1

Indian Industrial Policy and Global Competition

N. S. Siddharthan1 Institute of Economic Growth Delhi University North Campus, Delhi 110007, India Email: nss@iegindia.org

Abstract This paper evaluates the impact of Indian economic policy, examines the Indian investment climate and business environment in relation to our main competitors like China and the East Asian countries, and discusses policy options for the future. In particular, it analyses trends in Foreign Direct Investment (FDI) inflows, regional distribution of FDI in India, and issues related to attracting efficiency seeking investments. In addition, this paper also analyses the impact of liberalisation measures on Indian exports, technology acquisition and productivity growth. In this context the crucial role of the IT sector and small and medium enterprises is reviewed. In analysing the global economic environment it considers the main provisions of the WTO regime and the ongoing technological revolution.

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 Impact 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
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I am grateful to the participants of the seminar on Indian Industrial Policy and Global Competition held at IIMB on August 20-21, 2005 for their several helpful comments and suggestions.

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 firms 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 D Es 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,

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. IMF 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

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 Information 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. consequences. This change in the MNEs strategy has led to some notable

Traditionally, design, engineering, and technological innovation were Very little R&D was performed in the host

mainly conducted in the home country.

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 However, unlike the earlier investments, some of the current

possessed at home.

investments are technology-augmenting investments aimed at exploiting host country resources (asset-seeking FDI). In the MNEs 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

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. mobility. The internet revolution has created virtual labour

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

and controlling for the standard determinants of trade growth, they find that the growth in the number of websites in a c ountry 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

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

products and automobiles) was 150 per cent and it has come down to 20 per cent in 20034 (again excluding items like alcohol, agricultural products etc.). In addition to these measures, the government introduced a fiscal squeeze during 1991-92 and 1992-93 accompanied by exchange rate depreciation. In July 1991 the rupee was devalued by 19 per cent and the depreciation process continued. This resulted in a virtual 40 per cent devaluation in nominal terms and 25 per cent in real terms over 1991 1993 (Joshi and Little 1996). Two important intentions of the 1991 Industrial Policy Statement, namely, transparency in enforcement of rules and regulations and elimination of delays continue to remain important even now as seen from the policy statements of the Prime Minister and Finance Minister in 2004. During the years 2000 and 2001 India announced important policy initiatives relating to Science and Technology and Information Technology. These policy statements and enactments will have far reaching effects on Indian industrys competitive advantages.

INDIAN SCIENCE AND TECHNOLOGY POLICY India announced a new Science and Technology policy Statement on October 29, 2001 with the objective of revitalizing the scientific enterprises in the country and raising the standards of the science and technology (S&T) institutions in India in order to meet the challenges of the technologically sophisticated world. The government discovered that the university system was under strain and the science departments had difficulty in attracting good students and faculty. Most good students opted for business management and other related areas that offered better avenues for employment. Even engineering

students from prestigious institutions like IITs (Indian Institute of Technology) opted, after graduation, for Master of Business Management (MBA) courses rather than pursue higher studies in engineering. Research laboratories faced the problem of an aging pool of scientists as students moved away from the fundamental sciences. The structure of the Indian institutions also did not promote collaborative research with industry and with overseas research institutions. The main objective of the 2001 statement was to reverse this trend. The document was a blueprint for new initiatives. The document advocates the selection of about 25 universities and an equal number of technical institutions for special support to raise the standard of science teaching and research. In this context special attention was to be paid to medical and engineering institutions with emphasis on integrating teaching and research. The emphasis is on the simplification of administrative and financial procedures to permit efficient operations of research projects. A key component of the policy is the creation of an autonomous structure for funding basic science research. Another important component of the policy is to enhance the linkages between the Indian national laboratories and teaching institutions and universities. This will be mutually beneficial to all. Several colleges face a resource crunch and consequently are unable to provide high quality laboratory facilities to their students and teachers. By teaming up with better equipped national laboratories they would be able to do better research. Scientists from the national laboratories will also benefit by interacting with young and energetic students. Furthermore, to promote innovative activities the policy requires every technical department of the government to earmark a part of its budget for this purpose.

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The policy also encourages the development of Indias 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. International 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 Indias entry to ecommerce 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 Indias 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 p er 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 3.1 FDI Inflows (Millions of US Dollars)

Host region World 1980 Share % 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Developing economies 54 957 100 69 456 100 59 302 100 51 453 100 60 214 100 57 632 100 86 458 100 139 849 100 163 770 100 192 492 100 208 664 100 158 859 100 167 007 100 225 580 100 255 939 100 333 818 100 384 960 100 481 911 100 686 028 100 1 079 083 100 1 392 957 100 823 825 100 651 188 100 8 392 15.27 23 576 33.94 27 257 45.96 17 783 34.56 18 402 30.56 14 909 25.87 16 420 18.99 23 245 16.62 30 421 18.58 29 323 15.23 36 948 17.71 43 325 27.27 55 341 33.14 81 572 36.16 104 332 40.76 114 891 34.42 149 759 38.90 193 224 40.10 191 284 27.88 229 295 21.25 246 057 17.66 209 431 25.42 162 145 24.90 Hong China Kong, 57 710 0.10 1.29 265 2 063 0.38 2.97 430 1 237 0.73 2.09 636 1 144 1.24 2.22 1 258 1 288 2.09 2.14 1 659 -267 2.88 -0.46 1 875 1 888 2.17 2.18 2 314 6 250 1.65 4.47 3 194 4 979 1.95 3.04 3 393 2 041 1.76 1.06 3 487 3 275 1.67 1.57 4 366 1 021 2.75 0.64 11 156 3 887 6.68 2.23 27 515 6 930 12.20 3.07 33 787 7 828 13.20 3.06 35 849 6 213 10.74 1.86 40 180 10 460 10.44 2.71 44 237 11 368 9.18 2.36 43 751 14 766 6.38 2.15 40 319 24 580 3.74 2.28 40 772 61 939 2.92 4.45 46 846 23 775 5.69 2.89 52 700 13 718 8.09 2.11 India Malaysia Thailand 79 934 189 0.14 1.70 0.34 92 1 265 294 0.13 1.82 0.42 72 1 397 188 0.12 2.36 0.32 6 1 261 358 0.01 2.45 0.70 19 797 408 0.03 1.32 0.68 106 695 164 0.18 1.21 0.28 118 489 263 0.14 0.57 0.30 212 423 352 0.15 0.30 0.25 91 719 1 106 0.06 0.44 0.68 252 1 668 1 778 0.13 0.87 0.92 237 2 611 2 575 0.11 1.25 1.23 75 4 043 2 049 0.05 2.55 1.29 252 5 138 2 151 0.15 3.08 1.29 532 5 741 1 807 0.24 2.54 0.80 974 4 581 1 369 0.38 1.79 0.53 2 151 5 815 2 070 0.64 1.74 0.62 2 525 7 297 2 338 0.66 1.90 0.61 3 619 6 323 3 882 0.75 1.31 0.81 2 633 2 714 7 491 0.38 0.40 1.09 2 168 3 895 6 091 0.20 0.36 0.56 2 319 3 788 3 350 0.17 0.27 0.24 3 403 554 3 813 0.41 0.07 0.46 3 449 3 203 1 068 0.53 0.49 0.16

Source: World Investment Report 2003, United Nations Conference on Trade and Development, CD.

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Chart 1
Year Wise Graph

70 000 60 000 50 000 40 000 $ Million 30 000 20 000 10 000 1980 China 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 - 10 000

Years Hong Kong, China India Malaysia Thailand

2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 Years 1991 Graph 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 8 000 7 000 6 000 5 000 4 000 3 000 2 000 1 000 India $ Million Malaysia 1992 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 Chinas 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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decreased drastically in 1998, that is, from $6323 million in 1997 to $2714 million in 1998. FDI inflows recovered slightly in 1999 reaching $3895 million and during 2002 it was $3203. Roughly half of what it was in 1997 but seems to have stabilized around $3000 million. FDI trends in Thailand were very different from that of Malaysia. During 1998 FDI inflows almost doubled, from $3882 million in 1997 to $7491 in 1998. It remained high in 1999 also but declined sharply in 2000 and in 2002 it declined to a mere $1068 million, roughly one third of Indias share. During the period 1988 to 1993 Thailand had been enjoying FDI inflows that were several times higher than that of India. Since 1995 Thailand has been receiving inflows that are comparable to that of India (except for the two abnormal years of 1998 and 1999). Having pointed this out, it is important to bear in mind that a small country like Thailand is not comparable to a very large country like India. If at all comparisons are made, they should be between India and China. Nevertheless, it is important to note that despite being a much smaller country, Thailand has been enjoying high FDI inflows. The increase in FDI inflows to Thailand during 1998 and 1999, immediately after the currency crisis, needs explanation. This was mainly due to the Japanese MNEs increasing the equity share in their affiliate firms to a higher proportion or to majority participation. Such acquisition of stocks was intended to help the affiliate tide over the crisis and it did play a critical role in the revival of the company. In this connection, the examples of Toyota and Honda in Thailand are often cited. Toyota was one of the first multinationals to set up operations in Thailand. Its objective was to mainly serve the domestic market and also export to a limited extent. However, the economic crisis forced

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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 DIFFERENCES IN FDI INFLOWS 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 Realized Region Value Share 10 Million Total Beijing Tianjin Hebei Shanxi Inner Mongolia Liaoning Jilin Heilongjiang Shanghai Jiangsu Zhejiang Anhui Fujian Jiangxi Shangdong Henan Hubei Hunan Guangdong Guangxi Hainan Sichuan Chongqing Guizhou Yunnan Shannxi 34,834,549 1,439,843 1,327,461 679,748 152,585 64,089 1,484,450 292,167 366,392 2,833,979 4,373,047 1,118,759 303,430 3,351,038 271,287 2,110,910 431,743 642,956 524,340 9,819,210 694,305 622,978 317,858 224,886 42,238 96,978 304,595 100 4.13 3.81 1.95 0.44 0.18 4.26 0.84 1.05 8.14 12.55 3.21 0.87 9.62 0.78 6.06 1.24 1.85 1.51 28.19 1.99 1.79 0.91 0.65 0.12 0.28 0.87

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Gansu Qinghai Ningxia Xinjiang

45,616 1,968 12,856 36,967

0.13 0.01 0.04 0.11 2.43

Others 845,870 Source: www.chinafdi.org.cn

Table 3.3 India: FDI Approval by States (August 1991 September 2000) States Maharashtra Delhi Karnataka Tamil Nadu Gujarat Madhya Pradesh Andhra West Bengal Orissa Uttar Pradesh Haryana Rajasthan Punjab Kerala Bihar Goa Pondicherry Himachal Chandigarh Unallocated Investment (Rs.10mill) 40,726.09 31,817.55 19,796.78 16,895.50 11,175.31 9,752.81 9,448.91 8,375.66 9,986.74 4,067.35 2,983.87 2,539.62 1,938.90 1,277.23 851.67 529.35 394.85 361.66 141.84 66,596.43 Share (Percentage) 17.12 13.37 8.32 7.10 4.70 4.10 3.97 3.52 3.36 1.71 1.25 1.07 0.81 0.54 0.36 0.22 0.17 0.15 0.06 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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FDI and domestic investment. Uneven development and in particular uneven distribution of FDI among the states/provinces is an important issue for both China and India. To analyse these issues it is important to examine the factors affecting the investment climate. Furthermore, meagre levels of FDI inflows into India compared to China also necessitate a close examination of the investment climate in India, China and the East Asian countries. In the next section, it is proposed to analyse in detail the investment climates of India, China, Malaysia. Thailand and Singapore based on the data provided by the World Business Investment Survey (WBES) of the World Bank (Batra et. al. 2003).

IV

INVESTMENT CLIMATE

The World Business Environment Survey uses a uniform core questionnaire for enterprises n i eighty countries and as stated in its introduction it provides a basis for inter country comparisons of investment climate and business environment conditions, and comparisons of the severity of constraints that affect enterprises. It also permits some evaluation of conditions in specific countries. It captures companies perceptions of key constraints in the business environment perceptions that shape operational and investment decisions as well as several quantitative indices of companies experiences (Batra et. al 2003, page 1). The survey is important in the context of a number of countries concern about how conducive the business environment is for private investment and business development. It is also useful in examining the relative standing of the countries in the globalised world. The tables presented below are derived from WBES data set.

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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 Singapores 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 Corruption 60.43 Judiciary 29.12 Financing 52.13 Infrastructure 61.98 Policy Instability 62.96 Inflation 67.91 Exchange Rates 42.77 Street Crime 22.91 Organised Crime 21.84 Anti Competitive na Policies Taxes and 39.23 Regulations Note: na refers to not asked. China 31.25 13.83 80.20 30.69 41.00 42.42 21.74 18.18 19.59 38.78 28.71 Malaysia 22.73 21.35 41.05 19.79 27.37 39.26 28.26 18.48 14.61 27.27 20.43 Thailand 87.06 25.00 75.24 64.89 90.85 90.59 94.77 92.59 100.00 95.40 84.25 Singapore 8.00 9.09 30.30 11.00 11.00 12.00 26.00 6.00 10.10 20.62 11.00

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 t hese 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 Indias 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 Constraints India China Malaysia Thailand Singapore 26.18 27.72 27.55 26.92 9.28 50.27 21.05 63.68 16.00 34.95 14.63 40.64 19.58 67.86 41.15 19.79 14.43 50.00 30.00 29.89 42.71 29.67 26.88 17.53 36.17 20.83 47.64 53.98 42.44 42.07 33.73 80.91 69.93 10.75 24.00 9.28 5.10 5.00 31.96 12.00

Country/Variable Business Registration Customs Labour Foreign Currency Environmental Fire High Taxes Tax Administration

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.

Country/Variable Collateral Bank Paperwork High Interests Special Connections Banks Fund Shortage Access to Foreign Banks Access to NonBanks Access to Export Finance Access to Lease Finance Access to Credit

India 50.53 50.53 81.18 34.97

Table 4.3 Obstacles to Firm Financing China Malaysia Thailand Singapore 20.20 41.49 49.35 29.17 29.00 32.99 44.61 21.65 35.35 52.58 84.24 32.99 25.53 34.74 51.24 18.75 20.22 14.29 15.19 14.71 7.69 21.84 79.39 71.67 61.90 64.84 60.61 75.34 3.23 5.43 11.24 10.11 8.70 13.04

18.48 37.00 22.03 17.14 23.98 12.79 25.61 21.33 20.59 22.47 32.12 44.44

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 4.4 Percentage of Firms Rating the Quality of Services as Bad Country/Variables India China Malaysia Thailand Singapore Customs 40.00 14.29 11.59 28.76 1.09 Courts 28.34 20.55 29.51 20.26 0 Roads 68.53 22.47 21.11 40.00 0 Postal na 11.46 8.60 6.31 0 Telephone 26.24 14.14 7.29 15.89 0 Power 40.30 14.74 7.29 17.52 2.02 Water 29.63 12.64 14.58 20.42 0 Health 48.17 30.77 14.46 28.42 2.06 Military 8.94 Na 15.63 19.86 1.10 Government 40.35 Na 17.78 39.59 1.16 Parliament 60.24 Na 25.00 45.17 1.16 Central 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. Portos (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. Weis (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.

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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common knowledge, institutional reforms to eliminate them have not been initiated so far in India. The advent of the internet and the consequent emergence of E-governance have facilitated the promotion of transparency in government dealings. Several vital matters like information on tenders, status of a case or a project, land records, forms and other materials for which one had, earlier, to approach an official in person, can now be put on the web pages. It is also possible to put on a web site the details of administrative procedures. These measures will reduce personal contact with the bureaucracy, increase transparency and reduce corruption. But not all state governments have opted for Egovernance. In India, only a handful of states have made a beginning. The majority of them have not shown a willingness to introduce E-governance. Research and development is yet another area where the state can facilitate the networking of R&D units belonging to private enterprises, the public sector and the national laboratories. The state can also encourage the establishment of joint R&D units by several enterprises in a given industry to take advantage of economies of size in research. It is also important to give subsidies and tax concessions to private R&D units. In this context it is essential to note that multilateral agencies like the WTO permit subsidies and concessions to R&D units and most developed countries have taken advantage of this WTO clause to heavily subsidise their R&D units. So far India has not made any worthwhile move in this direction. The state has to play a proactive role in improving the skill content of the population. In this context, skill up-gradation is not a one shot process. The vital need for the continuous up-gradation of skills because of changing technology, trade and

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management governments. innovative

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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 f ollows it is proposed to survey the main findings from literature and draw policy inferences for India.

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The Chinese 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 nonChinese 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 Indian Experience 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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firms that possessed higher labour productivities and had lower productivity gaps with MNEs were able to enjoy higher spillovers while those with larger productivity gaps could not benefit much. As a result, firms with better endowments in terms of productivity and technology benefited from liberalisation and FDI presence. Firms with large productivity gaps became the victims. Other studies also show the importance of R&D in attracting spillovers. A study by Kathuria (2002) showed that Indian firms with low or nil R&D expenditures did not benefit from the spillovers. Furthermore, in the case of low R&D intensive industry groups the impact of import liberalisation was found to be productivity depressing. Kathuria, therefore, concluded that spillovers were not automatic and they depended largely on the level of investment a firm made in R&D. In sum, only firms that had low productivity gaps benefited from spillovers.

Latin American Experience Spillovers from MNEs need not always be positive. Studies for Latin America have reported negative spillovers. For example, a study by Aitken and Harrison (1999) using annual census data for over 4000 Venezuelan firms for the period 1976 1989, presents two interesting results with regard to spillovers. They have found a positive relationship between increased foreign participation and plant performance only in the case of small plants, namely, plants with less than 50 employees. For large enterprises when plant specific differences (fixed effects) are taken into account the positive foreign investment effect disappears. They argue that foreign firms are not more productive but they invest in more productive sectors. Thus the higher productivity observed is due to sector effect

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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--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 economys ability to take advantage of potential spillovers.

Policies to Increase Spillovers 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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laboratories and academic institutions and furthermore, it has prompted the scientists to adopt devious ways to appropriate the fruits of their technology creation like taking a short-term foreign assignment and patenting their creation while in the US or like not revealing their entire project results to the government in their project report. As explicitly recognised by the S&T Statement of 2001, the public sector science establishments are not able to attract talent despite Indians being in the forefront in high tech areas like biotechnology and IT. The inability to appropriate the fruits of research by researchers and institutional difficulties for meaningful interaction with business are two reason for this. Another is bureaucratic hurdles in professional advancement. For example, in frontier areas like IT and biotechnology, it is essential for scientists to present papers and participate in international conferences. In each field there are about three or four international conferences every year where participation is a must if a scientist has to remain in the frontier. Universities in developed countries automatically fund faculty participation in such conferences for all persons whose paper has been accepted for presentation. Most Indian universities do not fund scholars for presenting papers in international conferences and other technology institutions like IITs permit funding for attending only one conference in a year. This is not due to scarcity of funds it is a bureaucratic regulation. Most Indian scholars in the US and European countries point to this rule as a major reason for not returning to India. To be in circulation among their peer groups they have to present papers and participate in these gatherings. They further state that the IIT directors are aware of this problem but are helpless as they lack the power to change the rule.

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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). Arms 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 arms 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.

MNEs and Exports The statistical support for a positive relationship between MNEs/joint ventures and exports has been very weak. For example, Aggarwals (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 firms 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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SMEs 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.

Liberalisation and Value of Exports 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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Policy Imperatives to Increase Exports 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 smallscale 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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