Why we should get retail right

Why we should get retail right

What does a retailer in the West know that an Indian does not?" That was the pointed question asked last week by the Bharatiya Janata Party leader Jaswant Singh. The question was triggered by a report in this paper about a new government-sponsored study on the impact of organized retail chains on small shops.

A few years ago the McKinsey Global Institute released a magnificent study of what determines why some countries grow rich and others don’t. The key: rising productivity over time.

Within countries, the McKinsey researchers observed startling variety in productivity rates across industries. For example, some countries might have high productivity in automobiles, but low productivity in construction. Others might be tops in electronics but laggards in transportation.

The study’s most striking conclusions were about the economic importance of the retail sector. William Lewis, the founding director of the institute, tells this tale in his book The Power of Productivity: Wealth, Poverty and the Threat to Global Stability. Productivity in the retail sector is critical for understanding the relative success rates of national economies.

For example, India’s antiquated retail sector has yielded bizarre market distortions. “In India, the price of ready-made shirts from domestic manufacturers is about 35% higher than the price of a tailor-made shirt," Lewis says. “The manufacturing cost of the shirt is about the same as the tailor-made price. However, the manufactured shirt has to get to the consumer. In India, that’s a huge problem because of the undeveloped retail sector."

Lewis points out that productivity gains in retailing have dynamic effects throughout a nation’s economy. For example, when most Americans and others think of the drivers of the US economic performance, they immediately think of successful tech firms such as Microsoft and Intel, or innovative financial services players such as Goldman Sachs. However, it is efficiency gains in the retailing sector that powered much of America’s economic performance in recent years.

“Evolving to a more productive retail format mix," Lewis says, “has large spillover effects in improving the productivity of consumer goods manufacturing and wholesaling." The effect is enormous. Improvement in US retailing “was the single largest contribution to productivity acceleration in the US economy in the late 1990s," he says. It trumped that of even the much-heralded Silicon Valley.

How is this possible? Lewis points out that “large-scale retailers improve their efficiency in part by buying in bulk from efficient, large-scale manufacturers. Thus, world-class British supermarkets, Carrefour and Wal-Mart have worked with suppliers in many countries to increase their scale of operations…" These efforts have “improved productivity significantly in the manufacturing sector itself". What’s more, Lewis continues, “world-class retailers have reached a scale that allows them to bypass the wholesale sector and buy directly from manufacturers. This...has put enormous pressure on wholesaling to improve its performance." Thus, greater efficiency in retail yields greater efficiency and productivity in sectors such as manufacturing and wholesaling. These beneficial spillover effects can be further found in transportation, agriculture, textiles and more.

It is for this reason that the current debate over the future of retail in India is too constricted. Opponents of big retailers fret that small mom-and-pop shops will be put out of business. The study reported in Mint last week shows this worry is realistic.

Proponents of large-scale retail typically counter that consumers will benefit from the lower prices large retail can provide as well as the greater range of goods. This is no doubt true. But as the McKinsey data demonstrates, there is so much more to the story.

The role multi-brand retailers play in large, modern economies is to inject knowledge and know-how into the sector and into the larger economy, touching almost every industry. Today’s most advanced retailers serve as change agents, pushing through needed business reforms that make manufacturing and other sectors far more efficient and productive.

The right answer to Singh’s question now becomes clear. Large retailers in the West have been engineering efficiency gains for the better part of the last four decades. They have been among the main drivers of economic growth. And they do, indeed, know a lot that other retailers simply haven’t had the opportunity to learn yet, mostly due to government policies protecting small retailers from competition.

There is hardly any shame in the fact that some Western retailers may know more than their Indian counterparts. Gains from trade work both ways. In the US last week, National Public Radio reported about American filmmakers and animation artists working with and learning from their counterparts in India. American industries, including Hollywood, are benefiting from the specialized knowledge in some of India’s most dynamic industries.

Given the importance of a sophisticated retail sector to economic performance, the latest row over retail’s future couldn’t happen too soon. India’s continued rise on the global stage depends on reform and advance in this sector.

Nick Schulz is a research fellow at the American Enterprise Institute and the editor of TCSDaily.com. He is writing a book with Arnold Kling, Economics 2.0, to be published in 2008. Comments are welcome at theirview@livemint.com