FDI and Industrial Organization in Developing Countries

The Challenge of Globalization in India

Pradeep Kanta Ray

• Publisher: Routledge
• Year: 2019
• Print ISBN: 9781138619661
• eBook ISBN: 9781351158305
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Originally published in 2005. Analyzing the impact of FDI on industrial organization in India in the midst of changes wrought by globalization is a daunting task. The Indian economy is large and disparate, with a multitude of economic and political institutions and an unsteady record of policy reform. Drawing comparisons with other Asian economies, this monograph identifies the factors that contribute to the successful creation of globally competitive industries by illustrating the nature of interchange between FDI, indigenous capital, industry policy and institutions. It also analyzes the contribution of foreign affiliates and domestic enterprises to industrial development. Using case studies and quantitative analysis, the work reveals new and significant features of Indian business and industry. In view of the recent interest generated regarding India's prowess in high technology sectors and its potential to be the next economic 'powerhouse', the empirical analyses and issues raised in this book are both timely and comprehensive.

Chapter 1

Introduction

Two seemingly competing approaches to industrial organization stand facing the developing world today: a transnational network of firms that straddle across geographic borders, and a group of new indigenous firms that are scaling new heights to contest this transnational network.

India’s rapid economic liberalization in 1991 sparked a widespread anxiety among many business communities that their lesser domestic enterprises would become marginalised by the entry of giant transnational companies. Yet, more than a decade on, large Indian local enterprises continue to flourish even as transnational corporations (TNCs) consolidate their presence in India’s industrial landscape.

In this monograph, I am mainly concerned with the question of whether a model based on indigenous enterprise is still a relevant and a useful repository of technological capabilities, or whether an exclusive ‘firm’-oriented transnational network view of capabilities be adopted.¹ One need hardly underscore that the impact of the transnational view of capabilities and its attendant externalities are yet to be formally modelled for India. Few researchers have attempted to go beyond casual empirical analyses.

Using both case studies and quantitative analyses, the 11 chapters in this monograph present the manner in which an interchange between policy and enterprise can exact a dynamic balance between the objectives of market success and the need to address institutional deficiencies. The analysis of Indian industries that follows addresses for the first time some rather neglected issue in the literature.

The Challenge of Development

Does FDI boost the welfare function of the country which welcomes it? In the usual case, the answer is yes, because FDI represents a net addition to the investible resources of that country. Perhaps what we should be asking is whether FDI helps the process of creating a niche of locally relevant and globally competitive industries in their host economy?

As is well known, India’s perceptibly different attitude towards FDI in 1991 was the outcome of a complex set of events transpiring at the time. A grave financial crisis had threatened the Indian economy in 1991. The severity of the crisis had forced the government to seek IMF-World Bank assistance to bail India out. Once this assistance was sought, the regime had little choice but to accept the prescription set by the Fund-Bank aegis to reverse India’s earlier interventionist stance. The declining barriers to trade and investment then became a godsend to TNCs, providing access to India’s large markets, resources, skills and knowledge. Concurrently, a progressive ‘hollowing out’ of production in industrialized nations occurred, shifting manufacturing to low wage labour locales like China and services to India.

Meanwhile, TNCs amassed an enormous influence on the world economy. Their sales of almost $19 trillion became more than twice as high as world exports in 2001 (UNCTAD 2002). Foreign affiliates alone controlled one-tenth of world GDP and one-third of world exports in 2001. The sales of top 200 TNCs accounted for a staggering 27.5 per cent of world GDP in 1999.² According to UNCTAD, of the world’s 50 largest ‘economies’ by value added, 14 were TNCs and 36 were countries (UNCTAD, 2002). Yet globalization powered by TNCs also brought with it an ungainly downside. The phenomenon became allegedly associated with the widening gap between the wealthier and poorer countries – average income in richest 20 countries became 37 times the average in poorest 20. This gap doubled in the last 40 years, and along with it, a wave of anti-globalization protests swept the industrialized world. Protesters showed increasing concern about the costs and benefits of globalization, and a great many came to reject the conservative complacency about the world in which they lived. According to Amartya Sen,³

We live in a world incomparably richer that ever before. The command over resources, knowledge and technology that we take for granted would be hard for our ancestors to imagine. But ours is also a world of extraordinary deprivation and staggering inequality. The world in which we live is both remarkably comfortable and thoroughly miserable.

Hence the debate regarding the merits of TNC-led globalization and development is still alive in the new milieu. The theme of Chapter 2 presents this debate through the lenses of different schools of thought. The welfare aspects of the TNC as an institutional device of international capitalism first emerged in 1960 in Stephen Hymer’s seminal thesis towards his doctorate at the Massachusetts Institute of Technology. Hymer introduced the concept of FDI as a converse of international trade. Whereas trade promotes division of labour between countries based on mutual comparative advantage in different industries, FDI promotes division of labour within firms integrated across countries. In the debates that followed, the point of contention was whether affiliates of TNCs behaved differently to their domestic counterparts owing to organizational ties to their parent, and whether their foreign presence exerted an independent (and often inimical) influence on development. This debate had in fact become commonplace in academic and policy circles in the 1960s through the 1970s and even had the engagement of important supranational agencies such as the United Nations.

Empirical evidence on the impact of FDI however emerged as inconclusive. The main cause of the so called ‘failure’ of empirical literature was partly due to methodological difficulties, and partly due to the conflict of value perspectives. The task was rendered more complicated by questions such as which product and process technologies are appropriate for developing countries, and which less so? What priorities should developing countries pursue, and how? In fact, the source of discord was not only about the existence and magnitude of cost and benefits of FDI, but also about what constitutes cost or benefit, and for whom.

Today, the question foremost in the policymaker’s minds is whether, given their institutional context, globalization would allow domestic capabilities and the requisite skill, capital, and technology to evolve simultaneously; or would foreign owners of scarce but mobile resources reap the rewards of enterprise, capital and management and leave poor countries to specialize in low skilled labour?⁴ Apart from these issues, concerns persist about the effects of FDI on income distribution, employment, appropriateness of products and technology – and the effects of these parameters on production and consumption.⁵ For example, when income distribution is highly skewed, a country’s institutional context calls for efforts to be directed towards cost-competitive products as opposed to the mere fine-tuning of existing products that originate mostly in developed countries.⁶ Similarly, when there is a dualistic pattern of development caused by urban and rural divide, this will call for rethinking which products constitute appropriate social characteristics, and the R&D that will help to produce them. Such questions bring to the fore the salience of dynamic factors rather than comparisons of static equilibria. They also highlight the importance of national policies. Unfortunately, the neoclassical paradigm fails to ask these questions. The paradigm defines economic problems of valuation in such a way that the economist can say nothing about the social desirability of commodities. Sam Pitroda, the architect of India’s telecom revolution, has observed for the industry:⁷

While developments in the telecom sector are critical in the modernisation of India … (one) has to take into account each country’s own ecosystem as a process with a long range vision instead of piecemeal; an ongoing dialogue with stakeholders; high level commitment; and new management and new work, re-engineering, and human resources. … [It] is possible that businesses may only focus on lucrative urban and corporate markets whereas universal service has been achieved in all advanced countries through cross subsidies. Hence, a certain minimum level of local engineering development is essential to enable developing countries to choose the right technology from overseas and also build and keep in-country talent. This raises the importance of tailoring firm-specific objectives to the cultural, legal, political and economic conditions.

It may be argued that a near-unqualified application of neoclassical economics to developing countries would conflict with the stance taken by many development economists who see limitations in the theoretical framework and seek to supplement it with other theories or tools of policy (Stewart, 1991). Indeed, it would be ill-advised to move on without examining issues such as urban and rural divides (which create dualism), low and skewed income distribution, lack of education, skills and training, lack of health facilities, and so forth. A passive open door policy to FDI without prioritization of the investment, its composition, structure and intended use, can lead to a great deal of wasted effort. On the demand side, policymakers must deal with several characteristics of developing countries, namely abysmally low incomes and skewed distribution; a dualistic economy; and the presence of many different cultural characteristics affecting preferences. On the supply side, the issues are endemic shortages of basic inputs, soaring transactions costs, institutional idiosyncrasies, and the lack of skills, training and education for using technology.

In addition there are deeper socio-economic contradictions on the supply side that prevent the development of a harmonized institutional system in India, which is different to the East Asian experience. Bagchi (1999) explains that in India networks of trust are knitted around caste and region. Most caste–clan–region business networks were traditionally not only closed in upon themselves but also served as barriers to entry, especially to people belonging to the so-called lower castes, and also most of the artisans. The cases of the Agra complex and cheap leather goods in Calcutta illustrate vividly the caste, or community based trust networks, separated by almost impassable fault lines. Lack of education and integration with the local people and the refusal of the formal financial system to promote and extend credit to small scale producers keep the few large and the numerous small producers tightly segmented, even if the latter produces goods for bigger firms with established brand names (Bagchi, 1999).

By contrast, in East Asian countries, the provision of a uniform system of education, and the relative absence of socio-economic inequalities have facilitated a unified engagement of all stakeholders in the economy. Hence the importance of whether the relevant institutions are present and whether capabilities are sufficient to adapt to changing dynamics of competition cannot be underscored further.

The Institutional Context and Industrial Capabilities in India

In Chapters 3 and 4, the forces that underpin industrial dynamism in a developing country are explored, setting the groundwork for understanding the empirical work in this book. Understanding empirical phenomena requires locating the functionality of businesses within the parameters of institutions – an item of research that is yet to be featured prominently in the literature on FDI. Why development does not occur even with capital, technology and market access, or where and under what conditions exceptions do occur, are discussed.

In conventional welfare economics, the regulatory role of the state is to mitigate market failures, defined as the failure of decentralized agents to reach the outcomes that fulfil the conditions of competitive equilibrium. Neo-liberals argue, however, that state intervention may not improve welfare and may even make it worse because of the transactions costs involved in such operations – or because of sectional interests, which may subvert the tasks undertaken. Yet the ‘Miracle’ economies of East Asia amply demonstrate how policy mechanisms can assist developing countries to overcome the disparities in technological capabilities. Technological leverage from borrowed know-how within a carefully designed institutional and policy framework has transformed Japan and the newly industrializing economies (NIEs) into technological powerhouses. The exemplars, Japan and Korea, have set unprecedented standards in identifying, creating and nurturing existing and new institutions to enable individual agents to perform optimally.

In India, the evolution of policy that enhanced capability development at different stages of progress is instructive. Overall, the performance of the Indian private corporate sector, including that of transnational corporations, has been mixed, even as certain high technology sectors have achieved spectacular results. Superior performance of computer software, satellite technology, space research and pharmaceuticals has drawn heavily on strong scientific and technological policies, which aided factor markets by making early investments in education and training. Although these investments were rather thinly spread, they proved invaluable in overcoming the barriers that prevent entry into such sectors by developing countries. Indeed, the success of India’s software industry provides a glimmer of hope for her long awaited human capital revolution. I outline the changes brought about by economic liberalization and re-examine the implications of the so-called ‘threat’ of large scale disruption of local enterprises by the entry of TNC-affiliates. Economic liberalization appears to have opened up a window of opportunity for enterprises to compete globally as never before. But here, a more prudent approach to the participation of foreign capital in industries of national importance needs to be exercised – more so given the fact that local industrial activity demands competitiveness as well as local relevance.

Market economists argue that a decentralized, unplanned, laissez-faire economic system, would have helped a more rapid development in India. The case of Singapore is often cited as a successful example in this regard – relative to the interventionist states, where allegedly growth has been slower. But the conditions in Singapore were quite different then and continue to remain so, even today. Singapore was a small city-state with lower diversity, inequality and structural asymmetries than India. Moreover, in Singapore, the Economic Development Board pursued a stated strategy of attracting TNCs and then pressuring them to broaden their range of activities. The gradual development of a highly skilled industrially trained workforce, a state-of-the-art infrastructure and technological and related institutions also greatly facilitated the transition from simple value added activity to complex production by TNCs. In turn, this process induced a whole host of local suppliers and institutions to conform to increasingly stringent delivery mode...

Table of contents

• Cover
• Half Title
• Dedication
• Title Page
• Copyright Page
• Table of Contents
• List of Figures
• List of Tables
• Foreword
• Acknowledgements
• List of Abbreviations
• 1 Introduction
• 2 The Role of Transnational Corporations in Economic Development
• 3 The Institutional Underpinnings of National Capabilities: Some Conceptual Issues
• 4. Economic Liberalization, Industrial Organization and Enterprise Performance in India
• 5 Technological Accumulation and Dynamic Capability Development in India’s Telecommunications Industry: The Dual Initiatives of Public Enterprise and FDI
• 6 Global Competition in Local Territories: The Case of Transnational Corporations and Local Enterprises in the Consumer Electronics Industry in India
• 7 FDI, Indigenous Enterprise and the Pharmaceutical Industry in India
• 8 Transnational Corporations, Local Adaptation and Inter-Firm Linkages in Developing Countries: Some Contrasts with Local Enterprises in India
• 9 The Structure of Vertical Inter-Firm Linkages and Foreign Dependence in Transnational Corporations: The Case of Computer Software, White Goods and Consumer Electronics in India
• 10 Creation and Appropriation of Intellectual Property in Transnational Corporations
• 11 FDI and the Challenge of Globalization in India: Concluding Remarks and Future Directions
• Bibliography
• Index