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Indian Industrial Policy and Global Competition
N. S. Siddharthan 1 Institute of Economic Growth
Delhi University North Campus, Delhi – 110007, India
Email: [email protected]
AbstractThis paper evaluates the impact of Indian economic policy, examines the Indianinvestment climate and business environment in relation to our main competitors likeChina and the East Asian countries, and discusses policy options for the future. In
particular, it analyses trends in Foreign Direct Investment (FDI) inflows, regionaldistribution of FDI in India, and issues related to attracting efficiency seekinginvestments. In addition, this paper also analyses the impact of liberalisation measures on
Indian exports, technology acquisition and productivity growth. In this context the crucialrole of the IT sector and small and medium enterprises is reviewed. In analysing theglobal economic environment it considers the main provisions of the WTO regime andthe ongoing technological revolution .
I THE BACKGROUND
In analysing issues relating to Indian industrial policy and global competition it is
important to consider the current international institutional and technological scene,
namely, the World Trade Organisation (WTO), conditions imposed by the International
Monetary Fund (IMF) for lending to countries and the roles of Information Technology
(IT) and internet in global business. The attempts by several developing economies (DEs)
to liberalise and integrate themselves with the global economy has to be viewed in the
context of the changing global institutional and technological environment.
WTO Regime and its I mpact
The emergence of the WTO regime in 1995 has fundamentally changed the international
trade scene. The WTO is the result of t he Uruguay round of negotiations that began in
1 I am grateful to the participants of the seminar on “Indian Industrial Policy and Global Competition” heldat IIMB on August 20-21, 2005 for their several helpful comments and suggestions.
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1986 in Punta del Este, Uruguay and concluded in Marrakech on December 15, 1993.
Two basic principles govern all WTO sections: national treatment and the most favoured
nation status. National treatment to all firms prohibits the local host government from
granting to the local firms favours, privileges and advantages that are not available to the
foreign firms. Thus in matters relating to government purchases, licensing etc., local
firms and foreign firms have to be treated on par. Likewise, the most favoured nation
status prevents the host government from favouring firms from one WTO member
country over firms from other WTO member countries. WTO has generally improved
transparency (it is one of the core WTO principles that extends across all agreements just
as national treatment and non-discrimination do), and it extends the rule of law. These
improvements reduce transaction costs through the external market. The new and heavily
used dispute settlement procedure improves compliance and enables firms to seek to
enforce fair trade by actions taken on their behalf by their governments. These
institutional changes have reduced transaction costs and have made exporting, licensing
of a firm’s proprietary knowledge and knowledge sharing in networking alliances
attractive options. Further, reductions in tariffs are also a part of WTO, and this
stimulates exports and efficiency-seeking FDI.
However, the WTO regime also restricts the scope for the governments of DEs to
regulate and control. For example, the Indian pharmaceutical industry developed rapidly
mainly due to the restrictive patenting regime in India, where product patents were not
allowed and process patents were for a shorter duration. Under the WTO regime, India
has to grant products patents for 20 years from the date of filing. Furthermore, copyrights
are now protected for 50 years, and they cover several items like software, databases,
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recordings, performances and broadcasts (20 years). Trademarks and service marks are
protected for 7 years and are renewable indefinitely. Moreover, compulsory licensing and
linking of foreign and domestic trademarks are prohibited. These are enforceable through
courts. The enforcement mechanism should be efficient and transparent.
Till recently, India and several other Asian countries have been insisting on local
content requirements from foreign firms. In this regard, in several cases, physical targets
were fixed to promote domestic procurement and to increase the local content. To prevent
the outflow of foreign exchange, trade balancing requirements were also imposed. These
limit the imports of foreign firms to their earnings of foreign exchange through exports.
In some cases, less stringent requirements like foreign exchange neutrality, namely, some
balance between foreign exchange inflows (through exports and investments and other
transfers) and outflows were enforced. WTO provisions prohibit all these measures.
Consequently developing countries had to give up measures like local content, trade
balancing and foreign exchange neutrality since January 2000.
Studies (Kumar 2002; Siddharthan and Rajan 2002) have shown that these
measures could reduce the quality of FDI inflows and inhibit the development of
domestic component industries.
I M F Conditionality
It is important to distinguish the operations of IMF and the conditionality imposed by it
from the operations of the WTO regime. While the WTO regulations apply to all member
countries, the IMF conditionality affects only those member countries that borrow from
IMF. By and large, IMF provides funds on the condition that the borrowing countries cut
deficits, raise taxes and interest rates, liberalise trade and currency exchange rates and
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move towards making their currency convertible in both current and capital accounts. In
some cases, the IMF fixes targets for each of these variables and monitors their
performance. In addition to liberalisation measures, it could also insist on privatisation of
government owned enterprises (Stiglitz 2002).
The Impact of I nf ormation Technology
The emergence of the current generation of information technology tools, in
particular the internet, has radically altered the nature of international transactions.
Earlier market-seeking multinational enterprises (MNEs) invested in foreign locations
mainly to exploit their firms’ ownership advantages (Dunning 1993, Caves 1996).
Currently, partly due to the WTO regulations and partly due to the vast changes in
information and communication technology (ICT), MNEs are opting for efficiency
seeking investments and especially non-equity alliances that often include acquisition of
knowledge assets. This change in the MNEs’ strategy has led to some notable
consequences. Traditionally, design, engineering, and technological innovation were
mainly conducted in the home country. Very little R&D was performed in the host
countries and where it was performed, it was of an adaptive nature intended to modify the
product or process to suit the resource conditions or tastes and preferences of the host
country. By and large, the MNEs invested abroad to exploit the advantages that they
possessed at home. However, unlike the earlier investments, some of the current
investments are technology-augmenting investments aimed at exploiting host country
resources (asset- seeking FDI). In the MNE’s decision process the new factor considered
is the skilled labour possessed in the form of a thin strata of educated labour in some
developing countries. This applies already in industries such as software and
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pharmaceuticals (and it is arising in some manufacturing industries also), and in countries
such as India and China (Kumar and Siddharthan 1997, Siddharthan and Rajan 2002,
Belderbos 2001, Florida 1997, Kuemmerle 1999).
Most importantly, the new knowledge sharing methods adopted by MNEs need
not be fulfilled by FDI. The internet revolution enables a range of non-equity alliances to
substitute for FDI. The immobility of labour across nations that compelled international
growth to take place either by trade or investment no longer applies to a range of
professional and technical activities. The internet revolution has created virtual labour
mobility. Professionals in home and host countries can transmit their labour services
electronically and instantly across borders; they do not need to move geographically.
Investments in operations abroad are not necessary; outsourcing and networking serve as
effectively. This has encouraged the creation of global R&D units that have removed the
differences in the R&D performed by the home and host country R&D units.
Consequently several MNEs have set-up strategic alliances with R&D units in a less
developed country like India where they are performing innovative R&D aimed at
pushing technological frontiers (Reddy 1997, Siddharthan and Rajan 2002). In the
pursuit of efficiency, MNEs are also likely to source high-tech components from their
strategic partners with whom they also share knowledge
In recent years, internet and e-commerce and in particular business to business
(B2B) commerce, have assumed importance. The study by Freund and Weinhold (2004)
finds that internet stimulates trade. They show that internet reduces the fixed cost of entry
into a foreign market and that helps firms from less developed countries and in particular
small and medium enterprises (SMEs). Using data on bilateral trade from 1995 to 1999
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and controlling for the standard determinants of trade growth, they find that the growth in
the number of websites in a country helps to explain export growth in the following year.
Accordingly the success of SMEs would crucially depend on their ability to network,
which in turn would depend on the infrastructure facilities for B2B commerce. Thus IT
has enabled SMEs to globalise. Given the context of the WTO regime and internet
revolution, all the markets have become global and consequently all firms – small,
medium and large - must have a global vision to succeed. Economic policies of DEs have
been responding to the altering international environment.
II INDIAN POLICY REFORMS SINCE THE 1990s
Some studies attribute the Indian reforms introduced in the early 1990s to the balance of
payments crisis in 1991 when India was left with just two weeks’ import cover (Bhaumik
et. al. 2002). The 1991 crisis could have acted as a catalyst for the reforms. But the entire
reform process cannot be attributed to the crisis. India has been deregulating its economy
since the year 1985 in response to the changes in the international environment discussed
in the previous section. Factors like the success of the Chinese and East Asian
liberalisation measures, Uruguay round of negotiations that started in 1986 and that was
nearing completion in the early 1990s, the collapse of the Berlin wall in 1989, the turmoil
in the erstwhile Soviet Union and the ongoing IT revolution contributed significantly to
the introduction of liberalisation measures in India and other DEs. In fact most countries
went in for liberalisation in the 1990s and India was no exception.
Nevertheless, the measures introduced in the year 1991 were not on par with the
earlier reform measures. The year 1991 was a landmark or a watershed. A statement on
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Industrial Policy was introduced in July 1991 that aimed at letting entrepreneurs make
investment decisions on the basis of their own commercial judgement. Under the
industrial license and permit regime this freedom was not given to entrepreneurs. The
statement also declared that the role of the government would be changed from one of
only exercising control to that of providing help and guidance by making essential
procedures fully transparent and by eliminating delays. This statement is a major
departure – a paradigm shift – from the earlier role of the government. Towards this
objective the government introduced a series of “measures to unshackle the Indian
industrial economy from the cobwebs of unnecessary bureaucratic control” (Industrial
Policy Statement 1991, Page 9). They covered several areas – industrial licensing policy,
foreign investment, foreign technology agreements, public sector and the MRTP Act.
These decisions include the abolishing of industrial licensing for all projects
except for a short list of industries attached in Annexure II; liberalisation of the granting
of import licences for capital goods; removal of the requirement of industrial approvals
for locating industries in cities with less than one million population; approval of FDI up
to 51 percent in priority industries (Annex III) and for trading companies; automatic
approval for foreign technology agreements in high priority industries (Annex III) subject
to lump-sum payments being less than one crore rupees and royalty being less than 5%
for domestic sales and 8% for exports; freedom to hire foreign experts; and the
amendment of the MRTP act to remove the threshold limit of assets of MRTP companies
and dominant undertakings. In addition, import duties have drastically come down over
the years. The peak tariff in 1991-92 (excluding high tariff items like alcohol, agricultural
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The policy also encourages the development of India’s indigenous resources by
enhancing research on traditional medicine and by applying globally acceptable norms of
validation and standardization. A purposeful programme to enhance the Indian share of
the herbal medicine market has been initiated. In this context an IPR (intellectual
property rights) system to protect innovations arising out of traditional knowledge has
been evolved and incorporated in the law.
I ntern ational Collaborations
The document encourages international collaborative programmes between academic
institutions and national laboratories in India and their counterparts in all parts of the
world. It lays special emphasis on collaborations with developing countries of the South
with whom India shares many common problems.
The document lists several policy objectives. They include greatest autonomy for
R&D institutions and science laboratories, interaction between industry and public
institutions in science and technology and international collaborations.
INFORMATION TECHNOLOGY ACT 2000 AND THE INDIAN SOFTWARE
INDUSTRY
The enactment of the IT Act of 2000 is an important landmark in India’s entry to e-
commerce and internet based transactions. The Act provides legal recognition for
transactions carried out by means of electronic data interchange and other means of
electronic communications, like, e-commerce, which involve the use of alternatives to
paper-based methods of communication and storage of information. The Act facilitates
electronic filing of documents with government agencies. In particular the Act provides
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for authentication of electronic records by affixing digital signatures. It allows the use of
asymmetric crypto systems and makes provisions for verifying electronic records.
The IT Act 2000 also ushers in Electronic Governance by according legal
recognition to electronic records and digital signatures. The law provides for the filing o
any form, application or document, the issue of licence or permit and the receipt or
payment of money using electronic records and digital signatures. Furthermore, it also
makes provision for the recognition of foreign certifying authorities. Thus the digital
signatures certified by these authorities will be valid as per the Act. In other words the
Act puts the necessary legal framework in place for Indians to participate and benefit
from the IT and internet revolution.
This section has mainly presented the important reforms introduced since 1990.
The impact of these reforms and the need for further reforms will be discussed later at the
appropriate places.
III FDI INFLOWS: INDIA, CHINA AND EAST ASIAN COMPARISON
The nature and character of FDI flows in the WTO regime is likely to be very different
from the flow during the pre-WTO regime. In the earlier regime one of the important
reasons for FDI inflows was to jump tariffs and exploit the host country markets (Caves
1996 and Dunning 1993). In some of the earlier studies, effective rates of protection
emerged as the most significant variable explaining FDI inflows (Lall and Siddharthan
1982). FDI inflows are mainly analysed using the Ownership – Location – Internalisation
(OLI) paradigm, which states that MNEs enjoy ownership advantages in terms of
technology, brand names and other intangible assets and they prefer to exploit them in a
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foreign location if internalisation advantages are large. That is, ownership advantages
could be exploited in three ways: (1) by producing goods in the home country and
exporting them to third countries, (2) licensing their technology and brand names to third
parties and (3) investing in foreign locations (FDI) and producing the goods in the host
country. The decision to produce goods in a third country instead of exporting to that
country or licensing their intangible assets to their partners will depend on internalisation
advantages and the international trading environment. Here, one of the important motives
for FDI happens to be host market exploitation. The WTO regime has drastically altered
the international trading environment. With the reduction of tariffs and abolition of
quantitative restrictions, exports have emerged as a viable option to market seeking FDI.
Furthermore, the intellectual property regime has made licensing of technology less risky.
Under these changed circumstances, the importance of host market seeking FDI
will decline. At present, partly due to the WTO regulations and partly due to the vast
changes in the communications and information technology, MNEs are deciding on
efficiency seeking investments and are using the host country as a platform to export to
third countries. This change in the MNEs’ strategy has led to some notable consequences.
In the case of host country market exploiting FDI, the MNEs carried out most of their
designing and innovative R&D in the home country. Very little R&D was performed in
the host countries and where it was performed, it was of an adaptive type intended to
modify the product or process to suit the resource conditions or tastes and preferences of
the host country. By and large, the MNEs invested abroad to exploit the advantages that
they possessed in their home. Unlike the earlier investments, some of the current
investments are by way of technology augmenting investments aimed at exploiting the
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host country resource (including knowledge base and human skills) advantages (Kumar
1998, 2000, 2002, Kumar and Siddharthan 1997, Belderbos 2001, Florida 1997,
Kuemmerle 1999, Siddharthan and Rajan 2002). Consequently, MNEs will locate plants
in third countries because it is more efficient to produce in that location. The
determinants of efficiency seeking FDI are very different from those of market seeking
FDI.
The WTO regime will also affect the investment behaviour of domestic firms
(both large and medium sized). In the global regime, Indian firms may not invest in India
if it is not efficient to produce that product in India. They may prefer to produce it in
China, Malaysia or Thailand and import it into India. Already there is some evidence of
this happening from newspaper and media reports. Therefore, it is not enough to study
the changes in the Indian business environment over the years and analyse their changing
trends. It is important to study the Indian business and investment environment in relation
to India’s main competitors in our neighbourhood like China, Malaysia, Thailand and
other ASEAN countries.
Table 1 presents the trends in FDI inflows – world, developing countries, China,
Hong Kong, India, Malaysia and Thailand. Trends from Table 1 are presented in Charts 1
and 2. Certain trends show up in the table and the charts. The share of the DEs in the FDI
inflows was more than 30 per cent during the first half of the 1980s. They sharply
declined in the second half of the 1980s and the DEs’ share came down to about 15 per
cent during 1989. It started increasing after that and reached over 30 per cent only during
1992. During 1997 it reached its peak of about 40 per cent and started declining again.
Currently the DEs’ share in FDI inflows is about 25 per cent. It turns out that the MNEs
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are mutual invaders and they prefer to invest in high income developed countries that are
also home countries of MNEs rather than investing in DEs. The share of DEs is modest
and FDI to DEs also flows to relatively high growth countries like China and East Asian
countries. Likewise technology has also been flowing into technology rich countries
(Siddharthan and Rajan 2002). Developed countries make more than 85 per cent of the
royalty payments and DEs make very little technology payments.
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Table 3.1FDI Inflows
(Millions of US Dollars)
Host region WorldDeveloping
economies ChinaHongKong, India Malaysia Thailand
1980Share %
54 957100
8 39215.27
570.10
7101.29
790.14
9341.70
1890.34
198169 456
100 23 576
33.94 2650.38
2 0632.97
920.13
1 2651.82
2940.42
198259 302
100 27 257
45.96 4300.73
1 2372.09
720.12
1 3972.36
1880.32
198351 453
100 17 783
34.56 6361.24
1 1442.22
60.01
1 2612.45
3580.70
198460 214
100 18 402
30.56 1 258
2.09 1 288
2.14 19
0.03 7971.32
4080.68
198557 632
100 14 909
25.87 1 659
2.88-267
-0.46 1060.18
6951.21
1640.28
198686 458
100 16 420
18.99 1 875
2.17 1 888
2.18 1180.14
4890.57
2630.30
1987139 849
100 23 245
16.62 2 314
1.65 6 250
4.47 2120.15
4230.30
3520.25
1988163 770
100 30 421
18.58 3 194
1.95 4 979
3.04 91
0.06 7190.44
1 1060.68
1989192 492
100 29 323
15.23 3 393
1.76 2 041
1.06 2520.13
1 6680.87
1 7780.92
1990208 664
100 36 948
17.71 3 487
1.67 3 275
1.57 2370.11
2 6111.25
2 5751.23
1991158 859
100 43 325
27.27 4 366
2.75 1 021
0.64 75
0.05 4 043
2.55 2 049
1.29
1992167 007
100 55 341
33.14 11 156
6.68 3 887
2.23 2520.15
5 1383.08
2 1511.29
1993225 580
100 81 572
36.16 27 515
12.20 6 930
3.07 5320.24
5 7412.54
1 8070.80
1994255 939
100 104 332
40.76 33 787
13.20 7 828
3.06 9740.38
4 5811.79
1 3690.53
1995333 818
100 114 891
34.42 35 849
10.74 6 213
1.86 2 151
0.64 5 815
1.74 2 070
0.62
1996384 960
100 149 759
38.90 40 180
10.44 10 460
2.71 2 525
0.66 7 297
1.90 2 338
0.61
1997481 911
100 193 224
40.10 44 237
9.18 11 368
2.36 3 619
0.75 6 323
1.31 3 882
0.81
1998686 028
100 191 284
27.88 43 751
6.38 14 766
2.15 2 633
0.38 2 714
0.40 7 491
1.09
1999
1 079 083
100
229 295
21.25
40 319
3.74
24 580
2.28
2 168
0.20
3 895
0.36
6 091
0.56
20001 392 957
100 246 057
17.66 40 772
2.92 61 939
4.45 2 319
0.17 3 788
0.27 3 350
0.24
2001823 825
100 209 431
25.42 46 846
5.69 23 775
2.89 3 403
0.41 5540.07
3 8130.46
2002651 188
100 162 145
24.90 52 700
8.09 13 718
2.11 3 449
0.53 3 203
0.49 1 068
0.16Source: World Investment Report 2003, United Nations Conference on Trade andDevelopment, CD.
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Chart 1
Year Wise Graph
- 10 000
-
10 000
20 000
30 000
40 000
50 000
60 000
70 000
1 9 8 0
1 9 8 1
1 9 8 2
1 9 8 3
1 9 8 4
1 9 8 5
1 9 8 6
1 9 8 7
1 9 8 8
1 9 8 9
1 9 9 0
1 9 9 1
1 9 9 2
1 9 9 3
1 9 9 4
1 9 9 5
1 9 9 6
1 9 9 7
1 9 9 8
1 9 9 9
2 0 0 0
2 0 0 1
2 0 0 2
Years
$ M i l l i o n
China Hong Kong, China India Malaysia Thailand
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Graph
-
1 000
2 000
3 000
4 000
5 000
6 000
7 000
8 000
1 9 8 0
1 9 8 1
1 9 8 2
1 9 8 3
1 9 8 4
1 9 8 5
1 9 8 6
1 9 8 7
1 9 8 8
1 9 8 9
1 9 9 0
1 9 9 1
1 9 9 2
1 9 9 3
1 9 9 4
1 9 9 5
1 9 9 6
1 9 9 7
1 9 9 8
1 9 9 9
2 0 0 0
2 0 0 1
2 0 0 2
Years
$ M i l l i o n
India Malaysia Thailand
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Ever since China started allowing FDI inflows it has been attracting inflows that
are several times that of India. However, FDI inflow figures for China and India are not
strictly comparable. Till recently India did not follow the IMF definition of FDI inflows,
namely, India did not consider retained earnings, reinvestments and raising of Indian
resources by MNEs as FDI. However, China included all these items in FDI.
Furthermore, only less than 30 per cent of Chinese FDI inflows came from OECD
countries (the developed countries). Most of FDI inflows into China came from overseas
Chinese and China’s neighbours (Wei 2004). Nevertheless, even if one takes into account
only OECD investments, the Chinese FDI inflows would turnout to be several times that
of India. During 1993 FDI inflows into both China and India more than doubled. For
China, it increased from 11 thousand million dollars to 28 thousand million dollars (its
world share in FDI inflows increased from 6.68 per cent to 12 per cent) and the inflows to
India increased from 252 million dollars (0.15 per cent of the world share) to 532 million
dollars (0.24 per cent of the world share). Since then the FDI inflows to both China and
India continued to rise till 1997 reaching $44237 million for China (9.18% of world
share) and $3619 million for India (0.75% of world share). From 1997 to 1999 FDI flows
declined for both countries reaching $40319 million for China and $2168 million for
India. Since 2000 FDI inflows have been increasing for both countries and in 2002 they
were $52700 million for China and $3449 million for India. Despite similarities in the
turning points and trends the two countries are not on par as India receives only a small
fraction of FDI compared to China.
The Asian financial crisis took place towards the end of 1997. However, it
affected Malaysia and Thailand differently. In the case of Malaysia FDI inflows
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Toyota to virtually stop production in two of its plants in November 1997. But by January
1998, it resumed production by injecting capital and using its influence to increase the
export share. The parent company injected an additional capital of 4000 million baht into
Toyota Motors Thailand, increasing its registered capital. But for this timely investment,
the Thai company would have collapsed.
The second example is that of Honda in Thailand. To save the company
from the economic crisis Honda injected three billion baht into its Thai holding company
and doubled the capital base of its Thai affiliate. In addition, it also injected cash into the
component manufacturers, purchased shares not fully subscribed and increased its equity
share in Showa Corpn, a joint shock-absorber venture in Thailand. Thus the relocation of
components production, injection of capital and the promotion of exports saved the
automobile firms in Thailand from the financial crisis. However, despite these helpful
investments by Japanese MNEs, FDI inflows to Thailand declined sharply during 2002.
Perhaps the investment climate was not favourable.
REGIONAL DI FF ERENCES I N FDI INF LOWS
As shown in Tables 3.2 and 3.3, there are substantial regional differences in FDI inflows
in India and China. In both countries about 8 states/provinces account for more than two
thirds of FDI inflows. Furthermore, these top 8 states/provinces also account for the bulk
of domestic investments and also enjoy higher income and better socio economic
indicators (for India refer to Siddharthan and Rajan 2002; and for China Yao and Zhang
2001).
Table 3.2
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China: FDI by Province and Municipality as of 2000
Region Realized
Value10 Million
Share
Total 34,834,549 100
Beijing 1,439,843 4.13
Tianjin 1,327,461 3.81
Hebei 679,748 1.95
Shanxi 152,585 0.44
InnerMongolia 64,089 0.18
Liaoning 1,484,450 4.26
Jilin 292,167 0.84
Heilongjiang 366,392 1.05
Shanghai 2,833,979 8.14
Jiangsu 4,373,047 12.55
Zhejiang 1,118,759 3.21
Anhui 303,430 0.87
Fujian 3,351,038 9.62
Jiangxi 271,287 0.78
Shangdong 2,110,910 6.06
Henan 431,743 1.24
Hubei 642,956 1.85
Hunan 524,340 1.51
Guangdong 9,819,210 28.19
Guangxi 694,305 1.99
Hainan 622,978 1.79
Sichuan 317,858 0.91Chongqing 224,886 0.65
Guizhou 42,238 0.12
Yunnan 96,978 0.28
Shannxi 304,595 0.87
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Gansu 45,616 0.13
Qinghai 1,968 0.01
Ningxia 12,856 0.04
Xinjiang 36,967 0.11
Others 845,870 2.43Source: www.chinafdi.org.cn
Table 3.3India: FDI Approval by States
(August 1991 – September 2000)
States Investment(Rs.10mill)
Share(Percentage)
Maharashtra 40,726.09 17.12
Delhi 31,817.55 13.37Karnataka 19,796.78 8.32Tamil Nadu 16,895.50 7.10
Gujarat 11,175.31 4.70Madhya Pradesh 9,752.81 4.10
Andhra 9,448.91 3.97West Bengal 8,375.66 3.52
Orissa 9,986.74 3.36Uttar Pradesh 4,067.35 1.71
Haryana 2,983.87 1.25Rajasthan 2,539.62 1.07
Punjab 1,938.90 0.81Kerala 1,277.23 0.54Bihar 851.67 0.36Goa 529.35 0.22
Pondicherry 394.85 0.17Himachal 361.66 0.15
Chandigarh 141.84 0.06Unallocated 66,596.43 27.99
Source: Ministry of Commerce and Industry
In China, by and large, provinces belonging to the Eastern Zone have been attracting FDI
and they also happen to be the provinces enjoying higher per capita income (see Yao and
Zhang 2001). The provinces belonging to the Western Zone have not been attracting FDI
and they also happen to be the poorer provinces. Thus while the average per capita
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income of China in 1995 at 1990 prices was 2970 yuan, it was a mere 1765 yuan for the
Western zone and 4223 yuan for the Eastern Zone. For the Central zone the average was
2299 yuan. In particular, the provinces that got high FDI also enjoyed high per capita
income. Thus the major recipients of FDI like Shanghai (Per capita GDP 10712),
Guangdong (5156) Beijing (6995) and other provinces enjoyed per capita incomes that
were almost double that of the national average.
In the case of India, the states that received FDI also happen to be the states that
received domestic investments (Siddharthan and Rajan 2002). By and large most
investments went to the coastal areas and the national capital region (Delhi and the
surrounding areas). The rest of the states received very little investment both domestic
and foreign. Furthermore, as in the case of China, in India also states that enjoyed higher
per capita income received higher FDI inflows. The per capita income of India in the year
2000 (at current prices) was rupees 15562. The states that received higher inflow of FDI
enjoyed higher levels of per capita income compared to the Indian average. For example,
the per capita income of the major FDI receiving states was: Maharashtra, Rs.23398,
Delhi, Rs.35705, and Tamil Nadu, Rs.19141. States that received less FDI like Bihar and
Uttar Pradesh had lower per capita income levels, namely, Rs.6328 and Rs.9765. In this
respect China and India share some similarities. Nevertheless, there is one major
difference. In the case of China the provinces that received high FDI happen to be the
core provinces. The peripheral provinces did not receive much investment. For India, it
was the other way around. The peripheral non-Hindi speaking coastal areas dominated in
attracting investments. The core Hindi speaking states that are politically important in
terms of the number of seats they represent in the Indian Parliament did not attract much
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Tables 4.1 and 4.2 present data on constraints to operations and growth. The
figures represent the percentage of firms ranking the constraint as a “moderate” or
“major” obstacle. The tables in addition to the four countries considered earlier, namely,
India, China, Malaysia and Thailand, also considers Singapore. It was decided to include
data on Singapore also as several studies consider Singapore’s investment climate as a
bench mark to evaluate other countries (Wei 2000). Singapore attracts the most
favourable response from investing firms compared to all the Asian DEs. Table 4.1
presents general constraints and Table 4.2 tax and regulatory constraints.
Table 4.1
General Constraints to Operation and Growth
Country/Variables India China Malaysia Thailand SingaporeCorruption 60.43 31.25 22.73 87.06 8.00Judiciary 29.12 13.83 21.35 25.00 9.09Financing 52.13 80.20 41.05 75.24 30.30Infrastructure 61.98 30.69 19.79 64.89 11.00
Policy Instability 62.96 41.00 27.37 90.85 11.00Inflation 67.91 42.42 39.26 90.59 12.00Exchange Rates 42.77 21.74 28.26 94.77 26.00Street Crime 22.91 18.18 18.48 92.59 6.00Organised Crime 21.84 19.59 14.61 100.00 10.10Anti CompetitivePolicies
na 38.78 27.27 95.40 20.62
Taxes andRegulations
39.23 28.71 20.43 84.25 11.00
Note: na refers to not asked.
Table 4.1 considers the following constraints: corruption, judiciary, financing,
infrastructure, policy instability, inflation, exchange rates, street crime, organised crime,
anti competitive policies, and taxes and regulation. As seen from Table 4.1 Thailand
comes out poorly with regard to all indicators except judiciary. An overwhelming
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proportion of Thai firms consider these as constraints and obstacles to their growth. This
result could be partly due to the timing of the survey, namely, 1998 – soon after the
currency crisis. It could indicate a sense of demoralisation of Thai firms with regard to
governance. Nevertheless, there has been a sharp decline in FDI inflows to Thailand
since 2000 and the drastic decrease in FDI inflows justifies the pessimism of the Thai
firms. Except for financing, in all other cases the Indian scores are higher than the other
three countries, namely, China, Malaysia and Singapore. More than 60 per cent of Indian
firms consider corruption, infrastructure, policy stability and inflation as obstacles to their
growth. The Chinese firms seem to complain only about financing and nothing else. A
majority of Malaysian firms do not consider these variables as constraints for their
growth. In this context it is important to note that Malaysia, which is smaller than some
of the major States in India receives as much FDI as India gets. The results presented in
the table, perhaps, explains the low FDI inflows to India compared to China.
Since a majority of the Indian firms emphasise corruption, it is important to
examine the details of their complaint to understand the magnitude of the problem. About
55 per cent of the Indian firms state that they regularly make payments to get things done.
The modal value of the additional or unofficial payment to secure the contract is between
6 and 10 per cent of the contract value. These figures for India compare unfavourably
with most countries that have been beneficiaries of FDI inflows. For example with regard
to a question regarding making regular payments to get things done, most firms from
several countries enjoying heavy FDI inflows denied making such payments. Thus in
Malaysia a mere 20% of the firms mentioned making regular payments against India’s
55%; the corresponding figures for some other countries are: Singapore 2%, Brazil 26%,
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and Chile 4%. By and large, the percentage is low for most of the East Asian and Latin
American countries. Likewise most of the East Asian and Latin American firms declare
that they had made no payment to secure government contracts, but only less than 12 per
cent of the Indian firms state that they made no payment.
Table 4.2
Tax and Regulatory ConstraintsCountry/Variable India China Malaysia Thailand Singapore
BusinessRegistration
26.18 27.72 27.55 26.92 9.28
Customs 50.27 21.05 29.89 47.64 10.75Labour 63.68 16.00 42.71 53.98 24.00ForeignCurrency
34.95 14.63 29.67 42.44 9.28
Environmental 40.64 19.79 26.88 42.07 5.10Fire 19.58 14.43 17.53 33.73 5.00High Taxes 67.86 50.00 36.17 80.91 31.96TaxAdministration
41.15 30.00 20.83 69.93 12.00
Table 4.2 presents the views of firms on tax and regulatory constraints relating to
problems and difficulties faced regarding business registration, customs, labour, access to
foreign currency, environmental regulations, fire, high taxes and tax administration. Here
also as in Table 4.1 the values for India are higher than for all the other countries with the
exception of Thailand. A majority of Indian firms had complaints against customs, labour
and high taxes. About 50% of Chinese firms had complains against high taxes. Except for
the high taxes, most of the Chinese firms seem satisfied with tax and regulatory
measures. In the case of Malaysia also only a minority of firms considered these variables
as constraints. Since 1998 India has introduced several tax reforms and currently India
aims at having a tax structure that is on par with ASEAN countries. Therefore, currently
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high taxes may not pose a serious problem for the Indian firms. Nonetheless, problems
relating to customs and other issues remain.
Table 4.3Obstacles to Firm FinancingCountry/Variable India China Malaysia Thailand Singapore
Collateral 50.53 20.20 41.49 49.35 29.17Bank Paperwork 50.53 29.00 32.99 44.61 21.65High Interests 81.18 35.35 52.58 84.24 32.99SpecialConnections
34.97 25.53 34.74 51.24 18.75
Banks FundShortage
18.48 37.00 20.22 79.39 3.23
Access to
Foreign Banks
22.03 17.14 14.29 71.67 5.43
Access to Non-Banks
23.98 12.79 15.19 61.90 11.24
Access to ExportFinance
25.61 21.33 14.71 64.84 10.11
Access to LeaseFinance
20.59 22.47 7.69 60.61 8.70
Access to Credit 32.12 44.44 21.84 75.34 13.04
Table 4.3 presents obstacles to firm financing. Figures given in the table refer to
percentage of firms ranking each component as “moderate’ or “major” obstacle. The
obstacles listed are collateral, bank paperwork, high interests, special connections, bank
fund shortage, access to foreign banks, access to non banks, access to export finance,
access to lease finance and access to credit. Of these items a majority of Indian firms
complained only against three, collateral, bank paperwork and high interests. Since 1998
(the year of the survey) the Indian interest rates have come down substantially and paper
work has also been simplified. However, many SMEs in India feel that the Indian banks
have a bias in favour of large enterprises and are reluctant to lend to SMEs. Most Thai
firms have complaints with regard to almost all the items listed. However, most Chinese
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and Malaysian firms have not voiced their complaint against most of the items except in
the case of high interest rates where more than 52% Malaysian firms have complained.
By and large, Indian firms do not seem to suffer from financing problems compared to
the Asian neighbours.
Table 4.4Percentage of Firms Rating the Quality of Services as Bad
Country/Variables India China Malaysia Thailand SingaporeCustoms 40.00 14.29 11.59 28.76 1.09Courts 28.34 20.55 29.51 20.26 0Roads 68.53 22.47 21.11 40.00 0
Postal na 11.46 8.60 6.31 0Telephone 26.24 14.14 7.29 15.89 0Power 40.30 14.74 7.29 17.52 2.02Water 29.63 12.64 14.58 20.42 0Health 48.17 30.77 14.46 28.42 2.06Military 8.94 Na 15.63 19.86 1.10Government 40.35 Na 17.78 39.59 1.16Parliament 60.24 Na 25.00 45.17 1.16Central Bank na 15.58 10.45 43.90 1.11
Table 4.4 presents data on the percentage of firms rating the quality of services as
bad. The services included are customs, courts, roads, postal, telephone, power, water,
health, military, government, parliament, and central bank. As seen from the table, except
for military and courts, the Indian scores are higher than other countries. For courts
Malaysia is higher and for military Thailand is higher. However, except in two cases, the
Indian scores, though higher than for other countries is less than 50.
As seen from the four tables, governance factors appear to be more
important than other factors affecting business environment. This finding is in line with
the findings of other studies. In particular, a number of studies have shown that tax
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concessions have not been very effective in attracting investments (Loree and Guisinger
1995). On the other hand, corruption increases the transaction costs, sometimes to
intolerable levels (Wei 2000), and results in costly delays. Porto’s (2005) study shows
that high transport costs, cumbersome customs practices, costly regulations and bribes act
as export taxes that distort the efficient allocation of resources, lower wages, and increase
poverty. Furthermore, high transaction costs and delays will drive away investments by
MNEs and domestic firms.
Wei’s (2000) study analyses the determinants of the bilateral stocks of FDI from
12 source countries to 45 host countries. The source countries include the US, Japan,
Germany, UK, France Canada and Italy. In analysing FDI the following explanatory
variables are used: tax rate, corruption, tax credit, political stability, GDP, population,
distance between the two countries, linguistic ties between countries and wage rates. The
study shows the overwhelming importance of the corruption variable in influencing FDI
in relation to all the other variables. Two measures of corruption are used – the first, the
corruption rating from the International Country Risk Group and the second,
Transparency International Index. The study concludes that an increase in the corruption
level from that of Singapore to that of Mexico would have the same negative effect on
inward FDI as raising the tax rate by 18 to 50 percentage points, depending on the
specifications. This strong result of Wei (2000) has been reinforced by more recent
studies (Habib and Zurawicki 2002; Globerman 2002; Porto 2005 and Globerman and
Shapiro 2003).
Habib and Zurawicki (2002) analyse the impact of corruption on FDI for 89
countries for the period 1996-98. They use the corruption perception index produced by
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Transparency International. In explaining FDI inflows, in addition to corruption they also
introduce the following variables: population, GDP growth, per capita GDP,
unemployment rate, openness of the economy as measured by the ratio of trade to GDP,
science and technology indicators, cultural distance and political stability. Their findings
suggest that corruption is a serious obstacle for investment. Apart from corruption,
geographical distance and economic ties also emerge as important determinants of FDI.
Globerman and Shapiro (2003) examine the statistical importance of government
infrastructure as a determinant of FDI. They conducted the analysis in two stages. In the
first stage the probability that a country was a recipient of US FDI was estimated. In the
second stage their analysis was restricted to those countries that did receive FDI flows
and estimated equations that were focussed on the determinants of the amount of FDI
received. The governance measures were taken from Kaufmann et. al. (1999). These
measures include: rule of law index, which measures contract enforcement, property
rights, theft and crime; political instability and violence index, which measures armed
conflict, social unrest, ethnic tension and terrorists threats; regulatory burden index,
which measures government intervention, trade policy and capital restrictions;
government effectiveness index, measuring red tape and bureaucracy, wastes in
government and public infrastructure; graft and corruption index, measuring corruption
among public and private officials and the extent of bribery; and voice and accountability
index, which measures civil liberties, political rights, free press, and fairness of the legal
system. Their results consistently show that governance infrastructure is an important
direct determinant of whether a country will receive any US FDI, and, if so, how much.
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In sum, the literature surveyed so far clearly demonstrates that governance
infrastructure, and in particular, absence of corruption is a crucial determinant of FDI and
its impact is much stronger than other determinants like tax and fiscal policies, interest
rates and labour laws. Moreover, bribes, cumbersome customs practices and delays lower
wages and increase poverty. It is essential to take cognisance of these findings from the
literature in formulating policies to attract investment and achieve higher rates of growth.
V POLICIES TO IMPROVE INVESTMENT CLIMATE
To improve investment climate and usher in good governance, institutional reforms are a
must and they should aim at reducing if not at eliminating corruption, delays and
bottlenecks. Several less developed countries have not been paying sufficient attention to
these aspects but have been concentrating on other features like tax concessions to attract
investment. The prevalence of corruption can be attributed mainly to three factors:
monopoly power enjoyed by officials and other individuals, lack of accountability and
lack of transparency. Institutional reforms have to target these three factors, reduce
discretionary powers of the bureaucracy wherever possible and increase the role of
accountability and make the decision making process transparent. The 1991 Industrial
Policy Statement mentions these three factors but at the ground level things have not
changed much and India continues to be rated high in the corruption index by agencies
such as Transparency International.
It is not possible to completely eliminate the discretionary powers of the officials
but it is possible to minimise the instances where such powers are used and insist on time
bound decisions. Most bribery cases, in particular, the extortionist ones, occur because of
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the power of the officials to cause costly and intolerable delays. Harassment by causing
delay is a common complaint of persons dealing with port and transport authorities,
customs officials, and income tax officials. Some of the East Asian countries that have
been enjoying a flourishing trade have succeeded in eliminating delays in their ports and
customs. In Singapore, for example, the average ship turnaround for a container ship is
less than 8 hours while for India it could be as long as a week. Container delays at Indian
ports cost about US $70 million per year. Likewise it takes about three weeks to clear
export cargo at Indian air ports, due to the non-availability of Jumbo X-Ray machines
necessitating manual opening and checking of all containers. Indian road transport is also
plagued by delays. Thus commercial vehicles in India run only about 250 km per day
compared to about 600 km in several other countries. Poor mileage in India could be due
to bad roads and delays at road check posts, toll gates etc. (For details on the cost of
delays at Indian ports, airports and roads refer to Banik 2001). Unless India follows their
example and gets rid of delays it will become a victim of the emerging global regime. In
this context, it is also important to point out the inordinate delays in the courts and other
dispute settlement mechanisms. It is essential to note that there are persons who are
beneficiaries of the delays in court cases but they are not often the ones who have been
on the right side of the law. Thus invariably a delay by the judiciary encourages those
who benefit by deliberately breaking the law and the regulations. Countries where
institutions like courts and judiciary dealing with dispute settlements and in particular
commercial disputes, are either not in place or do not function efficiently are not likely to
attract investments. As investors cannot afford costly delays, they will shift their
operations to countries where these institutions are in place. Though these problems are
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management patterns has not been sufficiently recognised by enterprises and
governments. Leading technological institutions like the IITs have to introduce
innovative in-service training programmes to improve the knowledge base of
technologists and to familiarise them with the rapid technological changes in their
respective fields. In all these cases the state should network with other institutions - both
the public and privately funded ones. It is not possible to launch a successful and
sustained programme to improve the skill content of the population without achieving
high levels of literacy and ensuring at least ten years of schooling for all children. While
India has been lagging behind in ensuring universal primary and secondary education,
several Asian countries have achieved this objective.
In addition to actively participating in the creation of human infrastructure, the
state has also to take a leading role in the creation of other physical infrastructure like
power, transport and communications Studies have shown that investments in
infrastructure have been more helpful in attracting investments than the offer of
concessions (Wheeler and Modi 1992, Loree and Guisinger 1995). In all these cases, the
state can induce the private sector to invest in infrastructure by removing some of the
century old archaic laws that are still in force. In this context, the Electricity Act of 2003
is in the right direction. However, it could run into several problems due to the practice of
cross subsidies, namely, industrial consumers paying a higher tariff to subsidise others
like agricultural and domestic (households) consumers. One way out of this problem
could be for the state governments to bear the cost of subsidies through a provision in
their budget rather than by asking the power units to bear the cost through cross
subsidisation.
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To drastically increase investment rates, the government should increase the
spending on infrastructure – both physical and social, introduce major administrative
reforms to improve efficiency and reduce delays and bottlenecks. These are not possible
unless the size of the government is reduced and transparency and accountability in
decision-making and administration are introduced. Recent studies have shown that the
per capita income of states that have large governments in terms of the size of the state
cabinet, number of departments and expenditure on bureaucracy has been growing more
slowly than that of those states that have smaller but purposive and more effective
governments. By and large a large, government is an enemy of an effective government.
The outsized governments also tend to spend all their revenue on administration and very
little on infrastructure and target groups like the poor and the underprivileged. The
introduction of a ceiling on the size of state and union cabinets is again a step in the right
direction.
VI FDI AND PRODUCTIVITY SPILLOVERS
It has been argued that FDI, apart from bringing superior technology and managerial and
marketing practices, will also have spillover effects resulting in increased productivity by
local firms. Studies have investigated the existence and importance of spillovers of FDI
for local firms in China, India and several South American countries. These studies show
that not all the local firms are likely to benefit from spillovers. Some firms will benefit
while some others will become victims of FDI inflows. In what follows it is proposed to
survey the main findings from literature and draw policy inferences for India.
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Th e Chin ese Experience
The impact of FDI on the performance of locally owned Chinese firms in manufacturing
has been investigated by Buckley et. al. (2002). In addition to analysing productivity
spillovers their study also analyses exports and the introduction of new products. One
important feature of the study is that it distinguishes different types of productivity
advantages for overseas Chinese investment and investments by developed countries. The
impact of FDI on government owned and privately (including collectively) owned
enterprises is also separately discussed.
The study shows that overseas Chinese capital did not enhance the productivity of
Chinese firms but the non-Chinese investments did. Their results further showed that
while non-Chinese capital generated both technological and market access (exports)
spillovers, the overseas Chinese capital enabled only market access benefits. The non-
Chinese investments also contributed to the creation of new products by the local Chinese
firms. The study also reveals that FDI did not contribute to productivity and export
spillovers for the government owned enterprises. Consequently, the spillovers were
limited to privately owned enterprises. This study thus brings out clearly the differential
capacity of firms to absorb technology based on ownership.
The I ndian Ex peri ence
A study by Siddharthan and Lal (2004) shows the presence of significant spillover effects
from FDI. During the initial years of liberalisation, namely, the early 1990s, the spillover
effects were modest but later they increased sharply and stabilised towards the end of the
decade. However, not all domestic firms gained equally from the spillovers. Domestic
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and not due to FDI. Moreover, their results show that the productivity of domestic
enterprises declines when foreign investment increases, suggesting a negative spillover
from foreign to domestic enterprises. They consider this as market stealing effect.
While Aitken and Harrison (1999) obtained a negative spillover effect for
Venezuela, Kokko et.al. (1996) have not found evidence of technology spillovers from
FDI in Uruguayan manufacturing plants. Their regression analysis shows no signs of
spillovers from FDI for a sample of 159 locally owned manufacturing plants. However,
they have found positive spillovers in the case of a sub sample of plants that had small
and moderate technology gaps vis-à-vis foreign firms but not in the case of local plants
facing large gaps. Perhaps when foreign and domestic firms operated on the same
technological paradigm they experienced spillovers, not otherwise. They have also found
many domestic plants experiencing higher productivity levels compared to foreign firms.
In such cases the spillover could be from the domestic to the foreign firm.
Some studies argue that the kind of spillovers will depend on the nature of the
economic regime, namely, import substituting or trade promoting regime. In this context,
Balasubramanayam et. al. (1996) demonstrate that unlike import-substitution regimes,
export-promoting regimes attract FDI which has a significant impact on the growth of
GDP. Kokko et.al. (2001) analyse the characteristics of FDI inflows during two different
trade regimes in Uruguay and examine whether FDI in the two regimes had differential
impacts on Uruguay industry. Their results suggest that foreign firms established in the
import substitution regime, that is, before 1973, generate positive productivity spillovers
to local firms but the impact of foreign firms established after 1973 is the opposite. Thus
the presence of import substituting MNEs had a more beneficial effect on labour
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productivity of local firms than the presence of export oriented MNEs. Some studies
relate the spillovers to the development of local markets. For example, Alfaro et. al.
(2004) argue that the lack of development of local financial markets can limit the
economy’s ability to take advantage of potential spillovers.
Poli cies to I ncrease Spil lovers
From the literature survey three factors emerge important in influencing spillovers –
technological capabilities of the local firms as indicated by the productivity and
technological gap between the local firm and MNE/affiliate; networking of firms,
namely, networking between firms, academic institutions, research laboratories, and
MNEs; and institutional and legal environment. These three factors are not mutually
exclusive. Rather, they mutually interact. Technological capabilities of firms depend on
networking with academic research institutions and national laboratories. The S&T
statement 2001 of the Government of India explicitly recognises the importance of
academic institutions and national laboratories collaborating with industry. However, it
does not present a concrete plan of action. In recent times several developed countries
like Japan and Germany have realised the importance of such collaboration and have
enacted Acts to facilitate such cooperation. India can also benefit from the experience of
these countries and enact similar Acts to promote the technological development of
Indian enterprises.
Germany and Japan found that they were lagging behind the US in science-based
sectors like biotechnology. These countries found themselves in what is termed as
“public sector bind” and lacked incentives for scientists to engage in commercial
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activities such as patenting and firm funding (Lehrer and Asakawa 2004, page 922). The
Indian situation is somewhat similar to that of Japan and Germany – the dominance of
national laboratories working in these areas and lack of achievement in terms of
commercialisation and patenting. In order to enhance global competitiveness of Japanese
firms in high tech industries and promote active collaboration between universities and
public sector laboratories Japan enacted the “Strengthening Industrial Technology Bill”
which was passed by the legislature in April 2000. The new law allowed the faculty in
national universities to assume management positions in companies established to
develop their technologies, to work after office hours with pay, and to take up to three
years off to commercialise discoveries and then return to their faculty positions (Lehrer
and Asakawa 2004). Furthermore, the Japanese lawmakers allowed universities to set up
their own technology licensing organisations. In 1999 the “Special Law for Revitalising
Industry” was passed that settled the ownership of government-sponsored research in
favour of the researcher - the US has similar laws in place.
In India, the output of government-sponsored research, in particular, that funded
by the Ministry of Science and Technology, is considered the property of the government
and the researcher has very little say in its commercialisation and application. This
separation of the technology creator from the use of technology has stood in the way of
commercialisation of technology. If India is to benefit from the technology its
laboratories have created, then it should enact laws that are in accordance with
international practice and in particular on the lines of countries that are leaders in
technology creation like the US and Japan. The restrictive Indian rules have resulted in
two negative fallouts. It has stood in the way of attracting world-class talent to national
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Cooperation between business firms and research units depends, to a large extent
on the R&D base of business units (Laursen and Salter 2004). Studies show that the
direct contribution of universities to direct industrial practice is concentrated in a small
number of high tech sectors among firms that spend on R&D. In fact one of the
objectives of in-house R&D units is to search and identify relevant technology for
commercialisation (Cohen 1995; Cohen and Levinthal 1989). Knowledge sharing and
cooperation between two units depend largely on forging of long term strategic alliances
(Helm and Kloyer 2004). Arm’s length purchase of technology rarely works as firms
normally do not trust unrelated third parties in matters relating to sharing of intangible
assets like knowledge and technology. The Indian public sector undertakings are at a
disadvantage here as the government audit rules favour arm’s length purchases against
open tenders and disapprove vendor development and long-term strategic alliances that
are crucial for technology development, knowledge sharing and product quality
improvement. Here again it is important to enact appropriate laws and build institutions
to encourage networking, undertaking joint R&D with vendors and backward and
forward integration through strategic alliances.
VII LIBERALISATION, MNEs AND EXPORTS
One of the objectives of liberalisation is to attract export oriented FDI, modernise industries
through technology acquisition and promote exports. International markets for standard and
traditional exports have been stagnating while the market for high tech and differentiated
products have been expanding rapidly (Lall 1999). Under these conditions it is important for
India to promote exports of sophisticated goods and move up the value chain. However,
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studies explaining inter-firm differences in Indian exports have found technology factors
like R&D and skill intensity of workforce important only in the case of low and medium
tech industries. R&D and skill variables were not significant for high tech industries (Kumar
and Siddharthan 1994). With regard to the role of MNEs in promoting exports, most studies
have captured it by using a MNE dummy and by and large, it was not significant, indicating
that the export behaviour of MNE affiliates and Indian firms are not very different.
Furthermore, studies have found that in low and medium tech industries, export
competitiveness is to be obtained on the basis of indigenous technological effort and through
use of labour intensive production process. In the high tech industries, on the other hand,
import of technology and thus networking with MNEs, a higher degree of automation, and
modernisation appear to be important for breaking into international markets.
M NEs and Exports
The statistical support for a positive relationship between MNEs/joint ventures and exports
has been very weak. For example, Aggarwal’s (2002) study does not find MNEs significant
in explaining export intensities of firms in India during the period 1996-2000. In the study
the significant determinants of exports are firm size and import of capital goods, materials
and components. The explanation given by Aggarwal is that India has been attracting host
market seeking MNEs and not efficiency seeking MNEs. For attracting export-oriented
efficiency seeking MNEs India needs to improve its infrastructure and other facilities apart
from introducing liberalisation measures. Likewise, studies for Sri Lanka (Athukorala,
Jayasuriya, and Oczkowski 1995) also show that MNEs’ export intensities are not higher.
Similarly Willmore (1992) found mixed results for Brazil. In this context, some studies
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have raised methodological issues and have questioned the methods used to test for the
role of MNEs in exports.
Siddharthan and Nollen (2004) argue that MNE affiliates behave differently from
other firms and that the magnitude and sign of the coefficients of some determinants of
exports will differ between the MNEs and other firms. Therefore, in order to obtain more
meaningful and interpretable results, they advocate fitting separate equations for different
groups of firms. Mere introduction of a MNE dummy as was done in the earlier studies
may not yield satisfactory results.
Their study demonstrates that for information technology firms in India, the
explanation of export performance depends in part on the firm’s foreign collaboration and
on the amount and type of technology that it acquires from abroad. For affiliates of
MNEs, both explicit technology transfer from purchases of licenses and payments of
royalties, and tacit technology transfer received from foreign ownership contribute to
greater export intensity. They do so independently, without a complementary interaction
to further boost export performance.
In contrast, the explanation for the export performance of strictly domestic firms
that have neither a foreign equity stake nor foreign licenses is different. For these firms,
more imports of raw materials and components as a source of product quality
improvement contribute to more exports of products, as do the larger size of a firm and
greater capital intensity. These export determinants for domestic firms are unimportant
for MNE affiliates, they argue, because the foreign ownership influence in the MNE
affiliates makes them less necessary.
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SM Es and Exports
The relationship between exports, technology and MNEs is a complex one. The Indian
evidence shows that MNEs do not play a significant role in Indian exports. In recent
years the export intensities of MNEs have increased but despite this their share in the
Indian export is small. On the other hand, the exports of small and medium enterprises
(SMEs) constitute the bulk of the Indian exports. If technology is crucial to exports, then
SMEs ought to be at a disadvantage as there are sizable scale economies in in-house
R&D and technology acquisition from other enterprises. This raises the question of the
nature of competitive advantage of the SMEs in exports. In this context there are some
interesting results from studies on the export performance of Italian SMEs and their
competitive advantages. India can draw valuable lessons from these studies.
The study by Nassimbeni (2001) based on a sample of 165 small manufacturing
firms in furniture, manufacturing and electro-electronics sectors in Italy reveals a number
of interesting results relating to technological and innovative capacity related factors that
significantly differentiate exporting and non-exporting small enterprises. It shows the
crucial role of the management of product related activities in promoting exports. Product
management depends on inventiveness and an ability to forge inter-organisational
relationships.
In this context, the role of internet and e-commerce and in particular business to
business (B2B) commerce assumes importance. The study by Freund and Weinhold
(2004) finds that internet stimulates trade. Accordingly the success of SMEs in the export
front would crucially depend on their ability to network, which in turn would depend on
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the infrastructure facilities for doing B2B commerce. These in turn would depend on the
cost, reliability and availability of internet facilities, the band width and connectivity.
L iberali sation and Value of Ex ports
Liberalisation and technology imports can affect exports in two ways: first, by increasing
export intensities of firms and the volume of exports, and second, by increasing the unit
value of exports or the quality of exported goods. Navaretti et.al. (2004) for a sample of
developing countries neighbouring the European Union (Central and Eastern European
countries and the Southern Mediterranean countries) have found evidence in favour of
higher unit value of exports implying higher quality of products consequent to
liberalisation and technology imports. Their paper argues that with declining trade
barriers new sources of technological inputs become available, some directly purchased –
machinery, blue prints and designs – and others acquired indirectly through spillovers.
They have found that the unit values of exports to EU for the sample countries rose
steadily between 1988 and 1996, relative to the unit values of world exports to EU. In
other words, liberalisation and technology transfer need not increase the volume of
exports but could increase the unit value of exports or the quality of exported goods.
Since international trade is growing faster in high quality goods than in standardised
goods, in the long run a switchover to a higher unit value exports would sustain exports’
growth better.
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Poli cy I mperati ves to Increase Expor ts
From the survey of literature discussed in this section, three important points emerge.
They are the crucial role of small and medium enterprises in exports, the significance of
networking and in particular B2B commerce, and the need to attract efficiency seeking
FDI. Indian policy does not recognise small and medium enterprises, it recognises small-
scale industries and tiny industries and has a policy for them that is mainly based on
reservations. This policy framework is out of date in the WTO era where import
restrictions are not allowed. Under this regime reservations will not be effective, as
imports cannot be prevented. Indian policy must change from an unviable protection to
active encouragement for modernisation and technological up-gradation. In the light of
the changed focus on technological up-gradation, it is important for policy to recognise
the category of small and medium enterprises, that is, enterprises that employ less than
300 persons, and formulate a plan for their modernisation and networking with other
enterprises in the world. With the enactment of the IT Act 2000, India has the legal
framework in place. However, India needs to create other supportive frameworks to make
SMEs globally competitive. In sum at present the target groups are not SMEs and so
policy should change and make them the main target group.
FDI has not been contributing much to Indian exports, as they have been mainly
host market seeking and not efficiency seeking ones. As discussed earlier, in the WTO
regime host market seeking FDI inflows are likely to decline in importance while
efficiency seeking FDIs are likely to gain in importance. Host market seeking FDI is
mainly influenced by the size of a country, GDP and its growth rate, and membership of
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regional union. Efficiency seeking FDI, on the other hand, will depend on cost structure,
physical infrastructure like ports, electricity, transport and communication, and
administrative infrastructure like rule of law, level of corruption, delays in courts, ports
and government offices. While the former would require huge investments, the latter will
require administrative reform that aims at zero tolerance of corruption and delays,
increased transparency in government dealings, increased accountability of the officials
and a drastic reduction in discretionary powers.
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