinated approach, and the possibilities with better planning, prioritising, and coherent effort. There are several aspects to these losses. For example, there's the difference between actual versus potential access to electricity, broadband, or roads/transportation/logistics. Second, there's the loss of functioning at lower skill or delivery levels, instead of gearing to higher levels of professionalism for all skills, and at all levels. Third, and perhaps most damaging, there's the underutilisation of human resources, because of employment and productivity constraints.

Manipulative claims only help perpetuate problems. An example of this is the level of electricity access in the country. A survey of several hundred rural households in 2015 regarding access to electricity uncovered large discrepancies between claims of high access and quality compared with actual levels.¹ Aside from households with no access to the grid, some with access suffered poor quality with high variations in supply, many days without electricity, or with only a few hours of supply each day. Worse, the gaps between tariffs for agricultural versus domestic versus commercial/industrial supply have continued. Power companies not paid on time for subsidies owed are in turn unable to invest to the extent required in equipment because of delayed government payments. This perpetuates a vicious circle of under-recoveries, and underinvestment in generation and distribution systems, leading to insufficient power of poor quality, and so on.

Similar problems affect other areas such as food supply and communications. In food supply, issues such as poor warehousing lead to spoilage. In communications, the need is for policies that will help use resources in the delivery of services. Legacy approaches need to be reconsidered with the purpose of actually providing for our needs. A can-do, problem-solving approach is likely to help take us forward. Meanwhile, improving our performance within present constraints will help in coping during the transition.

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Shyam (no-space) Ponappa at gmail dot com

1: "Access to Clean Cooking Energy and Electricity," 
Abhishek Jain, Sudatta Ray, Karthik Ganesan, Michael Aklin, Chao-Yo Cheng, and Johannes Urpelainen
CEEW Report, September 2015
http://ceew.in/pdf/CEEW-ACCESS-Report-29Sep15.pdf