The Telegraph
Since 1st March, 1999
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- The important task is to conduct a social cost-benefit analysis of FDI

The author is an economist at the Indian Statistical Institute, New Delhi

One area in which India almost certainly holds a world record is in the number of committees created by the different tiers of government. Many of these committees are “high-level” committees, while some others are “expert” committees. Perhaps, the lowest or most mundane committee is a “working” committee. But names do not matter because there is a very high probability that the reports of most of these committees meet the same fate — they simply gather dust in remote corners of different government offices.

The latest committee to come out with a report is the high-level committee on foreign direct investment chaired by N.K. Singh. This committee has made sweeping proposals, the most striking being the recommendation to either remove sectoral caps for FDI or liberalize them substantially. The committee has also made a number of important suggestions for simplifying procedures so as to improve the overall environment for FDI. Such suggestions are most welcome because India’s record in attracting FDI is pretty dismal. Comparisons with China are inevitable — we seem to be able to attract only a fraction of the FDI-flow into China.

Unfortunately, the report has seen the light of day at a particularly inopportune moment. As the recent cabinet decision on postponement of disinvestment in the oil giants Bharat Petroleum Corporation Limited and Hindustan Petroleum Corporation Limited, reveals, there is a hostile wind blowing against pro-reform measures. And the issue of foreign investment is among the prickliest issues, since it has a close association with the dreaded word, “multinationals”. In fact, even domestic industrialists, who are all gung-ho on the issue of removal of government controls on their own activities, would typically prefer the government to maintain rather rigid controls over foreign investment.

Tarun Das, director general of the Confederation of Indian Industry, articulated these views of domestic industry some time ago. In fact, Das was one of the severest critics of increased flows of FDI. He launched a bitter diatribe against multinationals, and accused them of a long list of crimes. Das contended that the investment of the multinational companies in India has essentially been restricted to the supply of obsolete technology and second-hand plants. Some of the other alleged drawbacks of multinationals are that these companies overstate their investment costs, and leverage an Indian partner to get in and then capture majority owner- ship of the joint venture as soon as possible.

Of course, this was not the first time that Indian industrialists have voiced their opposition to the reform process. Readers will recall that in 1993, a small group of leading industrialists formed the so-called Bombay Club. This group also protested against the entry of multinationals into the Indian economy, but their protest was more muted. The Bombay Club claimed that the piecemeal approach to the dismantling of licenses and controls and the revision of tariffs implied that foreign companies had an unfair advantage over their Indian rivals, and hence demanded a “level playing field”.

It is not surprising that organizations representing domestic industries feel threatened by the large-scale entry of multinationals. Armed with better technology, vastly superior financial resources and wider access to international markets, multinationals are obviously tough rivals, and only the very best of domestic companies can survive the competition. Many Indian companies must be feeling the impact of foreign competition in terms of falling market-shares and lower profits. But what is bad for Indian industry is not necessarily bad for domestic consumers, who are in the ultimate analysis more important than producers. So the important task is to conduct a social cost-benefit analysis of FDI.

Some of the benefits of FDI are obvious enough, and it is not difficult to understand why FDI has become such a highly attractive source of private capital inflow to developing econo- mies. For instance, foreigners need to be paid returns on their investment in any project only if the project makes profits. This is in contrast to projects that are financed by foreign debt, since interest obligations have to be honoured even if the project incurs a loss. FDI is also much more attractive than portfolio investment since the latter can be suddenly withdrawn, as the Mexicans found out to their cost a few years ago.

Another benefit of FDI is that typically the government stipulates a “minimum export quota” clause. This gives rise to beneficial externalities. These exports with the “Made In India” label make foreign consumers aware that Indian products are not merely cheap textiles, but also manufactured products bearing famous brand names. This generates obvious synergies, and other Indian exports of manufactured goods find easier access to foreign markets.

What are the costs of FDI' Consider, for instance, the accusation that multinationals have brought in second-rate technology into India. In several cases, this must be true. But, surely the important question is whether the technology imported by the multinationals is better than the technology used by domestic firms. Obviously, the multinationals or joint ventures could not have survived competition from domestic firms if the latter had better technology. Unfortunately, the second-hand technology of the multinationals must be several leagues ahead of the technology used by the hitherto pampered domestic firms.

The unpleasant fact is that there is a market for second-hand technology in India, and multinationals are supplying this market. If multinationals are debarred from entering this market, then very soon a market for third-hand technology will be created. The obvious moral here is that the second-hand market itself was created because multinationals were prevented entry into the Indian economy.

Another allegation against multinationals is that their actions are guided by short-term profit considerations. But are multinationals more mercenary than Indian firms' Companies which are motivated by long-run considerations will surely invest in research and development activities, since they know that innovations which lower the costs of production or bring new products into the market are crucial ingredients of success in the long-run. Unfortunately, the well-known fact that levels of research and development activity in Indian companies are abysmally low reveals that domestic entrepreneurs also have quite short time horizons.

In the past, it was also felt that the remittance of profits by multinationals was a drain on the country’s foreign exchange. To the extent that foreign exchange is a scarce resource, this could be used to justify some restrictions on the entry of multinationals. However, the Indian economy has now accumulated a huge stock of foreign exchange reserves. The governor of the Reserve Bank of India will probably feel relieved if the remittance of profits by multinationals eats into these reserves.

So, countries requiring foreign capital inflows as well as those where a market exists for better technology need to attract FDI. “Selling out to the multinationals” has become a fashionable epithet, and even domestic oligopolists have found this a convenient means of furthering their own ends, namely the continuance of an environment where domestic firms had consumers at their mercy. However, there is nothing in our past experience to suggest that Indian firms are more reliable than multinationals.

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