Indian economic strategy in the new globalisation

by Vijay Kelkar and Ajay Shah.

A great global order has run astray. For over half a century, the world operated under an open system of movement of goods, services, capital and people, a system that was built by the post-war Western powers. India, for all its post-independence suspicions of the market and the world, was a big beneficiary of this order. From 1991 to 2011, India’s GDP growth quadrupled, not solely from an act of internal genius, but on the back of a global system that allowed Indian goods and services to find markets, that established the flow of capital, technology and business knowledge into India. Global companies brought new levels of productivity and knowledge into India, while foreign financial firms gave capital to India’s high-tech sector, and foreign buyers purchased Indian services exports that are at a run rate of $400 billion a year. Foreign companies provided the foundational technologies -- the CPUs, operating systems, the Internet and all the systems software -- on which India's knowledge economy was built. The champions for Indian openness, such as Jagdish Bhagwati and Ashok Desai, were proved right in abundance.

We must first confront a difficult truth: India's growth from 1991 to 2011 was partly built on a global system's benign neglect, a diplomatic dividend that has now been fully spent. In those years, India did not always play by the rules. We, as a nation, maintained a plethora of tariff and non-tariff barriers, all the while taking for granted the access granted to us by a world that was, for the most part, exceptionally indulgent. This indulgence stemmed from the West's perception of India as a decent, democratic country that would, in time, graduate to being a valuable successful country that would be a good citizen in the world economy. The West saw the idea of India; they felt India was a nation on a path to prosperity that was worth supporting, even if it did not always reciprocate with fair play when it came to economic nationalism. This benign neglect is an important element of India's growth story in the great years of 1991-2011, an element that is often neglected.

That era is now over.

The year 2016 was clear and sombre turning point. Donald Trump's rise to power and his subsequent policies of "America First" signalled the end of the post-war consensus on globalisation. At about the same time, China became estranged from the world due to its sustained use of unfair trade practices, going beyond tariffs to a dogged pursuit of economic nationalism where the ability of foreigners to operate in China is undermined. What we are witnessing is not a temporary hiccup, but a major change in the world economy. This is a new Globalisation, where the two poles of the old order (the US and China) are either hostile to the system or using it to their own unfair advantage.

So far, the US economy has endured the Trump shocks. We should not, however, be complacent about this good fortune. There are concerns about what will happen in the US economy on four fronts: local inflation which would then require tough monetary policy, loss of export competitiveness, adverse impact upon investment through increased uncertainty and punishment from the financial markets (Shah, 2025). Just as there are `gains from trade' with GDP growth induced by liberalisation, economic laws work in reverse also: Deglobalisation will harm growth, and the two epicentres of this problem are China and the US. All this paints a more sombre outlook for the world economy. A US with policy capabilities akin to those in an emerging market will be viewed with greater hesitation by global investors, inducing new stresses in financial markets. This is bad for the significantly outward-oriented economy that modern India has become: we need a successful prosperous world economy in order to sustain our rise.

For us in India, this is not a crisis moment on the scale of 1991. We are not facing an immediate balance of payments collapse. But it is an inflection point of equal, if not greater, long-term significance. The old strategies will no longer work. We cannot continue to rely on the indulgence of an open world that supports the rise of India. The path to India's ascent has just become considerably harder, and a commensurate, well-thought-out response is required.

The task of economic thinkers in India today is to strategise that response. Many good writings have emerged on this: Chinoy, 2025; Das, 2025; Ninan, 2025; Rao, 2025; Sengupta, 2025; Sharma, 2025. In this article we draw on all these and synthesise a full picture.

The New Core: Embracing the OECD (ex-US)

The first step in this new world is a pragmatic reassessment of our trade partnerships. If the US and China are now problematic partners, where does India’s future lie? The answer is to pivot aggressively and strategically towards a new core: the set of countries we can term the "OECD ex-US." This group includes the United Kingdom, the European Union, Japan, Canada, Australia, South Korea and many others. Adjacent to this are sophisticated countries such as Taiwan which are not members of the OECD. These are advanced, rules-based economies that remain committed, for the most part, to an open global system. While there are blemishes -- such as the agriculture policies of the EU -- by and large this remains the the sensible and stable core of globalisation today.

It is worth prioritising engagement with them as (a) They have a high level of GDP and (b) Their democratic and pro-globalisation policy frameworks are grounded in the Second Globalisation. Advanced mature democracies operate as institutions; policy movements are not personalised into the whim of a leader; when an agreement is made, it will stick for a long time, which is the time horizon required for private firms to commensurately respond.

We in India need to push on two approaches with these countries.

First, we should work with these countries to construct a new system of globalisation, where a variety of the unfair practices that were tolerated under the GATT or WTO are blocked [EiE Ep96 Is globalisation doomed?] That would be the best response. India has the opportunity to be in the founding group of such a new system. Once this is up and running between a core of important countries, such a system can be presented as an open system available to all countries, should they commit to deep globalisation on a defined set of conditions. The Trans Pacific Partnership ("TPP") -- which morphed into the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) with the 11 countries going ahead without the US -- and the EU are examples of modern multilateral deep trade agreements.

Alongside this, we should make it a top priority to seek a new style of Free Trade Agreements (FTAs) or Comprehensive Economic Cooperation Agreements (CECAs) with every country in this bloc. The term `Deep Trade Agreements' (DTAs) vividly suggests the nature of bilateral trade agreement that is now desirable. The recent Indo-UK FTA is a step in the right direction. But it must be seen as the beginning, not the end. A DTA is not just about reducing tariffs; it is about harmonizing regulations, setting common standards, and creating a predictable legal and business environment that supports free movement of goods, services and capital. Such agreements would allow Indian firms to integrate into advanced global supply chains, gaining access to high-quality technology, capital, and markets.

This strategy demands an Indian retreat from the traditional protectionist approach. Our long-held reliance on high tariffs and a Byzantine web of non-trade barriers, a long list of redlines that subverted meaningful trade deals, is no longer viable. The benign indulgence we enjoyed in the past is gone. Our traditional ways, in a world of rising trade tensions, will be met with a reciprocal, and likely unpleasant, response. The United States is going through the throes of a great upsurge in populism; we cannot afford to provoke a turn towards aggressive economic nationalism, and a rejection of the global trading system, from the rest of the advanced economies. The message must be clear: India is no longer an aspiring economy seeking special treatment, but a serious global player willing to offer an equal, level playing field, and engage in deep globalisation.

This idea is not unique to us. Sensible policy thinkers the world over are looking at the wreckage of the post-Trump trade environment, and thinking on similar lines (Froman 2025, Hinz et. al. 2025).

Such deep engagement would make many new kinds of economic activity possible, which are presently not undertaken:

• Consider the German automotive industry under conditions of a DTA with the EU. Indian firms could then become part of the BMW or Mercedes-Benz supply chain, not just for low end parts, but for high tech components and software of the future automobile. This would require harmonising standards and IP protections.
• Consider the Japanese electronics or South Korean shipbuilding industries. A DTA with these countries could create conditions for them to see India as a China+1 partner (or really, OECD(ex-US)+1) for their advanced manufacturing.
• There are remarkable developments in defence R&D and manufacturing currently emerging, in the coalition of Poland and South Korea. Under conditions of deep integration with these countries, there is an opportunity for India to be a manufacturing platform for this joint work, harnessing Indian skills and geographical remoteness. This would simultaneously give India access to high technology and better defence equipment.

The Inward Turn: Removing the Domestic Shackles

Maximising our engagement with the OECD ex-US bloc is only half the battle. The other, and perhaps more difficult, half is to look inwards. To trade more intensely and successfully with a smaller, more discerning group of partners, Indian firms must be more globally competitive. This requires a sweeping agenda of domestic policy reforms that remove the shackles upon the domestic economy. Eight things loom large.

I. The indirect tax system

The current Goods and Services Tax (GST) regime, while a monumental step forward, is plagued by a major flaw: it fails to fully reimburse exporters for all indirect taxes paid. For the GST to actually be the promised "destination-based consumption tax", you do not tax non-residents. The existing system leaves many taxes (cesses, electricity, fuel, municipal taxes) embedded in the cost of production, which are not refunded to the exporter, thus making Indian exports artificially expensive. Input tax credit (ITC) has to flow fully, so as to generate the complete refund at the point of export. We advocate for a move to a single, low-rate GST, coupled with a simple carbon tax (Kelkar and Shah 2022, Kelkar, Modi and Shah 2025). Such a system would not only make Indian goods more competitive but would also align with evolving global standards, such as the European Union’s Carbon Border Adjustment Mechanism (CBAM), which taxes imports based on their carbon footprint (Jaitly & Shah, 2023).

II. Regulatory reform

We need to build on the intellectual foundation of the Financial Sector Legislative Reforms Commission (FSLRC). The FSLRC’s core ideas -- checks and balances for regulators that wield legislative and executive and judicial power -- are not limited to the financial sector. They must be applied across all statutory regulatory authorities in India. When regulators are enveloped in checks and balances, their arbitrary power will be diminished and their behaviour will become more predictable. This predictability is the bedrock of business confidence, both for domestic firms and foreign investors. This agenda is the sensible interpretation of the fashionable word `deregulation' (Shah, 2025; Krishnan, 2025).

III. Improving the judiciary

None of this can succeed without fundamental improvements in the Indian judiciary and legal framework. The delays in Indian courts, and the risk of matters being decided incorrectly, are a major drag on economic activity. Businesses, both Indian and foreign, are hobbled by disputes that can last for decades. This unpredictability hinders modern business arrangements which are grounded in contracts that perform as promised, and help to create a significant "India risk" premium. There is now a body of knowledge and experience in building better courts which can be brought to play upon this problem (Shah, 2024).

IV. Cities are where production actually happens!

Whether it is services or manufacturing, export oriented production happens in cities. There is a direct connection between the Indian urban reforms agenda -- the economies of agglomeration of talented people into livable spaces -- and the ability of India to produce and export. Thus far, there is little to report on the agenda of decentralisation to city governments, and to better town planning. A great deal of knowledge has now been developed in the country and can be usefully deployed into these questions.

V. Solve the logjam in agriculture

We have long known that Indian agriculture is broken owing to the comprehensive array of state intervention. The Indian state is overseeing and subsidising a faulty system of intervention that is inducing a health crisis through bad nutrition and the burning of fields. Indian protectionism in this field is proving to be disproportionately costly for the overall Indian economy. This underlines the priority of obtaining progress in this area. The essential idea is to have a full play of the price system in agricultural inputs and outputs, with freedom for individuals to buy and sell land, to sell agricultural products, to trade in commodity futures markets in India and abroad, to store agricultural products, and to move agricultural products within India and across the border. Achieving these changes will need to be done with a comprehensive sense of all the margins of adjustment (partial liberalisation is harder for the people) and political wisdom. The metaphor of structural adjustment programs is required for solving the sites of the highest intervention in the past, i.e. Punjab and Haryana.

VI. Macroeconomic resilience

In this turbulent environment, it will be particularly important to maintain macroeconomic stability. The path to macroeconomic stability lies not in autarkic instincts, or stifling private sector innovation, but in creating institutions for resilience. India has made one big movement forward in the form of the inflation targeting system [EiE Ep68 Inflation targeting], which has now delivered better CPI inflation stability from 2015 onwards. We must keep a zealous watch on CPI inflation, and ensure it does not deviate from 4% as is specified in the inflation target. With that problem mostly under control, there are now four areas of work for establishing macroeconomic resilience:

1. There is a problem with fiscal prudence, with a debt/GDP ratio that has risen considerably, and a primary deficit which is well above zero in all years. New institutional designs such as a Fiscal Council can help in this journey.
2. There is a problem with exchange rate inflexibility: a floating exchange rate [EiE Ep67 Exchange rate flexibility] is a great shock absorber when faced with difficult times (Shah, 2024).
3. Much needs to be done to create robust and resilient financial markets, which can absorb shocks in times of need (Shah 2026).
4. The gradual dismantling of the financial repression system (Chitgupi et. al. 2024) will create a new kind of strategic depth for the Indian state in terms of its ability to borrow from voluntary lenders, both onshore and offshore.

VII. Finance as the brain, financing as the raw material

The financial sector itself needs a fundamental overhaul, again drawing on the FSLRC’s vision. Indian firms currently operate with a significant disadvantage: a higher cost of capital compared to their global peers. This is a direct consequence of the malfunctioning financial system and the partially closed capital account. The Indian system of financial repression -- where the state uses regulation to appropriate a portion of private savings -- must be dismantled. Financial reforms will increase the quality of thinking that finance, the brain of the economy, is able to put in when allocating scarce domestic savings. By liberalising the capital account in a careful, sequenced manner, we can allow Indian firms to access the cheapest possible capital from global markets, making them more competitive.

VIII. Improved engagement with the information space

Economic policy acts through the process of reshaping the optimisations of self-interested people, about the nature of government coercion and the strategy for future policy reforms and institution building (Shah, 2018). In this, the communication strategy of the government achieves importance. Central to the 1991-2011 macroeconomic boom was the trust and respect of the private sector, for a shared understanding of the strategy for reforms, carried across multiple elections and multiple teams. As the old adage runs, the policy maker must `say what you will do and then do what you just said'. The modern information environment has become more daunting, with the rise of social media. In such an environment, there is great value in a government that is known for truth telling. A strong orientation towards truth speech would be a powerful asset in improving the structure of expectations of the private sector.

All large global firms are looking to do less in the US and in China. If we play our cards right, India can be a OECD(ex-US)+1 centre of activity for many important firms. But this requires profound improvements in how the Indian state treats foreign firms. India needs to move towards a system of OECD-quality tax treaties and bilateral investment protection agreements. Most importantly, we need a clear Parliamentary law that establishes equal treatment for foreigners, moving away from a mindset of economic nationalism. This would send an unmistakable signal to the world that India is a safe and predictable place to do business.

Engaging the Giants from a Position of Strength

Once India has put its own house in order and established a new core of trade partners, it will be in a position of strength to deal with the two most difficult partners in the new world order: the United States and China.

The problems presented by these two countries are indeed knotty and cannot be solved with chest-thumping nationalism or bluster. Dealing with leaders who have an inward-looking political style requires deft handling and a deep understanding of their political economies. Public posturing or slighting them will not be consistent with Indian interests. The union government needs to create a sophisticated brains trust with a profound understanding of the US and China: their domestic politics, their economic vulnerabilities, and their negotiating styles—to do better in these complex engagements. Through border conflicts in Doklam and Galwan, the Chinese state has primed the Indian intellectual community with questions and concerns, and a significant depth of knowledge on the path forward is now understood (Bambawale et. al., 2021).

The problem of Chinese overproduction is real and immediate (Patnaik and Shah, 2024). The Chinese state's policy of subsidising its firms to maintain employment, which leads to a glut of cheap exports, is a form of economic warfare. It is not just unfair; it is destructive to the manufacturing bases of other nations, including India. A vigorous set of barriers against Chinese imports is not just justified, but necessary. However, this is not an argument for complete disengagement. There are many paths to engagement with China that can and should be pursued, particularly in areas where our interests align, such as in global institutions or in addressing global challenges. Collaboration between China and India is essential for global decarbonisation.

The United States presents a different, and perhaps more fundamental, challenge. The US, which built the old world order, is now in a period of self-doubt and retreat. There is no guarantee that a post-Trump environment will get the US back to its former normalcy as a champion of free trade. The protectionist genie is out of the bottle. Until the US finds its footing again, our primary strategy must be to embrace the OECD ex-US bloc. We should engage with China where it is rational, while recognising the sustained misbehaviour by China against India on numerous episodes before, and we should wait for the US to find its feet one day.

Conclusion

In summary:

1. India was a great beneficiary of globalisation
2. We must recognise that the nature of globalisation has changed, and that this is detrimental to India's interests
3. This is an important turning point in India's history; it is our duty to strategise a response.
4. India needs to be a prime mover of a new deep globalisation arrangement between the advanced economies -- excluding the US -- and India.
5. India needs deep trade agreements ("DTAs") with the advanced economies, excluding the US.
6. The competitiveness of producing in India needs to be addressed by domestic reforms: a globalisation-ready indirect tax system, regulatory reform, financial sector reform, legal system reforms, an environment of institutions for macroeconomic stability, making better cities, solving the policy stuck in agriculture, and shifting the communication strategy in favour of more truth.
7. We should engage with the highly flawed objectives of the US and China from such a vantage point of strength.

The era of India’s economic rise on the back of an indulgent, open global system is over. This is not a Balance of Payments crisis, where we have to mortgage RBI's gold in London, but it is an equally important moment. Our future depends on it. The leadership needs to take the opposition into confidence, as was done by A. B. Vajpayee in 1998 after the nuclear tests, and collaboratively lead this transformation. For all of us in India, for the people and the firms, this is a time to rise to our best and prove our mettle.

The authors are with the Pune International Centre and XDKR Forum.

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Evaluating India's Customs Authority for Advance Rulings (CAAR) and charting a path for reform

by Vijay Singh Chauhan, Prashant Narang, and Monika Yadav.

Advance rulings are critical for trade facilitation - they offer clarity on tariff classifications, customs duties, and valuation, enabling importers and exporters to navigate complex regulatory environments with confidence.

India's journey with advance rulings began in 1999 with the establishment of the Authority for Advance Rulings (AAR), which handled both direct and indirect tax matters. However, the AAR faced severe criticism for its procedural inefficiencies and delays. As one senior customs consultant quoted in the paper noted, "We had cases pending for 4-5 years, forcing many businesses to abandon their plans entirely." The centralised structure, with its single Delhi office, created substantial logistical challenges for businesses across India.

In response to these shortcomings, the Customs Authority for Advance Rulings (CAAR) was introduced in 2018 under Chapter VB of the Customs Act, transforming India's framework from a judicial model to a quasi-judicial one led by senior customs officers. This reform aimed to leverage domain-specific expertise and decentralise operations with benches in Delhi and Mumbai.

However, has CAAR succeeded in delivering timely and consistent rulings, and how does its performance measure up against international benchmarks?

In our recent paper, “Decoding CAAR: Insights, Challenges, and Pathways for Reforms”, we critically assess CAAR's performance between January 2021 and August 2024. Our mixed-methods analysis combining stakeholder interviews with quantitative evaluation of 414 advance rulings uncovers systemic inefficiencies impeding CAAR's effectiveness, notably delays beyond the statutory 90-day timeframe and inconsistencies from limited nationwide applicability.

Despite improvements over its predecessor (AAR), CAAR remains burdened by procedural bottlenecks - chiefly, dependence on port commissioners for technical inputs, uneven workload distribution, and outdated manual processes. Drawing comparisons with jurisdictions like the U.S., Canada, and Australia, we propose actionable reforms: establishing dedicated in-house technical expertise, adopting AI-driven case management systems, and ensuring the nationwide and indefinite applicability of rulings.

By identifying critical gaps and presenting pathways for reform, our research seeks to align CAAR with global standards -essential for strengthening India's role as a reliable global trade partner.

Measuring CAAR's performance: The 90-Day challenge

A central finding of the research is that CAAR struggles to meet its statutory obligation to issue rulings within 90 days. The analysis of rulings issued between January 2021 and August 2024 reveals that only 46.2% of decisions were delivered within this mandated timeframe. This compliance rate varies dramatically among officers, with one achieving 86.1% compliance while another managed just 2.2%.

The primary bottleneck identified is CAAR's dependence on port commissioners for technical inputs. Although regulations allow commissioners just two weeks to provide comments, these responses are often delayed, extending the ruling process by months. As one CAAR presiding officer acknowledged in an interview, delays frequently occur when "comments from jurisdictional commissioners are not received on time," leaving officers with "no option but to delay further".

Some CAAR officers have developed informal practices to mitigate these delays, including sending reminders, making personal phone calls, and issuing demi-official letters. However, these efforts reflect systemic inefficiencies rather than sustainable solutions. The research also highlights the CAAR's reluctance to issue ex parte rulings (without port commissioner input), despite having the authority to do so under Regulation 8(8) of the CAAR Regulations, 2021.

Port-specific applicability: A self-imposed limitation

Another significant limitation is the port-specific applicability of rulings. Unlike systems in the United States, Canada, and Australia- where advance rulings apply nationwide - CAAR rulings are binding only at the specific port where they're issued. This creates inconsistent enforcement across India's customs jurisdictions, forcing businesses that import through multiple ports to seek separate rulings for identical goods.

One respondent articulated this frustration: "Rulings should be consistent across all ports. My classification should not fall under X at one port and Y at another". This limitation not only increases administrative burdens but also undermines the predictability that advance rulings are designed to provide.

The temporal restriction of rulings to a three-year validity period further compounds these challenges. Globally, countries adopt more flexible approaches - Australia's rulings remain valid for five years, while those in Canada and the U.S. have indefinite validity unless there are changes in law or circumstances. As one participant noted, "Unless there is a change in the product or technology, limiting advance rulings to three years seems unnecessary".

Workload imbalance: The Mumbai-Delhi divide

The research reveals significant disparities in workload distribution between CAAR's two benches. The Mumbai bench handles substantially more cases (256) than Delhi (158), with Maharashtra alone accounting for approximately 37.11% of Mumbai's workload. This concentration of cases in Mumbai is followed by Tamil Nadu (31 rulings, 12.11%) and Karnataka (27 rulings, 10.55%), with these three states collectively accounting for about 59.77% of Mumbai's workload.

In contrast, Delhi's jurisdiction shows a different distribution pattern, with Delhi (NCT) itself accounting for 54 rulings (34.18%), followed by Haryana (23 rulings, 14.56%) and Uttar Pradesh (9 rulings, 5.70%). These regions together contribute approximately 54.43% of Delhi's total caseload. The Mumbai bench also faces the additional challenge of 75 orders lacking specified applicant addresses, which further complicates case management.

While both benches experience procedural bottlenecks - such as delays in receiving feedback from jurisdictional commissioners - the Mumbai bench appears disproportionately burdened, given its coverage of the economically significant regions of Western and Southern India. The paper acknowledges this workload imbalance but, rather than recommending additional benches, focuses on process-oriented solutions discussed below.

A path forward: Recommendations for reform

The paper proposes several actionable reforms to enhance CAAR's efficiency and alignment with global best practices:

1. Transition to a Technical Unit Model - Establish in-house technical expertise through dedicated classification specialists and valuation analysts, modeled after systems in Australia, Canada, and the U.S. Pilot at one bench first, with performance measured through turnaround times and stakeholder feedback.
2. Digital Process Optimisation - Implement AI-driven case management using Large Language Models (LLMs) to auto-generate case briefs and identify classification issues. Develop long-term AI solutions integrating HS codes, trade agreements, and global tariff jurisprudence.
3. Nationwide Applicability of Rulings - Amend Section 28J(1)(c) of Customs Act to mandate uniform enforcement across all Indian ports, eliminating jurisdiction-specific inconsistencies.
4. Extending Ruling Validity - Introduce auto-renewal mechanism maintaining rulings' validity unless material facts or trade laws change, reducing business compliance burdens.
5. Enhanced Transparency and Accountability - Create real-time performance dashboard tracking case disposal rates, 90-day compliance, appeal rates, and ruling consistency while maintaining necessary confidentiality.

Implications for India's trade ecosystem

The study's findings have significant implications for India's position in global trade networks. While CAAR represents progress compared to its predecessor, systemic inefficiencies continue to hinder its full potential. Addressing these challenges is crucial not only for domestic traders but also for strengthening India's reputation as a reliable trade partner internationally.

The research highlights an encouraging statistic: more than two-thirds of CAAR rulings align with the applicant's proposed position. This suggests that when the system functions effectively, it provides valuable certainty to businesses. However, the procedural bottlenecks identified in the study prevent this benefit from being fully realised.

As global trade regulations evolve and become increasingly complex, ensuring that CAAR remains agile and responsive is critical to sustaining India's economic growth. The reforms proposed in this paper offer a roadmap for enhancing the efficiency and relevance of advance rulings within India's broader trade facilitation framework.

Conclusion

This process audit of India's Customs Authority for Advance Rulings (CAAR) provides a rigorous assessment of its strengths and limitations. The study effectively documents progress since transitioning from AAR while identifying persistent operational inefficiencies, particularly the 90-day timeline compliance challenge, port-specific applicability constraints, and the technical expertise gap compared to global benchmarks.

For policymakers and trade stakeholders, this research offers a clear roadmap to transform CAAR. The evidence-based recommendations target critical friction points in CAAR's workflow: establishing in-house technical expertise to reduce dependence on port commissioners, implementing AI-driven case management, expanding nationwide ruling applicability, and extending validity periods. These practical reforms align with international best practices observed in jurisdictions like the United States, Canada, and Australia.

Here is the link to the paper.

Vijay Singh Chauhan is a Executive Director at Deloitte Touche Tohmatsu India LLP, Prashant Narang and Monika Yadav are researchers at the TrustBridge Rule of Law Foundation.

Markets in everything: using Coasean bargains to resolve culture conflicts

by Samrudha Surana and Bhargavi Zaveri-Shah.

Introduction

In pluralistic societies with multiple, and often conflicting, cultural, religious, or ethical beliefs, disputes between groups with conflicting norms are highly likely. Take the case of a diverse society such as India. Hindus often complain about the Muslim cleric's call to prayer on loudspeakers, non-Hindus complain about the noise levels during celebratory festivals, Jains complain about the eating habits of other communities, and so on. Often, such conflicts get escalated to courts in the form of disputes, to the government in the form of lobbying for bans, or worse, as law and order problems. Pluralistic societies almost always face the following question: how can differences between conflicting norms be reconciled without resorting to State coercion or violence? In this article, we argue that voluntary commercial transactions between parties with conflicting norms are a powerful mechanism to resolve such conflicts.

Drawing from Ronald Coase's work on externalities and property rights, we argue that the principles underlying Coasean bargaining are not limited to economic contexts, but are also broadly applicable to social and cultural disputes. By internalizing the costs associated with conflicting norms, Coasean bargains enable parties to reach mutually beneficial agreements through voluntary exchanges. We illustrate this through a recent real-world example from India, where voluntary market transactions helped members of two religious communities reconcile their conflicting religious norms. A key policy implication of our argument is that it is imperative for policymakers to minimize the transaction costs for such voluntary transactions.

Coasean bargains in theory

Conflicts arise when one person's actions impose costs on another, creating competing interests that must be balanced. The economist, Ronald Coase, illustrated this through an example of cattle owners and farmers (Coase, 1960). Straying cattle may destroy a neighbouring farmer's crops, benefiting the cattle owner but harming the farmer. Preventing the cattle from straying, however, would impose a cost on the cattle owner. The problem is clear: allowing the cattle to stray increases cattle supply at the expense of crops, while restricting their movement favours crops at the expense of cattle. This is a problem of a reciprocal nature. Resolving such conflicts requires determining the value of what is gained versus what is sacrificed. In such cases, using a stream of case law from the US courts, Coase argued that instead of the State determining the hierarchy of who should prevail, one of the parties could internalize the costs arising to the other, from the exercise by the former of her property right. A Coasean bargain offers a way for individuals to resolve such conflicts through voluntary agreements that align their interests and minimize the costs of the conflict. For instance, a farmer might pay a cattle owner to install fencing, or the cattle owner might compensate the farmer for crop damage. When multiple actors are involved-such as several cattle owners and farmers-the feasibility of Coasean bargains depends on the transaction costs. While high transaction costs may prevent agreements in some cases, parties able to negotiate successfully can still improve their situations by reaching mutually beneficial agreements.

While Coase advocated this framework for the allocation of conflicting property rights, in the next few paragraphs, we demonstrate that the framework has implications for enforcing conflicting values as well.

A Coasean bargain in action

Last year, on the occasion of Eid Al Adha (Bakri-Eid) a festival widely celebrated in India and several countries with a significant Muslim population, a group of people were reported to have raised some money and purchased some goats from an Old Delhi market to rescue them from ritualistic slaughter. This incident was seen as an act of religious intolerance on the part of the rescuers. The undertone of these arguments was that the animal rescue on Eid Al Adha was driven by the rescuers' religious intolerance for Muslims and not genuine compassion towards animals. The rescuers profess Jainism, a religion founded on the value of ahimsa (non-violence towards all life forms). The Jain community is perceived to be populated by rich Jain merchants, who generally vote for the BJP. In a society so deeply divided on religion as India is today, this context creates suspicion for the rescuers' motivations behind this act.

The act of rescuing animals through voluntary transactions between the rescuers and the animal vendors is an example of a Coasean bargain that enabled the Jain and Muslim communities to resolve conflicting values without impinging on the rights of the other community. In this incident, the Jain purchasers perceived a harm from the sale of goats for slaughter . But, to stop the sale of goats would have harmed the seller. If the seller refused to sell to the Jains, the cost of slaughtering goats would have been internalized by the seller in the form of forgone payments from the Jains. In this case, the Jains internalized the costs that would have arisen from the slaughter of the goats purchased by them. Both the buyers and the sellers benefitted from the transaction. The sellers of the animals got value for their goats. The buyers got 'value' for their money in the sense that they managed to use the money to honour a value that they hold. As a Muslim man interviewed by the news reporter said in response to this incident, "It's their religion, and if saving animals (like goats) is part of it, we don't mind. Let everyone practise what brings them peace."

Coasean bargains work where the property rights of the people are more or less clearly defined. For example, consider a hypothetical, but realistic, scenario in a diverse urban neighbourhood where a temple's ceremonies or a mosque's call to prayer disturbs the residents of that neighbourhood. Under a Coasean bargaining framework, a standard example similar to this scenario is that of a firm installing a noise-creating windmill affecting the adjoining property owners' enjoyment of their property. In a world where the law confers property rights on people, a negotiation can start. The firm would offer the people some money in exchange for putting up with the noise, and people sensitive to the noise will perhaps use that money to install noise proof windows. These bargains are possible because nuisance has been defined as a tort under common law. That is, the law entitles people to enjoy their property without disturbance. Similarly, in our hypothetical scenario, in a diverse neighbourhood, the group affected by the noise levels might offer to fund the temple's or mosque's acquisition of a quieter sound system to reduce the noise impact. Alternatively, the temple or mosque may make a similar offer to the neighbourhood residents allowing them to enjoy their property without interruption. In the absence of such clarity on property rights, the scope for arriving at Coasean bargains is extremely limited. Similarly, in instances where the property rights are contested, such as whether the land on which a mosque stands belongs to the trust which runs the mosque, Coasean bargains may not offer a solution. In such cases, it would generally fall upon the courts to define the property right.

Coasean bargains versus coercion

A key benefit of Coasean bargains is that they help build a culture of religious tolerance, as compared to the use of State institutions to address religious conflicts. Even in countries whose constitutions allow their citizens the freedom to practice and propagate a religion of their choice, the State machinery is often used to perpetuate religious leanings. For example, in India, almost every year, like clockwork, several petitions are filed at one court or another in or around the festival of Eid-Al-Adha to restrict ritualistic animal slaughter.

Asking the State and courts to resolve these conflicts is problematic as it empowers them to impose a hierarchy of values on the society at large. For example, in the case illustrated above, a court order restricting the rights of Muslims to slaughter animals would have impliedly placed a higher value on the ritualistic notion of slaughter than the Jains' religious notion of non-violence towards animals. Since courts are designed to enforce rights and interpret laws, they are ill-suited to resolve conflicting values or norms that do not contradict the law. For example, consider the following conflicting values:

1. animal welfare activists rescuing goats from ritualistic slaughter
2. climate activists purchasing ceramic Ganesha idols from the vendors of such idols and disposing them to pre-empt them from being submerged in the ocean
3. climate activists purchasing firecrackers during Diwali and disposing of them to pre-empt noise and air pollution

It is hard for any central institution to explain why one of these values should take precedence over the other, and then impose such preference ordering over the rest of society. In a voluntary transaction, on the other hand, the question of addressing the hierarchy of values is immaterial, since the transaction is based on the subjective value that each party places on their beliefs. A Coasean bargain allows the people practising these conflicting values to order their preferences without forcing them to do so. Further, empowering the State creates opportunities for rent seeking. In electoral democracies, this risks allowing a majoritarian bias to be played out in such conflict resolution, and exacerbates the mistrust of people in the State and the courts.

Voluntary transactions that allow the transacting parties to uphold norms that are important to them are similarly preferable to the common counterfactual of violence, aggression and the exclusion of practices that don't meet one's religious or philosophical leanings.

Conclusion

The Coasean framework underscores the power of voluntary agreements to internalize costs and balance competing economic interests between persons. We extend this intuition to the resolution of conflicting religious and cultural norms, which are likely to exist in any pluralistic society. The incident of Jain members purchasing goats during Eid Al Adha demonstrates how Coasean bargaining through market mechanisms can resolve religious conflicts without state intervention. This case demonstrates that voluntary market transactions, motivated by individual preferences, can yield broader societal benefits by reducing friction between conflicting norms. In a country like India that is ridden with cow protection laws, state sponsored beef bans and religious violence, the volition of this transaction has tremendous significance.

While rooted in a specific cultural context, the insights derived from this example resonate beyond India. The Coasean approach underscores how the market enables each party to achieve their goals while respecting others' freedoms, creating positive societal benefits as an unintended consequence. Many seemingly intractable conflicts between religious communities might find resolution not through legal battles or state intervention, but through Coasean bargaining, where mutual respect and cooperation emerge naturally from the market process, even when religious tolerance itself is not the participants' primary goal.

Finally, as Coase emphasized, the feasibility of these transactions is dependent on the transaction costs. In environments with high transaction costs, such transactions will be fewer, if at all. The goal of the policymaker, therefore, should be to lower the transaction costs to make Coasean bargains between extremely unlikely transacting parties work.

Reference

Coase, Ronald (1960), "The Problem of Social Cost", Journal of Law and Economics, 3 (Oct., 1960).

The authors thank Ajay Shah and three anonymous referees for their inputs.

Economic stress in Russia

by Ajay Shah.

The Russian economy has faced a series of adverse shocks after the invasion of Ukraine:

• Many de facto restrictions have emerged upon international trade,
• Many foreign companies have chosen to pull out or restrict activities in Russia, spanning non-financial and financial firms,
• Many individuals living in Russia have chosen to emigrate; these are likely to be high skill people.

We may think it is not hard for Russia to absorb these shocks. After all until 1991 it was the USSR, a land of central planning and autarky. We think they will just go back to those ways. However, the recent events are likely to impose substantial costs for the Russian economy.

Russia is no longer a centrally planned economy

It sounds funny, in today's world, to think of officials owning a target for exports, to think of officials making calculations about how much steel will be required in the light of what the five-year plan has envisaged for building railway lines. But that non-market mechanism for thinking and allocating resources did exist in the USSR (as it did in India).

That institutional capacity has been lost after 1991, and it cannot be quickly recreated. Now, Russia is a capitalist economy. The shocks will be dealt with by the price system in its usual ways.

Disruptions in the price system

Within the domain of the price system, trade and FDI have a deep influence upon the structure of production. Every modern economy involves millions of decisions about what to produce and how to produce. These decisions are made in a decentralised way, and millions of contracts are in place that govern the purchases and sales of each firm.

When 10% or 30% of these relationships are disrupted, it adds up to a storm in the economy. Yes, production can be reconfigured in a self-reliant way (and self-reliance will always induce greater poverty), but that takes time. There is a period of extremely volatile prices, of shortages, where every firm is cautiously waiting for the dust to settle before establishing a new set of self-reliant contracts. Millions of negotiations have to take place, to get a new set of production relationships going. There is a learning process where some contracts fall into place, and then prices change, and then once again some contracts are disrupted or renegotiated, and so on.

When the price system is humming, it is a marvel to behold, and when it is disrupted, getting back to normalcy (even the low level normalcy of self-reliance) is hard.

In the case of Russia, foreign goods and foreign technology are particularly important. They are an economy organised around selling natural resources and importing everything else. Hence, cutting off ties to the rest of the world will be particularly painful. Russia is more like Saudi Arabia and less like India in this regard.

Finance is the brain of the economy

Every real sector decision is shaped by finance. To get to the correct decisions in the real sector, we need finance to be operating correctly.

Russian finance is not operating correctly. The Moscow stock exchange was closed down on 25 February. For a month, the economy has not known stock prices. It is difficult for managers to make real sector decisions without the direction that stock prices provide. Conversely, the lack of observation of stock prices induces private decision makers to wait and see.

The credit market is also disrupted. Foreign banks have a position of about $120 billion (about 8 per cent of GDP) and are downgrading or exiting their role in the economy. Many borrower firms have a cashflow crisis owing to fluctuations in the economy, and would default on banks. A large scale banking crisis is likely. These fears, in turn, would hamper the ability of banks to fund real sector firms in rebuilding for a world of self-reliance.

The mind of the firm

In this thinking, it's important to go into the minds of the key persons of Russian firms. They are debating and thinking to themselves: Will I default on debt? What will happen when there is a default? What will input and output prices be a year from now? How can I put my skills to the best use in this environment, so as to buy locally and sell locally and make a profit? How do I address the departures of some of my employees? Should I leave? How much emotional and financial resource should I commit to overcoming this crisis? Do I just wait this out, and there will be a regime change, and we will go back to globalisation?

Many firms will choose to lie low and wait for the storm to end, as opposed to jumping to action in reconfiguring production for a new world of self-reliance. This inaction will increase the short term pain in the economy and increase the time required to get back to a humming economy.

The threat of emergency central planning

While Russia evolved into a market economy in the post-1991 period, in every society, when faced with a war and an economic crisis, there is a greater danger of central planning by the state. For an analogy, think of the behaviour of Indian officials when faced with Covid-19. In a crisis, there is a greater risk of abandoning the price system, of officials giving orders to firms. The lack of rule of law and constitutionalism in Russia implies that there is more of a free hand for officials to behave like this.

To the extent that central planning resurges in Russia, it will make things worse.

Conclusions

There are three levels of bad economic performance.

Economic performance is bad when there is self reliance.

It gets worse when we layer self reliance with central planning.

It is worst when the self reliance and central planning are brought in suddenly.

In steady state, Yes, it is possible to do self-reliance. We know that self-reliance will induce mis-allocation of resources and a low GDP, but it can be done. A sustained estrangement by Russia will taken them back to conditions reminiscent of the old USSR or the self-reliant India of old.

But getting to that (poor) state is itself a difficult task. In the short term, the Russian economy is in even worse shape than the mere self-reliance scenario.

The fact that the USSR was once the prime exponent of central planning and autarky does not mean that it is easy for today's Russia to readily go back to autarky and central planning. Russia now operates in the price system; the institutional capacity for central planning has atrophied and cannot be readily recreated. The sudden difficulties in trade, FDI, and finance, create a very difficult environment for every private firm. Self-reliant structures of production can indeed be created, and they will achieve a low level performance of the economy, but it will take years to get there, to reconstruct the complexity of the modern economy in a self-reliant way. In the short term, there will be a large scale economic collapse.

I have previously argued that freezing central bank assets is not that important. But the rest of the economic sanctions are an imposing barrier, that will likely induce an economic collapse, even without considering the direct cost of waging war.

I am grateful to Alex Etra and Josh Felman for useful discussions.

The industry structure of India's large firms: IT is the biggest industry

by Ajay Shah.

When trade liberalisation took place, roughly 1991-2007, there was large turbulence in the structure of production in India. It's interesting to take stock and wonder: What is the present industry structure of the large firms of India?

The overall output of the country is, of course, made up of both large and small firms. Small firms are illegible, so we know much less about what is going out in the vast informal sector. What we do observe with confidence is the large firms. So, while we recognise that the industry structure of the large firms is not the industry structure of the overall economy, we examine this here.

We look at the 26,040 non-financial firms where data is visible for 2018-19 in the CMIE database. For each firm, we focus on gross value added (GVA) and the wages paid. Our crude estimator of GVA, from the income side, is profit before tax (PBT) + depreciation + wages. All values are nominal.

Industry	No. firms	Wages	GVA	Share in	Share in
		(Rs. Trn.)	(Rs. Trn.)	wages (%)	GVA (%)
Information technology	1117	3.83	5.56	30.92	22.84
Chemicals	1997	0.95	3.44	7.69	14.12
Mining	175	0.64	1.82	5.16	7.49
Transport equipment	899	0.69	1.78	5.60	7.30
Miscellaneous services	4043	1.08	1.37	8.75	5.62
Metals, metal products	1525	0.48	1.34	3.86	5.51
Wholesale, retail trading	4378	0.61	1.19	4.93	4.90
Food, agro-based products	1645	0.40	1.06	3.27	4.37
Machinery	1591	0.51	0.98	4.08	4.03
Electricity generation	640	0.30	0.88	2.41	3.62
Electricity trans., distn.	120	0.47	0.66	3.77	2.69
Consumer goods	645	0.25	0.58	2.02	2.38
Construction materials	416	0.18	0.58	1.43	2.36
Transport services	783	0.45	0.57	3.67	2.36
Ind., infr. construction	2255	0.39	0.54	3.11	2.21
Communication services	153	0.32	0.50	2.55	2.07
Textiles	1111	0.31	0.50	2.48	2.04
Misc. manufacturing	1005	0.14	0.35	1.15	1.44
Div. non-fin. services	692	0.20	0.31	1.58	1.26
Div. manufacturing	82	0.05	0.13	0.40	0.55
Hotels, tourism	564	0.12	0.13	0.93	0.54
Real estate	204	0.03	0.07	0.26	0.29
All non-fin. firms	26040	12.39	24.35	100.00	100.00

IT was the most important industry: with 30.92% of the wages and 22.84% of the GVA. This category includes computer services and IT-enabled services.

There are six big industries, which have atleast 5\% of either wages or GVA, and they are: IT, Chemicals, Mining, Transport equipment, Misc. (non-financial) services, and metals. The fortunes of the economy are now primarily about the fortunes of these six industries, which add up to about 60 per cent of the total.

It's surprising, how little is going on in some labour-intensive industires like textiles which is at 2.48 or 2.04 per cent.

The mean firm size (overall) is Rs.935 million of GVA or about \$12 million. In the case of IT, the mean firm is bigger, at about Rs.4,978 million or \$65 million.

Some will read read this table and jump to calls for industrial policy that favours these six industries. This would work poorly, as all industrial policy does. But this table should influence our thinking on the prioritisation of the public goods that will serve the six most important industries, and most notably IT.

India is in a position of strength in IT. This is inconsistent with the language of weakness in a lot of policy thinking on IT, where we see an emphasis upon national champions and protectionism [example]. It is in India's best interests to favour an open global order for the IT industry, but the Indian state tends to argue for a world of narrow domestic walls.

Instant cross-border payments vs. current account inconvertibility

by Ajay Shah and Bhargavi Zaveri-Shah.

The Reserve Bank of India announced a project that may potentially link an Indian payments system, UPI, with PayNow, a peer-to-peer payment system operated by the Monetary Authority of Singapore. A UPI-PayNow linkage will facilitate instant peer-to-peer cross border payments. It would be a striking solution to the long-standing problems of high transaction costs faced by cross-border transactions. It would help increase India's internationalisation.

In this article, we examine the legal foundations for making this project a reality for the end consumer and merchant. We argue that connecting Indian payment systems with cross-border payment systems would face significant procedural complexities involving current account transactions. While UPI-PayNow connectivity is desirable -- as is connectivity between diverse cross-border payments systems -- barriers to convertibility on the current account can render this connectivity illusory.

Current account inconvertibility

What does a desirable cross border payments system look like? It should allow economic agents to make and receive payments with high speed and low cost. It should impose the minimum inconvenience upon every user. In the field of international trade, there is a clear distinction between tariff barriers and non-tariff barriers, in recognition of the idea that there can be substantial barriers to trade even when an overt tariff barrier is absent.

As per India's commitment to the IMF's Articles of Agreement, Indian residents enjoy full current account convertibility. This means that Indian residents should be able to exchange Indian currency, free of restrictions, for any foreign currency of their choice at market determined or pre-fixed (in case of managed currency regimes) rates. Article VIII(2) of the IMF's Articles of Agreement codifies the obligation of full current account convertibility for its members, thus:

Subject to the provisions of Article VII, Section 3(b) and Article XIV, Section 2, no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions.

Section 3(b) of Article VII deals with the replenishment of scarce currency. Section 2 of Article XIV deals with transitional arrangements. None of these provisions, which are more exceptional in nature, apply to normal circumstances.

A multilateral treaty such as the IMF's Articles of Agreement is given binding effect by enacting domestic law to that effect. In India, the International Monetary Fund and Bank Act, 1945 ("IMF Act"), was enacted to give effect to the IMF's Articles of Agreement. However, at the time of its enactment, the IMF Act excluded the said Article VIII(2) as India was not a fully current account convertible country at that time.

When India graduated to current account convertibility in 1993, the Foreign Exchange Regulation (Amendment) Act, 1993 amended FERA to reflect a more liberalised current account regime. However, it allowed the RBI to wield considerable discretion in introducing frictions for making and receiving cross-border payments on the current account. At the same time, the IMF Act was not amended to give binding effect to the said Article VIII(2) of the IMF's Articles of Agreement as domestic law.

After FERA was replaced by the Foreign Exchange Management Act, 1999, more transactions in foreign exchange became feasible for Indian residents than was once the case. However, the economic notion of full current account convertibility of being able to buy and sell foreign exchange, free of all restrictions, for current account transactions, was not realised in the new law. The FEMA, six years after the 1993 announcement, allows the Central Government to impose restrictions on current account transactions. The current account is less restricted than the capital account. But in 2021, Indian residents continue to face barriers to realising the benefits of `full current account convertibility'. Several barriers, both substantive and procedural, exist that make current account transactions difficult or costly for the average Indian retail consumer and merchant, that are not found in countries that have current account convertibility. These barriers are of two types:

1. Some hurdles are explicitly imposed by the foreign exchange law and its ad hoc enforcement.
2. India has restrictions on capital account convertibility. To ensure that the payments ostensibly made or received for current account transactions are not applied towards settling obligations arising from restricted capital account transactions, banks are appointed as gatekeepers. Banks, in turn, have implemented an elaborate procedural machinery to effectively vet each foreign exchange transaction made by a consumer. This creates frictions that hinder current account transactions.

The IMF Articles of Agreement envisage this possibility and attempt to pre-empt it. Article VI(3) of the IMF Articles of Agreement, which allows members to impose controls necessary to regulate international capital movements, specifically provides that, "no member may exercise these controls in a manner which will restrict payments for current transactions or which will unduly delay transfers of funds in settlement of commitments."

There is a third set of rules and regulations under FEMA that violate the spirit of current account convertibility, even if not the strict text of the IMF's Articles of Agreement. These rules and regulations mandate exporters and earners of foreign exchange to repatriate their foreign exchange earnings within a certain period after their realisation. While this period is generally in the range of six to nine months, again, like all other provisions of FEMA, this too is amenable to revision by the RBI and the Central Government.

Barriers to instant peer-to-peer cross-border payments

While the technicalities may differ across transaction type, the bank in question, the merchant and the jurisdiction of the counter-party involved, the hurdles that consumers and merchants face when making cross border payments for current account transactions can be broadly classified into three categories:

Legal restrictions on current account transactions

In exercise of the power conferred on the Central Government under the FEMA, the Central Government has enacted the Current Account Transaction Rules, 2000. These rules prohibit some current account transactions altogether. For example, they prohibit remittances for "hobbies" or the purchase of banned magazines. They also mandate the prior approval of the Central Government for certain types of current account transactions, such as remittances for cultural tours or publishing advertisements in foreign print media. For a third set of transactions, the rules impose caps that may be revised by the RBI from time to time. This effectively means that authorised dealers in foreign exchange must check the rule book when undertaking current account transactions, for they may fall in any of these categories. Particularly, since the restrictions are imposed by rules and legislation made by agencies (not the Parliament), the frequency of revisions is likely to be higher and allow for lesser transition time as they often take effect overnight.

Restrictions linked to payment instruments

Several restrictions against current account convertibility operate through rules about the payment instrument or payment service provider even when it is used for current account transactions.
The Current Account Rules, 2000 impose restrictions on the usage of international credit cards (ICCs) from an Indian issuer. Some of these are in the letter of the law. For example, the rules explicitly prohibit the usage of an ICC for making payment to foreign airlines in a currency other than INR. Other restrictions manifest themselves through enforcement processes. For example, there have been instances of the RBI having issued enforcement letters to holders of ICCs for availing cloud computing services by a foreign company not having operations in India. The basis of the enforcement actions was that the ICCs were meant to be used for current account transactions 'while on a visit outside India'. The outcomes and due process underyling the enforcement actions undertaken by the RBI are rather opaque. The RBI does not issue reasoned orders for its enforcement actions, unlike most other regulators in India. Owing to this opacity, we are not able to know whether holders of ICCs actually ended up paying fines for having used their credit cards for certain current account transactions and the legal foundations of such enforcement actions.
Similarly, until 2015, Indian residents could use the services of online payment gateway service providers (OPGSPs) for the receipt of export proceeds of upto USD 10,000. Later, in order to promote online e-commerce, the RBI allowed Indian importers to use the services of OPGSP to make payments of upto USD 2,000 for imports. Additionally, the RBI mandated OPGSPs that wish to facilitate cross border payments from or to India to set up liason offices in India.

Transaction vetting by banks

RBI has vested banks with the responsibility of acting as gatekeepers for ensuring that payments ostensibly made for current account transactions are not used for engaging in capital account transactions. Technically, this requires banks to vet every single cross border transaction in order to judge its compliance with the FEMA.
To make cross border outward remittances easier for Indian individual residents (as distinguished from corporate bodies and other artificial juridical entities), the RBI issued a `Liberalised Remittance Scheme', which sets annual caps on the amount of foreign exchange that Indian residents can repatriate outside the country, for both capital and current account transactions. This means that making outward remittances requires a payer to fill up atleast one form swearing compliance with the limits and the terms and conditions of the LRS.
Counter intuitively, the friction is exacerbated for inward remittances in the INR denominated bank account of the recipient. To comply with the letter of the law, banks have put in place a system that requires the beneficiary to furnish the bank with a whole bunch of information, such as the purpose of the inward remittance, the bill numbers where the remittance is on account of exports, etc. This form is required to be filled up and submitted for every transaction. Depending on whether the recipient bank is a public sector bank or not and its operational efficiency levels, these forms may require to be furnished in hard copy by visiting a bank branch. It may involve a couple of phone calls from bank representatives asking this, that or the other clarification. For a first time or the occasional recipient of a foreign payment, this practically puts inward remittances on a T+1 settlement cycle!

Current account convertibility means that there is no difference between going onto an e-commerce website and buying from an Indian merchant vs. buying from an overseas merchant. But Indian residents are often asked to perform know-your-customer checks, uploading images of identity documents, when buying from an overseas merchants. In contrast, domestic purchases only require supplying money and not the burden of KYC procedures. This violates globally accepted notions of full current account convertibility, and will be a significant hurdle to making instant cross-border payments a reality for the average Indian consumer.

The problem of convertibility on the current account

Current account convertibility means that cross-border transactions, for the purpose of current account activity, are as frictionless as domestic transactions. Many people believe that India is fully current account convertible; it is sometimes claimed that India has achieved current account convertibility in 1993 and is now inching towards convertibility on the capital account. This is an inaccurate depiction of where India is. There are explicit prohibitions, restrictions or tarriff barriers. There are procedural barriers that drive up the cost of cross-border transactions. There are threats of ad hoc enforcement or disparity across payment instruments or payment service providers.

At first blush, UPI-PayNow connectivity is a sweet and logical idea, there is the possibility of obtaining a quantum leap in reducing transactions costs for cross-border payments. However, it requires the invisible infrastructure of current account convertibility, which is at present lacking in India. The project of building UPI-PayNow connectivity is a great opportunity to re-open these questions and remove all the frictions, whether on paper or in practice, described above. Our objective should be to make India-Singapore payments on the current account as frictionless as (say) payments between the UK and the US.

This situation is not unique to the UPI-PayNow connection. The `fintech revolution' is limited by infirmities of financial regulation in numerous dimensions. Many ideas that first appear eminently sensible tend to break down when placed into the Indian policy environment [example: regulatory sandbox].

Ajay Shah is a researcher at xKDR Forum and Jindal Global University. Bhargavi Zaveri-Shah is a doctoral candidate at the National University of Singapore.

India's supply chain vulnerability with Chinese APIs: Industrial policy vs. sophisticated policy design

by Gautam Bambawale, Vijay Kelkar, Raghunath Mashelkar, Ganesh Natarajan, Ajit Ranade, Ajay Shah.

India has a remarkable drugs industry. This involves a high dependence upon Chinese manufacturers of `active pharmaceutical ingredients' (APIs). Given the willingness of the Chinese state to behave in unusual ways in economic engagement (e.g. rare earths), there is a certain supply chain risk that is faced by Indian firms.

Should state power be used in addressing this problem? And if so, how should this be done? How do we avoid the long decades of failure in industrial policy, i.e. the experiments with policy pathways where a government picks winners, with a government that claims to know the correct ways in which production should be organised? Today we saw a fascinating article: Drugmakers cry ‘monopoly’ as Modi govt picks 1 firm each to make over 20 key raw materials by Himani Chandna in The Print. This narrates the story of a 1960s style Indian industrial policy intervention played out poorly.

Our book Checkmate China: Winning through strategic patience and accelerated economic growth is forthcoming from Rupa Publications later this year. A paper based on this book has been released in the public domain and summarises our strategic thinking for India about the China question. In the book, we have a treatment of the API question. This text is excerpted ahead. It represents our attempt at learning from 75 years of failure with industrial policy. This approach would have likely avoided the difficulties described in Himani Chandna's article.

Book excerpt: Designing a government intervention to address the supply chain risk faced by Indian firms that import APIs from China

The Indian drugs industry is a heavy user of Active Pharmaceutical Ingredients (APIs) sourced from China. In an environment where we see China as a bad actor in the global economy, where Chinese nationalism can harm counterparties abroad, this presents a risk to the supply chain. It is easy to design Indian economic nationalism which can combat this. However, as with all aspects of industrial policy, such use of state power raises many concerns. It is difficult for a government agency to know whether a certain industry merits subsidies and whether certain firms merit subsidies. There is a long history, in India, of “infant industry” arguments being used for decades, in which some well-connected Indian firms stay infants and continuously collect fiscal subsidies. Similarly, trade barriers in the form of quantity restrictions are prohibited under the WTO and tariffs are harmful and should best be avoided.

Thus, we face a puzzle: How can state intervention be designed, which can make a difference to India’s China problem with the supply of APIs? Given the failures of industrial policy as it was practiced in previous decades, how can this one sharp problem (supply chain risk faced by Indian pharma companies who rely on Chinese producers of APIs) be addressed by state action? How can this state action be done at the minimum fiscal cost, and while imposing the minimum distortions upon the economy? How can the risk of central planning – of officials determining the outcomes of the market-based competitive process – be avoided?

When faced with supply chain risk with a certain API from China, we should not jump to the conclusion that the answer lies in making the API in India. Perhaps the efficient solution is to import the API from a country other than China. Perhaps the efficient solution is to make it in India. Policy makers cannot assume that India has competitive advantage in making the API, when private persons have thus far chosen to not build such factories in India.

The first step in every policy analysis must be a thorough understanding of the behaviour of the private sector assuming there is zero state intervention. When faced with this new supply chain risk, what are Indian drug companies likely to do out of self interest:

1. Customers of these bulk drugs would be conscious about the business risk that they carry. They would watch the rise of nationalism in China with concern.
2. They would increasingly seek to diversify their sourcing. As an example, we are seeing Fortune 500 companies increasingly reduce the share of China in their global production.
3. One important response by the firms will be to buy APIs from countries other than China, e.g. Taiwan or Japan or Brazil. This is perfectly adequate solution, from the viewpoint of an Indian firm, to the threat of Chinese nationalism. Our problems with Chinese nationalism only imply that we should diversify away from China; this does not justify self-reliance.
4. One element of the process of looking for non-China sourcing is higher demand for firms in India that make APIs, which would kick off a supply response. Ordinarily, this market process will work itself out. But it is a difficult and slow journey. A government program can be designed that addresses this problem, which has a few key features: (a) We do not assume that in the long run India will be a successful producer of APIs, but we consider this possible; (b) The intervention is pre-announced and in a few years, liquidates itself; (c) The intervention imposes zero trade barriers upon imports or exports of APIs or drugs with respect to any country.

This proposed intervention would involve the following steps:

• A government agency would identify the top 50 APIs and the quantities $q = (q1, q2, .. q50)$ which are being imported from China.
• We establish the objective of domestic production that comes up to half of the imports from China over a five year period. This suggests escalation of quantities as: $0.1q, 0.2q, 0.3q, 0.4q, 0.5q$ over a period of five years.
• We put out a binding commitment on the part of the state that the government will run procurement restricted to domestic producers only, where there will be purchases over the next five years of these quantities. The government will commit to placing orders with 3 lowest-cost firms that produce in India, in each year’s bidding. The requirement from a bidder should be that production is done in India. Foreign or Indian firms should be permissible, subject to a restriction against firms controlled by the Chinese state e.g. bar a firm where any one member of the board of directors is an employee of the Chinese state or the CCP.
• These commitments about a rising scale of GOI procurement will create incentives for Indian/foreign firms, located in India, to build knowledge and physical capacity to produce APIs at a large scale.
• The government agency has only one objective: to trigger off economies of scale and competition by producers in India. Once the goods are purchased by the Indian government agency, what is it to do with them? Indian firms might not like to buy these APIs at the purchase price, as the purchase price may well be higher than the world price of these APIs. Once the goods are purchased, this agency would run a global auction to sell the same goods off, at the highest possible price. Indian drug companies could potentially choose to buy these goods, but these purchases would be at an import-parity-pricing price. As a consequence, through this program, the Indian government would be drop shipping the goods, purchased in the make-in-India auction to buyers who came into the sell-from-India auction.

This scheme constitutes a promise to buy from Indian firms, at rising quantities over five years, at the lowest prices that Indian firms are able to muster (3 firms for each product in each year). At first, the price in India will be high. Under this proposal, GOI will instantly turn around and sell off the goods at the highest possible price through a global tender. The gap between the two prices will be the fiscal subsidy that is being put down, to spark off API production in India.

At the end of five years, the domestic firms would be on their own. If the theory of change is correct – that there is a fixed cost of building knowledge and facilities to make APIs – then this is the minimum intervention that gets the job done. If the theory of change is incorrect – that India is not actually a good platform for making APIs – then in five years, this fiscal outgo would end, and India would not be a producer of APIs.

There are many strengths of this design:

1. Private persons face no new coercion, other than the coercion implicit in mobilising tax resources which are the source of government spending on this program.
2. There is no tariff; there is no interference in international trade. This program is layered on top of a free trade system.
3. It is a simple and transparent intervention. What it requires is the bureaucratic capability in the Indian state to do procurement: to run these auctions, to buy APIs in India, and to sell the same goods globally, doing high volumes of non-complex commodities. Indian officials are not asked to form a judgement about what APIs are important, about whether an API can efficiently be made in India, about the technology through which an API can be made, about whether public money should be used to build factories to make APIs.
4. There is a lack of fudge factors where there can be lobbying and negotiations.
5. No central planner should ever assume s/he knows the way forward. This design respects the possibility that India might actually have no place in API production. In this case, at the end of this program, there will be no API manufacturing in India. The program would have wasted taxpayer resources, but it would not distort the economy.

However, there are four main difficulties of this design:

1. For the desired impact upon incentives of private firms who should commit themselves to investing in building large scale API production, the private sector would have to believe that the deeds of the government will match the words of the government over the coming five years. If private persons feel that the Indian state cannot be trusted to stay the course for five years, then the incentive impact of the government program would not materialise.
2. The private sector has to feel safe engaging with government procurement; it has to believe that the procurement will be done correctly, that payments will be made on time, that there will be no investigations by agencies.
3. If this works, at the end of five years, Indian API vendors will lobby to not shut this down. Every policy designed to support an infant industry ends up with entrenched infants who like to wield state power in their favour.
4. While the objective of the program should be to foster Indian or foreign firms who choose to produce in India, there is the possibility that this could be skewed to favour Indian firms.

Why is India's business history important?

by Tirthankar Roy.

Remembering Dwijendra Tripathi

In September this year, Professor Dwijendra Tripathi passed away. Until recently, he was the only business historian of India whose works were internationally recognized and respected. In the last twenty years, he produced as author or co-author a set of books, the Oxford History of Indian Business. The deep knowledge of the facts, love of the field, and a direct writing style, for which Tripathi was known, are in full display in these books.

I had interacted with Professor Tripathi closely in the 1990s, reviewed his books, visited his home, and admired him for his warm personality, scholarship, and his distance from ideological camps. On the last occasion we were in touch (7th July 2017), I emailed him the draft of a paper where there was a reference to Tripathi and Jumani in a mildly critical fashion, asking him if he would think that my criticism was unfair. He wrote: “Please go ahead with your paper; criticism is the life blood of scholarship.” Few Indian scholars I know of are so sporting.

With Tripathi’s benchmark books in existence, why write another book called "business history of india"? For that is what I did earlier this year (Cambridge University Press, 2018).

What is the idea of this new book?

This book is different, because it asks two questions that I have not seen others ask before. The first question is, how does a study of history help us understand the resurgence of private enterprise in India in recent times? We can ask this question for all emerging economies, which have seen dramatic transformations led by private capital. What are the historical roots of this emergence? I will call this the emergence question and come back to it ahead.

The second question is this. In a Bengali essay from the 1980s, Ashin Dasgupta wrote, “the more I browse the history of the last 300 years, the more I believe that Indian business has certain Indian features.” Dasgupta was writing about the descendants of Akrur Datta, a Bengali merchant of the 18th century. If this is true, if capitalism – like human beings – have different personalities, we should ask, what is Indian about Indian capitalism?

When I was a student, we learnt a way to connect the present with the past, according to which India was a great place for business until the 18th century -- a dark age unfolded when the British made money exploiting Indian resources, and Indians struggled to get a share of it -- and after 1947, a new dawn broke out. Most professional historians do not believe in this epochal transition model, because its facts are mostly wrong. But what is the alternative model linking the present with the past?

Observe any emerging economy today, and what we should see are hubs of private enterprise that are wealthy, innovative, and institutionally advanced, against the backdrop of a poor countryside that is changing slowly, even regressing by some benchmarks. The past looked exactly like this. Hubs of dynamic, wealthy, innovative capitalists did business in the backdrop of a poor countryside. We find such hubs in the Mughal cities, in the 18th century textile trade, in 19th century port cities, and in the IT or garment clusters today. We can then connect the past with the present by asking, are these hubs similar or are they different? That is what the book does.

We see surprising parallels across time. The most dynamic business towns of the past and those in the present are cosmopolitan, outward-looking, globally connected places. They traded with the world. Whether they exported textiles, or raw cotton, or software is a matter of detail. The people whom trade made rich had access to state-of-the-art knowledge and technology of their times, and knew the value of such knowledge. As an example, without the rich Indian merchants of nineteenth century selling cotton or indigo, you would not get the Presidency College of Calcutta (Kolkata) or the Elphinstone College of Bombay (Mumbai).

But this isn’t a happy story. Making money was a struggle against enormous odds. Interest rates were high, institutions were undeveloped, politics often unfriendly. Have these obstacles disappeared today? Hardly. Capital is still costly in India, all global metrics measuring institutional quality still place India towards the bottom of the list, and politics is still unpredictable. Why does capitalism work at all in an environment of expensive capital and dangers of expropriation by State agencies? The book answers, cosmopolitanism helped. And so did some very Indian resources, such as the idiom of caste or community, if only in some situations. These obstacles and the resources used to overcome them make Indian business history Indian. This is my story.

Who am I writing it for?

Three types of audience: business historians, economic historians, and India-watchers.

Business history emerged in the US and until recently was North American in its choice of examples and theoretical frameworks. This is changing and there is a drive to include more emerging market examples. While the book was not written with that aim, it helps that project.

My own field, economic history, has been preoccupied with a different question. For us, the big question is, “why do some countries grow rich while others stay poor”? While the modern West forged ahead (from early-1800s), why did countries like India and China stagnate and fall behind? Writers like Daron Acemoglu and James Robinson call this one of the most important questions for the social scientists. I am not sure of that, but certainly divergence has been the only game in town for some time.

I think this is a bad question to ask, for many reasons. Let me show only one reason here: The question prejudges India to be a basket case. Those who think this is the greatest question are forced to ignore and overlook the hubs of enterprise that I talked about above.

Business history does not judge. It does not carry the burden on its shoulder as economists do, that we must answer the greatest question in social science. It treats individual business decisions as context-bound, which is a more flexible approach to doing history.

My third intended reader is anyone interested in the historical roots of economic emergence. Many people try to answer the emergence question, and the answers can be odd. Around 2007, a team of 11 people published an article in the IIMA house journal about India’s emergence. The authors were top professionals, and like many thinking people, they felt compelled to say something about history. This is what they said. We should not be surprised that Indians are so good at buying and selling things, they have been doing that for centuries. Still, until now they failed in their historic mission to create a world-class capitalism thanks to “foreign invasions”. The authors wisely left the identity of the invaders open, you can write your favourite invader (Turks, Europeans) in the blank space.

But this cannot be right. India has not had a foreign invasion in the last 70 years, and still scores poorly on Ease of Doing Business index. Indeed, India has not been a cradle of capitalism, not now, not in the past. Doing business has always been a struggle to overcome obstacles. Economic history tends to exaggerate the obstacles. Business history shows the struggle as it was, and helps us understand the struggle today. My book is about that endeavour.

 

Tirthankar Roy is an Economic Historian at the London School of Economics.

The policy posture as an incomplete contract

by Ajay Shah.

1. A complete contract defines behaviour under all states of nature. In the real world, all contracts are incomplete: the parties are inevitably placed before unforseen situations.. But there is a useful distinction between skimpy contracts (where a small range of possibilities are forseen) and thorough contracts (where behaviour under numerous states of nature is specified).

2. The fundamental feature of policy is that it is a statement about how government will behave in the future, and that can vary by the states of nature. Policy risk is the fear that the government will not, in fact, behave in the future as it has promised to behave today.

3. Private persons face zero policy risk when (a) the decision function of the government is fully specified under all states of nature and (b) there is no possibility of the policy being changed. E.g. it would be nice to have a law that guarantees free trade under all states of nature. However, achieving zero policy risk, and complete policy credibility, is like looking for a complete contract.

4. In the real world, there is policy risk because (a) laws are incomplete contracts (there are unforseen states of nature), (b) because laws embed space for executive discretion and (c) because the law can change. A well drafted law reduces policy risk by writing down behaviour under many states of nature, and reduces executive discretion.

5. No matter how well a law is written, there is always a zone of executive discretion and the possibility that the law will change. Low policy risk, then, comes from trust in the thought process, the policy instincts, of the policy establishment. While lawmakers and the executive have the power to do weird things, we attach low probabilities to those events if and only if we trust the intellectual capacity of the policy elite, and the checks and balances (the due process) that will shoot down bad ideas.

6. Consider protectionism in the US. The law was an incomplete contract, in that there was executive discretion to go back to protectionism on the grounds of national security. But for many decades, that event had a low probability because private persons trusted in the intellectual capacity and instincts of the policy elite. When a new populist regime sweeps aside the traditional policy elite, this confidence is lost.

7. In many countries, the old policy elite has been replaced by new populist regimes. This has given heightened policy risk.

8. Clear thinking on globalisation is the hallmark of professional capability in economics. My posterior distribution of policy capability moves a lot when I see a country that engages in protectionism.


I thank Josh Felman for useful discussions.