The growing importance of trade for India

Trade enriches countries because it extends the scope for efficient division of labour

It is now time to dump a tired old assumption about India—that it has an economy closed to trade both within its territory as well as with the rest of the world. The reality is refreshingly different.

The new Economic Survey written by the team of finance ministry economists headed by Arvind Subramanian has used a unique data set of invoices from the goods and services tax network to estimate the level of trade between states (tangentially, we welcome the innovative use of Big Data in the Economic Survey. Railway passenger data has also been used to estimate internal migration patterns. The Indian government needs to embrace such use of Big Data).

The estimates in the Economic Survey show that interstate trade flows, which include the movement of goods between firms and within firms, are around 54% of gross domestic product (GDP). The usual assumption in economic geography, that large countries with substantial domestic markets have robust internal trade, can explain why interstate trade is so active in India, and is perhaps an antidote to the usual belief that the outdated barriers to trade across states reduce the movement of goods and services across borders.

What is unclear is how much of this internal trade is natural and how much a result of a perverse indirect tax system.

It is much the same story with international trade. The old shibboleths need to be discarded. India once suffered under a system of autarky. Much has changed since then. The ratio of trade to GDP has shot up after the economic reforms of 1991 but especially in the first decade of the current century.

Few seem to notice that India has since 2011 traded more with the rest of the world than China does. The trade intensity of both these economies has come down sharply since world trade started contracting a few years ago, but India continues to maintain its lead over China on this front.

What are the implications of these two facts? Trade enriches countries because it extends the scope for efficient division of labour. It thus raises productivity. And trade barriers are an invitation to poverty. So the new evidence that India actually has a robust trading culture should be welcomed.

The task of the Narendra Modi government is to push ahead with more openness on both fronts. The Prime Minister said in November that he wants India to become the most open economy in the world. The data in the Economic Survey shows that we are no laggards—but the challenge now is to keep dismantling barriers to internal and external trade.

The global task is an important one given the rise of protectionist sentiment in many developed countries. Free trade has helped hundreds of millions of Indians and Chinese emerge from the shackles of poverty. There is immense strategic value for India to combine with countries such as China and Japan to keep the flag of free trade flying in the age of Donald Trump. India should not see international trade as a zero-sum game.

The case for even more internal trade is also a solid one. The makers of our Constitution were perhaps still worried about the risks of separatism in the aftermath of Partition when they put in clauses such as Article 302 that gave Parliament the power to impose restrictions on trade between states, even though there could not be discriminatory policies that were specifically targeted at any one state.

Companies have been forced to build suboptimal supply chains because of a fragmented internal market. The agricultural produce market committee laws restrict the ability of farmers to sell across state borders. Such restrictions are past their due date, and the new goods and services tax will hopefully iron out some of these problems.

India is now a middle-income country that has seen the benefits of trade over the past 25 years. Internal economic integration as well as fewer barriers to international trade should be key policy concerns in the years ahead.

India needs to reclaim its place as one of the great trading cultures of the world. A lot has already been done since 1991. The task now needs to be completed.

What should the government do to open up the Indian economy to benefit more from trade?