Geography and Supply Chain Organization

Policy Context

Theoretically, governments either intentionally or unintentionally have a role to play in the existence of artificial barriers to trade. Such barriers can produce regional inequality as highly productive sector take advantage of administrative advantages to congregation, leaving other regions out of the picture.  Over time, this congregation can have compounding effects on a nation-wide scale. With this study, Piyush Panigrahi asks: How are production chains shaped by individuals firms’ characteristics and decisions? How does this shape regional income disparities? What role do regional barriers and federal governments play?

Study Design

In the early 2000s, India adopted an uncommon means of value-added taxation (VAT) which was administered at the state level, not the federal level. Due to state-specific tax credits and administrative ease, this decision led to a reported preference for firm-to-firm trading to take place within states rather than across borders which, in turn, created geographic clusters around certain goods within state borders. This would often be cited as a reason for regional differences in income between states. In 2017, India switched its VAT system to a federal administration, not state administration. Theoretically, this change should reduce inter-state barriers to trade and have a positive effect on aggregate productivity. Using tax data on over 20 million inter-firm relationships between 1.5 million firms, over 5 years, across 141 districts, Piyush examines the effect of the change in taxation policy on productivity.

Results and Policy Lessons

With the data, Piyush created a model of endogenous production network formation between spatially distant firms. The model suggest that upon market integration across Indian states, over half of the variation in changes in firms’ sales to other firms can be explained by changes within a given firm. The framework could be used to help governments answer questions around market integration, technology improvements, and allocative efficiency.