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Does India Need a Lot More FDI?

When comparing the levels of foreign direct investment in India and China, it is found that FDI in India is one-tenth of that in China. This paper compares the inflow of FDI in the two countries and finds that India may not require increased FDI, given India's factor endowments and the structure and composition of her economy.

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Does India Need a Lot More FDI?

When comparing the levels of foreign direct investment in India and China, it is found that FDI in India is one-tenth of that in China. This paper compares the inflow of FDI in the two countries and finds that India may not require increased FDI, given India’s factor endowments and the structure and composition of her economy.

V N BALASUBRAMANYAM, DAVID SAPSFORD

I
s India likely to outperform China on the growth league tables? Can either of the two countries sustain the relatively high growth rates they have achieved in recent years? These questions, which figure frequently in the media, are inspired by the similarities between the two Asian countries; both are populous with more than a billion people in each of the two countries, they are relatively large in size, both countries have initiated widespread economic liberalisation programmes and have achieved high growth rates.

There are also marked differences between the two countries. China is a much more homogeneous country1 than India that is known for the heterogeneity of its society – the diversity of its languages, religion and geophysical attributes. Much more striking is the differing political set-up in the two countries and the type of financial and legal institutions in place. India is a functioning democracy; China is best described as an autocracy presided by a single party. India’s financial institutions are also much more developed than those in China.

These attributes of India – its democratic political system, western-style financial and legal institutions and the felicity of its businessmen, bureaucrats and political leaders in English – the lingua franca of business should provide India a niche in international markets for goods, services and foreign capital. However, India ranks well below China on exports and inflows of foreign direct investment (FDI). It is the relatively low level of FDI in India, barely one-tenth of the inflows into China (Tables-1A and B), which has attracted much attention. A variety of explanations have been offered for the low levels of FDI in India. This paper argues that although India could do with much larger volumes of FDI than that it attracts now, the concern that it is well below the levels of FDI in China is misplaced. Given the structure, composition and factor endowments of her economy which are significantly different from that of China, India may not need larger volumes of FDI, in any case, not on the scale that China attracts.

Received Explanations

The literature on FDI identifies a number of factors which attract foreign firms to specific locales including the size of the domestic market for goods and services, the rate of growth of incomes in the host country, macroeconomic stability identified with price and exchange rate stability, a distortionfree economic environment and a stable political and policy environment [Balasubramanyam and Sapsford 2006; Dunning 1973].

India and China are not poles apart on most of these attributes. The domestic market for goods and services is expanding with the growth of middle and upper income groups in both countries; both economies have maintained a high degree of macroeconomic stability judged by the standards of developing countries. Average rate of inflation in India during the period 1991-2004 was less than 6 per cent and less than 1 per cent in China.2 The exchange rate too has not fluctuated wildly in the two countries though there is a continuing debate on the appropriate market value of China’s managed exchange rate.

The FDI regimes of host countries, which include both incentives for foreign firms and restrictions on their operations, is another frequently cited determinant of FDI. There are those who regard the Chinese FDI regime as much more liberal and pragmatic than that of India [Ghosh 2005]. Admittedly, India’s FDI regime has been none too liberal in the past but much has changed since the 1991 reforms. Measures designed to liberalise the FDI regime include: expansion of the list of industries open to FDI, enhanced list of industries eligible for automatic approval, expansion of the list of industries open to 100 per cent equity participation, offer of national treatment to companies with more than 40 per cent equity share and relaxation of trade-related investment measures [Kumar 2005].

In fact, it is suggested that India’s FDI regime may be much more liberal than the Chinese regime [Nagaraj 2003]. The Chinese regime offers a number of fiscal incentives to foreign firms but the recipients of these favours are also hemmed in by a number of restrictions; this combination of incentives and restrictions is aptly described by one commentator as the “golden straitjacket [Friedman 2000, cited in Rudolph Mathew 2006]. The restrictions include compulsory joint ventures with locally owned firms, compulsion to export and restrictions on the choice of location of foreign-owned plants. This sort of an attempt to have one’s cake and eat it too may succeed in the short-run but it is unlikely to endure, something the Chinese authorities appear to have recognised; they have recently eased the compulsory requirements relating to joint ventures.

Another familiar refrain is the delays and frustration for investors caused by India’s bureaucracy with its complex rules,

Economic and Political Weekly April 28, 2007 better described as rituals. Moriss (1982) succinctly captures the

nature and workings of this behemoth,

...The unimaginable bureaucracy of Delhi, battening upon the

capital – a power sucker, feeding upon its own consequence or

sustained intravenously by inter-departmental memoranda, trip

licate applications, copies and comments and addenda and ref

erences to precedent – a monstrous behemoth of authority, slumped

immovable among its files and tea trays. Much of it is concerned

not with practical reality at all but with hypotheses or dogma.

It is though arguable if the renowned or notorious Indian red tape is a major deterrent to FDI. In the presence of other alluring attributes of the business world in India, most investors learn to put up with it or get round it, here the cultural affinity between India and the western countries no doubt helps. In any case, the Mandarins in China may be no better or worse than the Indian bureaucrats.

Yet another hypothesis offered to explain the relatively high volumes of FDI that China harbours belongs to the realm of political economy. Huang (2003) argues that China has substituted foreign for domestic investments, put domestic investors lower down in the pecking order of firms – below state-owned enterprises and foreign firms – for the award of various sorts of concessions and incentives. Huang also argues that China has over extended its invitation to foreign firms and harbours much more foreign investments than she needs. This policy had retarded the growth of privately-owned Chinese firms.

Mathew Rudolph (2006) builds on Huang’s hypothesis and arrives at an interesting though arguable explanation for the high volumes of FDI at the expense of domestic investments in China. The Chinese strategy, according to this thesis, is two pronged

– limit the expansion and power of domestic capitalists who might challenge the authority of the party but, at the same time, achieve a high enough growth rate for promoting employment and other social objectives. The welcome mat China spreads for foreign investors is designed to achieve this goal of growth with a subdued domestic capitalist elite. The logic underlying the strategy, as Rudolph puts it, is that “independent business interests might contest the elite’s power to calibrate the country’s prevailing state-socialist structure of property rights and, ultimately, rival the party elite’s control of the economy”. Hence, the reliance of the state on FDI; bluntly put, foreign capitalist devils are easier to control and monitor than home grown ones. India, at least, until recent years, seems to have been wary of both foreign and domestic capitalists but has warmed to both since the 1990s.

The Rudolph thesis seems plausible but it is not a strategy that is likely to endure. Foreign capitalists though susceptible to the incentives may not be inclined to put up with the restrictions placed on their operations, especially the injunction to export, for the one attraction of China is its large domestic markets. Besides, even the most ardent advocates of FDI are wary of excessive control over national assets by foreigners.

Another set of explanations for the relatively high volume of FDI in China reside in the nature and interpretation of the reported data on FDI. One such explanation is that the reported figures on FDI on China are an overestimate, as a substantial proportion of what is regarded as FDI is in fact domestic investment. This is the so-called “round tripping” phenomenon, according to which domestic capital is taken out of the country to neighbouring countries and brought back into China to take advantage of the various tax concessions and subsidies. There are no estimates of the magnitude of round tripping in China. In any case, even if half of the inflows of FDI into China are reckoned to be of the round tripping variety, the gap between the volume of FDI in India and China remains considerable. Inflows of FDI into China and India in the year 2004 were $ 60.6 and $ 5.3 billion respectively. Even if the figure for China were to be pared down to $ 30 billion, to take account of round tripping, the volume of FDI in China would amount to six times that which India attracts. It is also noteworthy that Indian capital too is exported to Mauritius and brought back to take advantage of tax concessions, although the precise volume of such transactions is not known.

There is also the suggestion that when the relevant data is adjusted to take account of the differences in the economic size of the two countries the volume of FDI in India is not much different from that in China. Measured as a proportion of GDP, the figure for India (after reinvestments of profits by the foreign firms are included in the estimates of annual inflows) is 0.5 and that for China is 3.6 [Kumar 2005]. Further, Kumar suggests that when the Chinese data are adjusted for round tripping the two ratios at 1.7 for India and 2.0 for China are not far part. But, as said earlier, Indian businesses too engage in round tripping, data on the extent of such round tripping especially to Mauritius and back are not available. Even after all the adjustments are made, the volume of FDI in China is at least thrice the level in India if not much more.3

In sum, none of the received explanations for the low volumes of FDI that India attracts relative to China are entirely satisfactory, though each of them has some merit.

Optimum Level of FDI

Is it likely that the observed differing magnitude of FDI between India and China is a reflection of the differences in the factor endowments, sectoral composition of the national product and methods of production in the manufacturing sectors of the two countries? Is it likely that because of these differences, a unit of FDI is much more productive in India than in China? The ratio of FDI to GDP in India and China cited earlier, can also be seen as an indicator of the productivity of FDI in the two countries – a rough measure of the capital-output ratio. Viewed

Table 1A: FDI Overview – India and China

India China

FDI Inflow FDI Inflow FDI Inflow FDI Inflow
(millions US$) as Per Cent (millions US$) as Per Cent
of GFKF of GFKF

1985-1995

(annual average) 452 1.9 11,715 6.0 2001-2002 3,403 3.2 46,878 10.5 2002-2003 3,449 3.0 52,743 10.4 2003-2004 4,269 3.2 53,505 8.6 2004-2005 5,335 3.4 60,630 8.2

Note: Gross Fixed Capital Formation (GFKF). Source: UNCTAD World Investment Report, 2006.

Table 1B: FDI Overview – India and China

India China FDI Stock FDI as Per FDI Stock FDI as Per (millions US$) Cent of GDP (millions US$) Cent of GDP

1980-1981 452 0.2 1,074 0.5 1990-1991 1,657 0.5 20,691 5.8 2000-2001 17,517 3.7 193,348 17.9 2002-2003 30,827 5.2 228,371 16.2 2004-2005 38,676 5.9 245,467 14.9

Note: Gross Domestic Product (GDP). Source: UNCTAD World Investment Report, 2006.

Economic and Political Weekly April 28, 2007

thus, the statistic suggests that the productivity of FDI in India is higher than that in China. This suggestion, though it needs detailed statistical verification at the disaggregated level of sectors of industry, provides yet another explanation for the observed differences in the volume of FDI in the two countries. It is that India may not require as large a volume of FDI as China harbours. That which India attracts now may not be adequate for generating a 10 per cent rate of growth aspired for by India’s planners but the optimum level of FDI the country needs may not be much higher than the present level of inflows of FDI.

What then is the optimum level of FDI a country should aim for? The optimum level could be defined as that level of FDI which generates a targeted growth rate of national income. There is also the suggestion that in India, at present, it is not FDI which promotes growth but it is growth which attracts foreign firms. This may be so but FDI could accelerate the growth process in progress. FDI, however, is but one of the several factors which contribute to growth. As we have argued elsewhere [Balasubramanyam and Sapsford 2006] FDI is not a panacea for the development problem, it is a catalyst in the growth process. It enhances the efficiency of other inputs in the growth process through its well known role as a supplier of technology and know-how.

The efficacy of FDI as a catalyst depends on the extent to which the technology and know-how it contributes are assimilated and dispersed in the economy. Effective assimilation of imported know-how requires the adaptation of the imported know-how to suit local labour and factor markets. Equally essential for the efficient utilisation of FDI is the dissemination of imported technology and know-how to locally owned economic units. In other words, technology and knowledge imparted by FDI should spillover into contiguous areas of economic activity and enhance their productivity. Such spillovers of technology constitute an important source of externalities from FDI. The training and work experience gained by labour employed in foreign firms are also often disseminated to locally owned firms when labour, including managers, migrate to locally owned firms or set up their own establishments. The larger the extent of these sorts of externalities from FDI, higher would be the social rate of return to the host country as opposed to the private rate of return to the foreign firms from a unit of FDI.

The optimum level of FDI could then be defined as that level of FDI which maximises social rates of return. Social rates of return to FDI would be a function of not only the quality of FDI, signified by the nature and extent of ownership advantages possessed by the foreign firms but also the ability of local management and labour to assimilate the technology and know-how imparted by foreign firms. Prerequisites for the effective assimilation of imported technology and know-how include the presence of research and development facilities which would facilitate adoption of imported technologies, skilled labour which is adept at learning by doing and adequate communication networks.

The empirical work on spillovers from FDI yields mixed results, some report negative spillovers [see Gorg and Greenaway 2004, for a review of empirical studies]. Those that report positive spillovers identify availability of skilled labour, high level of technological capabilities on the part of host firms and quality of infrastructure as key factors that promote spillovers. India may be much better endowed with these ingredients than China .The Kearney report (2004) on the opinion of businessmen on the sort of investment incentives China and India provide is instructive: “Investors favour China over India for its market size, access to export markets , government incentives, favourable cost structure and macroeconomic climate” and “These same investors cite India’s highly educated labour force, management talent, transparency, cultural affinity and regulatory environment as more favourable than what China provides”.

The differing attributes of the two countries identified by businessmen reflects the differences in the structure and nature of economic activity in the two countries. The attraction of China to investors is its endowments of low cost labour most suitable for the production and export of relatively inexpensive labourintensive manufactures. FDI provides the means to utilise cheap surplus labour in the production of export goods – a source of growth identified by Adam Smith and elaborated by Hla Myint as the vent for surplus function of trade and foreign capital [Myint 1958], a concept which may have relevance for China’s export led growth [Fu and Balasubramanyam 2005].

India’s attraction to foreign investors is entirely of a different order. India provides the sort of co-operant factors-educated labour, management talent and a business culture which facilitates working partnerships between foreign and local firms to test new innovations, adapt new technologies to differing market conditions and engage in the production of new knowledge. No doubt these attributes contribute to the private rates of return that foreign firms expect to reap but they also enhance the social rates of return to FDI. Put another way the social productivity of a unit of FDI, both through its own efficacy and the spillovers it generates, would be relatively high in India because of the sort of cooperant factors the country possesses.

China is endowed with a much larger pool of people with a secondary level of education but her endowments of people with

Table 2: Education Overview – India and China

Total Population Highest Level Attained Average Years of Schooling
Male Aged Secondary Level Post-Secondary Level Secondary Post-Secondary
25 and Over Percentage of Total Population Percentage of Total Population Level Level
(million) Population (million) Population (million)

China 761 35.7 272 2.7 21 1.49 0.08 India 487 17.4 85 4.8 23 0.72 0.12

Notes: * The estimates are based on methodology used by Borensztein et al (1998). For example: India’s post-secondary school attainment is estimated as 0.12 where, only 4.8 per cent of the total male population aged 25 years and above(487 million people) attended post-secondary school. Out of this group, only 69 per cent of the total male population completed the degree (3 years) while remaining 31 per cent completed only thee first cycle (1.5 years). Then, post-secondary school attainment is: 0.048 *{(1.5*0.3125)+ (3*0.6875)}.

** For secondary education, the complete cycle is assumed to be 6 years. => 0.048 *{(1.5*0.3125)+ (3*0.6875)}=> 0.1215, meaning the level of total population in India above 25 years has an average of 0.1215 years of post-secondary schooling. Similarly, for China the estimate works out to 0.075, much lower than India.

Source: Barro and Lee (2000).

Economic and Political Weekly April 28, 2007 tertiary level education is only marginally below that of India. This data though does not fully account for either the volume or the quality of human capital in the two countries. When due adjustments are made for rates of completion of the relevant education programmes, China turns out to be ahead of India on secondary level education but her endowments of people with tertiary level education is lower than that of India (Table 2).

The data in Table 2 provided by Barro and Lee (2000) measures the number of years of schooling attained by the relevant age groups but says little about the quality of education in the two countries. There is though reason to believe that the average quality of tertiary education in India may be superior to that in China. India is endowed with reputable institutions of scientific and engineering research and teaching such as the Indian Institutes of Technology, Indian Institute of Science in Bangalore and Tata Institute of Fundamental Research in Mumbai. The two science research institutes date back to pre-independence days and the institutes of technology were established during the import-substitution industrialisation phase of the Indian economy, when substantial investments were made in science and engineering education. In addition, there are a number of universities with extensive facilities for training engineers and scientists in most states in the union. According to the data published in the Statistical Abstract of India there were a total of 15,703 degree awarding institutions of higher education in the country at the end of the year 2001-02. India has also the added advantage that the medium of instruction in all these institutions is English – the lingua franca of business.

The endowments of skilled people with a tertiary level of education not only attracts foreign firms specialising in science and high-tech oriented products and services but also facilitates the adaptation of imported know-how to Indian factor and labour market conditions. Furthermore, endowments of science and engineering educated personnel facilitate the spillovers of technology and know-how resulting in relatively high social rates of return from FDI.

Empirical studies on FDI in India endorse the proposition that the productive efficiency and spillovers from FDI tend to be relatively high in science oriented groups of firms and industries. Kathuria’s (2001) carefully crafted econometric study of the impact of FDI on productivity of Indian industry, based on data for 487 firms in 24 industry groups, for the period 1989-90 to1996-97 reports that: (a) following the economic liberalisation policies instituted in 1991, productive efficiency increased in the case of both foreign owned and domestically owned firms but the growth in efficiency was relatively high in the case of foreign firms; (b) only those domestic firms with a threshold level of research and development (R and D) gained from the presence of foreign firms; (c) in the scientific subgroup, or science oriented industries, the presence of foreign firms exerted a strong learning effect, i e, domestic firms in this group experienced technology spillovers from the presence of foreign firms; and (d) in the nonscience oriented industry groups, only those locally owned firms with an R and D base experienced spillovers from the presence of foreign firms. Another study on the impact of domestic R and D and imported technology on the productivity of Indian industry [Basant and Fikkert 1996] also concludes that in the absence of domestic R and D, locally owned firms would not experience any spillovers of technology from the presence of FDI. This study also finds that imported know-how through technology licensing agreements has a much stronger impact on productivity growth than domestic R and D. The suggestion here is that domestic R and D resources are better spent on adapting imported technology than generating technology at home.

These conclusions endorse the proposition that large endowments of scientific and engineering expertise are essential to benefit from FDI and India appears to possess such skills in relatively large volumes as suggested earlier.

It is also noteworthy that these endowments of skills India possesses are a factor in the sort of FDI India attracts – mostly, though not entirely, process oriented technology and know-how in sectors such as pharmaceuticals, chemicals, high-tech engineering industries, supplied by multinationals based in the EU, US and Japan. In contrast, a large proportion of FDI in China is from the Chinese diaspora based in east Asian countries and some in the US. An extensive statistical analysis of technology spillovers from FDI in China by Peter Buckley and associates [Buckley et al 2002] concludes that the sort of know-how provided by firms from the overseas Chinese (OC) as opposed to firms from the non-Chinese (NC, western countries and Japan) consists of marketing know-how rather than production know-how. This study also finds that spillovers were effective in increasing the productive efficiency of locally owned firms only in the presence of R and D facilities in locally owned firms. This productivity enhancing impact of FDI though was confined to the privately owned Chinese firms. The state owned firms, despite their access to relatively large volumes of R and D, had gained little from the presence of foreign firms in the sectors in which they operated.

The contrasting picture of FDI in India and China noted by these studies endorses the proposition that because of India’s relatively large endowments of R and D expertise, she is able to absorb imported know-how much more effectively than China. It is also the case that the sources of India’s FDI, the western countries, transmit process centred and productivity enhancing know-how, whereas the bulk, though not all, of the FDI China receives is from the overseas Chinese sources which transmit mostly marketing and organisational know-how [Buckley and Chen Meng 2005].

Labour-intensive technologies, especially those that specialise in production for export markets, such as those in China, require large volumes of FDI capable of transmitting organisation, supervisory and marketing skills including personal and public relations, marketing and advertising. Indeed, as Hirschman (1958) noted many years ago “the scope for poor performance becomes wider when more labour-intensive processes are used”. Poor performance arises because of poor management, labourintensive technologies by their very nature require much more intensive organisation and supervision than capital-intensive technologies. The presence of large volumes of FDI in relatively labour-intensive industries in China may in part reflect the country’s need for management and organisational resources which are in short supply at home.

It is the confluence of China’s endowments of cheap labour, her strategy of labour-intensive export led growth and the presence of a substantial number of Chinese diaspora endowed with money and the sort of expertise the chosen strategy of China requires that explains the large volumes of FDI in the country. A substantial proportion of FDI in China, around 30 to 50 per cent of a total annual inflow of around $ 55 billion is on account of the Chinese diaspora and most of the diaspora investments are in export-oriented activities. This would be the case even in the absence of injunctions to export, mostly because the Chinese diaspora is heavily business-oriented, engaged in

Economic and Political Weekly April 28, 2007

marketing and trading rather than in production. It is the marketing skills of the diaspora which are far more relevant for export of labour-intensive consumer goods and not so much manufacturing technology and know-how. China’s FDI strategy may be dictated by a genuine need for marketing skills and information, which locally owned firms do not possess. The requirements of China for marketing skills and expertise in the utilisation of labour-intensive technologies is met by the diaspora, whose strong cultural affinity to China, is of immense help in managing labour-intensive technologies.

Huang (2003), however, argues that China need not depend on FDI for the technology and know-how required for its labourintensive exports; it can obtain these through contractual agreements (technology licensing agreements) with foreign firms. This would be a valid argument if the sort of know-how required by Chinese firms was of a tangible variety, which can be stored on discs and tapes. Labour-intensive exports centring mostly on consumer goods may require intangible know-how such as expertise in organising labour, educating labour in the use of simple processes and assembly operations, and more importantly, marketing skills including advertising, exploration and capture of new markets. None of this can be easily transmitted via wires or the Internet as it were. They require the presence of the foreign owners of such know-how in the workplace in China.

The draft on these sorts of organisational and managerial resources would be relatively low in the case of primarily home market-oriented capital-intensive industries such as those in the Indian manufacturing sector. Most industry groups in India’s manufacturing sector are much more capital-intensive in their operations than comparable Chinese industries. Even those industry groups which are classified as low-tech by the Organisation for Economic Cooperation and Development (OECD) are far more capital-intensive in India than those in China (Tables 3 and 4).4

Factor intensity of various groups of industries is measured by the ratio of labour to output and the ratio of fixed capital to labour in the data reported in the two tables. Admittedly, these estimates provide only a rough guide to the differences in factor intensity for various groups industries between the two countries. The precise nature of products produced and their quality in each of the industries may differ between the two countries. Nonetheless, the differences in factor intensities across most industry groups in both the high-tech and low-tech categories are substantial between the two countries.

The proximate reason for the observed capital intensity of the Indian industry is the large number of inherently capital-intensive industries in the manufacturing industries and the distorted factor prices which encourage the substitution of capital for labour in the production process. The significant presence of industries which are inherently capital-intensive in the Indian manufacturing sector is due to the strategy of import substituting industrialisation pursued by India for more than four decades, which emphasised the domestic production of a variety of producer goods, all of which are characterised by capital-intensive production processes. On top of this is the substitution of capital for labour in the production processes of even those industries which allow for factor substitution. This sort of substitution of capital for labour in the production process in many Indian industries is due to distorted factor prices and rigid labour laws, which encourage entrepreneurs to substitute capital for labour. Admittedly, the capital intensity of Indian manufacturing limits employment opportunities but it is likely that it has also minimises the need for supervision and organisation of labour, and reduces India’s requirements for imported managerial and organisational know-how.

Even so, is it rational for a labour abundant country such as India to promote FDI in capital intensive industries? The obvious answer is that the country has to make the best of what it has inherited from the past. It cannot transform the composition of its manufacturing sector, in any case, not in the near future. It is also noteworthy that following the reforms of 1991, which reduced import tariffs and abolished the domestic industrial licensing system, the manufacturing sector of the country is much more open to competition from both imports and domestic firms. Inflows of FDI into the capital-intensive manufacturing sector in the liberalised economic environment are likely to be more influenced by considerations of comparative advantage than artificial policy determined incentives. The sector is unlikely to experience the sort of immiserising growth identified by Bhagwati (1973), which is specific to tariff induced FDI. Welfare costs arising from the tariff induced misallocation of resources would

Table 3: Manufacturing Industries in India and China 2002-03Labour to Output Ratio (per 1,00,000 Labour Units)

Low-Tech Industries High-Tech Industries China India China India

Wearing apparel 1.802 1.602 Petroleum refineries 0.231 0.029 Leather products 1.550 0.958 Machinery, except Fabricated metal electric 1.237 0.702

products 1.044 1.016 Transport equipment 0.701 0.460 Wood and products 1.252 1.323 Industrial chemicals 0.836 0.257 Food products and Machinery, electric 0.531 0.484

beverages 0.821 0.658 Professional and Textiles 1.486 1.208 scientific equipment 1.037 0.789 Basic metals 0.742 0.392 Non-metallic 1.684 1.486 Rubber and plastic 1.066 0.653 Printing and

publishing 1.328 1.047 Paper and products 1.092 0.776 Total Total Low-tech 1.153 0.811 High-tech 0.709 0.317 Average 1.261 1.011 Average 0.762 0.453 Total manufacturing 0.919 0.589 Total manufacturing 0.919 0.589

Source: UNIDO Industrial Statistics Database 2006.

Table 4: Manufacturing Industries in India and China 2002-03 Fixed Assets Per Unit of Labour

(PPP US $)

Low-Tech Industries High-Tech Industries China India China India

Wearing apparel 11,007 11,500 Petroleum refineries 191,349 1,200,201 Leather products 11,022 42,556 Machinery, except Fabricated metal electric 17,473 38,223

products 27,190 27,364 Transport equipment 45,695 64,982 Wood and products 39,648 56,283 Industrial chemicals 54,652 329,615 Food products and Machinery, electric 16,680 35,075

beverages 43,605 31,974 Professional and Textiles 26,718 37,839 scientific equipment 85,404 73,537 Basic metals 89,470 159,252 Non-metallic 41,858 57,641 Rubber and plastic 35,972 64,505 Printing and

publishing 41,806 36,095 Paper and products 55,796 93,710 Total Total Low-tech 39,578 53,168 High-tech 39,154 130,859 Average 38,554 56,247 Average 68,542 290,272 Total manufacturing 39,406 72,051 Total manufacturing 39,406 72,051

Sources: UNIDO Industrial Statistics Database 2006, National Bureau of Statistics of China, China Statistical Year Book 2003, Beijing, Annual Survey of Industries, Ministry of Statistics and Programme Implementation.

Economic and Political Weekly April 28, 2007 not be a problem in the absence of tariffs and other restrictions on imports. As discussed earlier, the attraction of India’s capital intensive manufacturing sector to FDI is its endowments of scientific and technical expertise which enables it to assimilate imported know-how.

It is also the case that the services sector in India including financial services, consultancy, transport services and telecommunications accounted for around 40 per cent of the total inflows of $ 38 billion of FDI for the period 1991 to 2006. Here again, the factors which have facilitated FDI inflows are India’s endowments of skilled labour and the presence of financial and legal institutions fashioned after those in developed countries. Sectors such as banking, finance and information technology oriented services are intensive in the use of human capital. In these service industries too, an unit of FDI is likely to be much more efficient than services which are intensive in the use of semi-skilled and unskilled labour.

A comparative analysis of the source of growth in India and China [Bosworth and Collins 2007], in fact, reports that the contribution of total factor productivity (TFP) to growth of services in India exceeds the contribution of TFP to growth of services in China. Admittedly, on all other counts including growth of output and the growth in labour productivity of the industrial sector, China’s performance is superior to that of India. Services is the only sector in which India comes close to matching China’s performance, with an increase in value added per worker of 5 per cent per annum during the period 1993-2004. Much of this growth was achieved through growth in TFP and not capital per worker.

The fact that India has not performed as well as China in other sectors is explained by the various constraints the economy faces including stringent labour laws, poor infrastructure and delays and problems in decision-making that are typical of a large democracy. It is also noteworthy that comparisons of India’s performance with that of China suffer from several conceptual and statistical problems. The Bosworth and Collins study includes public utilities, mining, construction and manufacturing in the industry category. The study also assumes the share of capital to be 0.4 for both countries in all three sectors. The production functions underlying manufacturing may be much different from the other categories in the industry definition. There are also studies that report a capital coefficient around 0.55 for manufacturing in India [Mitra and Ural 2006]. On balance, not withstanding all the statistical problems inherent in comparative studies, the fact remains that China has a much more impressive growth record than that of India. But it is a record based on a massive infusion of investment from abroad and domestic labour. India’s record is impressive mostly because it has been achieved in the face of numerous constraints and at a relatively low resource cost.

Conclusions

There are a variety of explanations for the low volume of FDI in India relative to that in China. This paper suggests that there may be yet another explanation – India’s requirements of FDI may be substantially lower than that of China because of the

Economic and Political Weekly April 28, 2007

structure and composition of her manufacturing and services sectors and her endowments of human capital. India’s manufacturing sector consists of a substantial proportion of science based and capital-intensive industries. The requirements of managerial and organisational skills of these industries are much lower than that of labour intensive industries such as those in China. Also, India has a large pool of well-trained engineers and scientists capable of adapting and restructuring imported know-how to suit local factor and product market conditions. All of these factors promote effective spillovers of technology and know-how from foreign firms to locally owned firms. The optimum level of FDI, which generates substantial spillovers, enhances learning on the job, and contributes to the growth of productivity, is likely to be much lower in India than in other developing countries including China.

This is not to say that India should not actively seek FDI. The country may need much larger volumes of FDI than it currently attracts if it were to attain growth rates in excess of 10 per cent per annum. There is, however, no reason to despair that the FDI in the country is only one-tenth of that which China, the frequently cited comparator country, harbours. It is also noteworthy that given her endowments of science and engineering skills, India may now be better placed than in the past to import know-how and technology through technology licensing agreements rather than equity based FDI. As is well known FDI is a bundle of technology, managerial know-how and capital. In the past, several countries including India, South Korea and Japan attempted to unbundle the package by importing technology and know-how through technology licensing agreements and raising capital through other sources including domestic savings and portfolio capital flows. Whilst Japan is a success story with her efforts at unbundling, India’s attempts to do so were less than successful. This lack of success with licensing agreements on India’s part was mostly due to a lack of technology absorptive capacity and various distortions arising from the inward looking trade policy and domestic industrial licensing regulations. In the postliberalisation era, policy-oriented distortions are likely to be low and long years of investment in tertiary education have endowed India with the sort of technology absorptive capacity or skills required to assimilate, adapt and restructure imported technologies and know-how. It is likely that the country is now in a position to unbundle the FDI package effectively and rely on sources other than FDI for its requirements of capital.

EPW

Email: v.balasubramanyam@lancaster.ac.uk

Notes

[We are grateful to participants at seminars at the Madras School of Economics (Chennai) and ICRIER (Delhi) for their comments on the paper.]

1 One of the basic tenets of Chinese civilisation is described as “uniformity

is inherently desirable, that conflict is bad, that there should be only one

empire, one culture, one script…,one tradition”! Jenner (1992) cited by

Bardhan (2002). 2 India’s policymakers are concerned that in recent months prices are

increasing at 6.5 per cent and have instituted measures to check inflation.

In China, a rate of inflation of around 3.5 per cent is considered to be

high – a signal the economy is overheating. But by most developing

country standards, inflation in both countries is low and inflation in India

has rarely exceeded 10 per cent. 3 There are several problems associated with the data on FDI in India. The

definition of FDI adopted by various reporting agencies differ from each

other, the Indian definition of FDI differs from that of the International

Monetary Fund and the United Nations Conference on Trade and Development, World Investment Report. Analysis of FDI by industries and across regions in India is not feasible because of the absence of data on the actual volumes of FDI across industries and regions. For the most part, published data refers to approvals of investment projects rather than actual amounts of investment.

4 Figures in Tables 3 and 4 measure capital intensity by the ratio of labour to output and the ratio of fixed investment to labour in various industry categories in India and China. The data are principally from the United Nations Industrial Development Organisation (UNIDO) annual survey of industries. These data are reported by UNIDO in purchasing power parity dollars and are roughly comparable. Another measure of factor intensity is the ratio of wages to value added but this measure is likely to be misleading if the average wage rate and its dispersion are substantially different between countries.

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Economic and Political Weekly April 28, 2007

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