Over the past several months, there has been rising concern among policymakers over declining inflows of foreign direct investment (FDI) in India. The World Investment Report, 2011 (WIR) issued by the United Nations Conference on Trade and Development (Unctad) shows that in 2010, when the emerging economies had recovered from the economic downturn, FDI inflows into India were below pre-crisis levels by as much as 42%. Even in the first four months of the calendar 2011 the pick-up in FDI inflows has been slow—they have been almost 9% below the levels recorded in the corresponding period last year.
But while the government of India is engaged in formulating the policies that would be helpful in reversing the recent trends of FDI inflows, WIR provides useful insights on the mode of operations of the enterprises that are the source of this form of capital, the transnational corporations (TNCs). Operations of TNCs have been changing over the past two decades, and this change has become a dominant pattern of their behaviour during the past decade. Instead of making mega-sized investments in host economies, TNCs have been sub-contracting various parts of the value chains by establishing joint ventures with local enterprises in a number of countries, thus establishing global value chains (GVCs). This fragmentation of production has twin advantages for these conglomerates: they are able to diversify their risk by collaborating with local enterprises, especially in the emerging economies, but perhaps more importantly, they are able to pick the more dynamic enterprises in their partner countries to improve their overall bottom lines.
Advantages of GVCs have been seen in India’s neighbourhood. South-East Asian countries have long been involved in these GVCs that were first triggered when Japanese firms moved away from their home country in search of more cost-efficient locations. In the past decade, firms located in China have brought these countries closer in the production networks, a phenomenon that has also contributed to deepening of economic integration within the South Asian region. The growing share of trade in intermediate goods in the total non-fuel trade between these countries provides the evidence of greater regional integration.
The extent of sub-contracting has varied across sectors: in case of toys and sporting goods almost 90% of the cost of the final products is obtained through sub-contacting, while for consumer electronics, the corresponding figure is 80%. Interestingly, generic pharmaceuticals is also witnessing a rise in sub-contracting, with almost 40% of the final product cost being obtained through contract manufacturing. This is a sector where Indian enterprises have been early movers.
Where does India figure in the sub-contracting business? Evidence provided by WIR indicates that India is still lagging behind in terms of its engagement with GVCs. As regards the major sectors that are witnessing the emergence of sub-contracting, Indian firms seem to be performing better in the generic pharmaceutical sector where firms such as Piramal Healthcare and Jubilant Life Sciences are among the top 10 global players in contract manufacturing. Yet again the prowess of India’s generic pharmaceutical industry has been recognized globally.
The performance of Indian firms in the IT-BPO sector has been disappointing as none of the leading Indian firms could find themselves in the global top 10. Although Tata Consultancy Services seem to have narrowly missed out from being counted in this list, the absence of any Indian enterprise should be viewed with some concern, particularly because India considers itself to be a global leader in this sector.
Quite clearly, India has not yet been able to provide globally competitive enterprises that have in them to be included in the GVCs. How can the situation be changed? Adoption of a proactive industrial policy, which seems to have found favour with many governments after years of neglect, seems to be the right way forward. There is evidence that most emerging economies have opted for an industrial policy, which includes policies to change the relative incentive structure as between foreign and domestic enterprises with a view to promoting the latter. Thus, countries such as China, Korea and Malaysia, among others, have rewritten their foreign investment policies in keeping with this objective.
In India, the contours of such an industrial policy would have to be written as a part of the manufacturing strategy that is currently doing the rounds. The objective of this manufacturing strategy, as underlined by the Union finance minister in his budget speech, was to increase the share of manufacturing in the gross domestic product from about 16% today to 25% over a period of 10 years.
For the realizing this goal, policymakers will have to adopt a two-pronged strategy. In the first instance, greater policy coherence will be required to improve the ease of doing business in the country. At the same time, needs of the globally competitive sectors such as generic pharmaceuticals and IT-BPO, among others, and emerging sectors such as auto ancillaries would have to be kept in view. The government would have to get the right mix of policies to ensure that these frontline sectors enjoy the right incentives to expand their businesses in the country.
Biswajit Dhar is director general at Research and Information System for Developing Countries, New Delhi.
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