FDI in India: focusing the debate

Updated: Mar 31 2005, 05:30am hrs
It was eminently sensible of Mr Chidambaram to leave out discussions on FDI and the labour policy from his Budget speech. Disagreement on FDI is at the root of many conflicts between the Left and the Congress. Unfortunately, it seems to revolve around the rather meaningless, but politically potent, issue of what level of foreign equity should be permitted. Meaningless, since even with strong regulators, an equity ownership of 10% gives foreign firms complete managerial control in a widely-held Indian company. Here though, I will try to look at the implications of arguing an economic case for FDI.

By and large, an FDI policy in developing countries should seek to promote exports, technology and/or jobs. Consider exports. If export promotion is the objective, FDI should be encouraged in areas presently reserved for small-scale industries (SSIs). Indias major manufacturing exports are garments and gems and jewellery, largely produced by SSIs. Given the low labour costs, these sectors are also highly employment-intensive. With prospects of a big increase in textile and garment exports after this January, it is natural to open SSIs to competition from domestic manufacturers, who can meet the expected huge export orders. By the same token, while 24% NRI equity is already permissible in sectors making products reserved for SSIs, it is illogical to restrict FDI in general from the textile and garment sectors.

What then happens to SSIs They are unlikely to be able to withstand the competition from foreign manufacturers and large domestic companies. For one, they do not have the capacity to benefit from the economies of large- scale production. This is important, as the new global market for textile and garments is likely to squeeze margins as competition becomes more fierce. Second, they do not have the capacity to modernise to increase productivity. On the other hand, if large foreign and domestic companies and FDI are kept out, business will go to China.

Another key aim of FDI policy is to promote technology, particularly in infrastructure. In this, the policy has been fairly successful in redirecting FDI, particularly in recent years. Yet, by definition, these are not necessarily sectors which promote employment. The power sector, for example, is capital-intensive. It also needs technology which FDI could bring in.

FDI policy should aim to promote exports, technology and jobs
Address equity by directly working to help SSIs upgrade efficiency
A third objective is domestic security. If this is the primary aim, then power projects should be out of bounds for largescale FDI. As the Enron saga has shown, the public-good nature of such projects reduces the bargaining power of governments.

That, then, is the dilemma. If FDI is to promote employment, it must be permitted in areas presently reserved for SSIs and domestic companies. To take the argument beyond manufacturing, there should be no limitation on FDI in, for example, contractual farming. Some FDI is already coming into these sectors, but on a discretionary case-by-case basis. Yet, discretion, by definition, is anti-competitive. How-ever, a policy of opening these sectors to FDI in general is a political minefield. On the other hand, if the present policy (successful) of directing FDI into infrastructure sectors like power, fuels and telecommunications is to be continued, then job creation cannot be the primary consideration.

The apparent contradictions are easy to resolve, if we understand what economists call the assignment problem. An efficient assignment is one which assigns one policy instrument to one problem. Consider FDI policy. If the aim is to promote exports, then FDI should be allowed in any sector where India is a major exporter, or where FDI controls the trading channels. To then argue that FDI is not going to promote equity considerations and oppose it on this ground is to violate the assignment principle. What then happens to equity It is for the government (via purchase agreements, technology upgradation funds, training programs, etc) to upgrade SSI efficiency. Failure on this must then be traced to failure of government policy on structural adjustment. To keep out FDI would be throwing out the baby with the bath water. Rather than futile debates, it might be useful for our politicians to visit the Taiwanese SSIs, who lead their export effort, to find what makes them tick!

The writer is a professor at the School of International Studies, Jawaharlal Nehru University, Delhi