Multinational Enterprises in India

:

A Case Study of Automobile Industry

A thesis submitted to the University of Mysore, Mysore, through the Institute for Social and Economic Change, Bangalore, for the Award of the Degree of Doctor of Philosophy in Economics

By

Venu Gopal Jarugumalli

under the supervision of

K. Gayithri

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INSTITUTE FOR SOCIAL AND ECONOMIC CHANGE, BANGALORE December, 2006.

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Dedicated To My Father

F ather this for you .....

jor all those til)J('J I Iqft it unsaid thallk ),011, Thanks,for bei!zf!, therefor me .,. for showif{~ me tbe way ...

for beingpatieJlt with INe even when I "lade it difficult for )'ou ...

for believing in »re ej'" ellcouragilzg !lIe to Dream ..

And being such an inspin'ng presence in "!)' life.

DECLARATION

I hereby declare that the thesis entitled "Multinational Enterprises in India : A Case Study of Automobile Industry" is a result of

research work carried out by me at the Institute for Social and Economic

Change (ISEC), Bangalore, under the guidance of Dr. K. Gayithri,

Associate Professor, Centre for Economic Studies and Policy, ISEC, Bangalore.

I further declare that it has not been previously submitted, in part or full, to this or any other university for any degree. Due acknowledgements have been made whenever anything has been borrowed or citied from other

sources.

Date:

Research Scholar Centre for Economic Studies and Policy (CESP) Institute for Social and Economic Change Bangalore - 560 072 India

CERTIFICATE

This is to certify that the thesis entitled "Multinational Enterprises in

India : A Case Study of Automobile IndustryU I submitted by

Venu Gapal Jarugumalli in fulfillment of the requirements for the

award of the degree of DOCTOR OF PHILOSOPHY in Economics is an

original work.

,

I also certify that it has not been previously submitted for the award of any

degree or diploma or associate fellowship of the University of Mysore or any other Univer-sity.

It!~!a:::

~ (K _ Gayithri)

Supervisor Associate Professor Centre for Economic Studies and Policy Institute for Social and Economic Change Bangalore -560 072 India

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Date: ~i (11/~b

Acknowledgment

Ph.D is a long way to look back. In the process one finds many people. who have helped to come out of slack phases. dilemmas and confusions. There are lots qf people I would like to thank for a colossal variety oj reasons. Firstly. I would like to thank my Supervisor. Dr. K.Gayithri. I could not have imagined having a better advisor and men tor for my Ph.D, and without her continues support. knowledge, perceptiveness and encouragement 1 uxiulci never have finished.

I am extremely grateful to my doctoral committee members Prof.

M.R.Narayana and late Prof Hemalatha Rao. Inspite of their busy schedule they gave incisive comments on my UXJrk.

[ should place on my gratitude to Prof Abdul Aziz for providing critical inputs throughout my Ph.D work and also Jor his useful comments given in my biannual seminars.

1 would also like to thank all the academic and supporting staff of the Institute for Social and Economic Change (ISEe) for providing me Fellowship and Ph.D. training through the courscroork. In this regard. I uiouul like to thank Prof. Govinda Rao and Pro]. Gopal K.Kadekodi, Jormer directors q( ISEC and the director in-charge, Prof.G.K.Karanth for their encouragernent. l am also grateful to all fanner Ph.D co-ordinators ProJ.D.Rajeshekar. Dr.G.S.Sasthry and Prof M.D. Us haDe vi and to the present co-ordinator Dr. Anand Imbanathan. And special thanks to K. S. Narayana of the Ph.D section.

I appreciate the assistance I have receivedJrom the [acultu at [SEC.

My special thanks to Dr.Madeshwaran, Prof Ramachandran, Dr. Venkatachalam. Prot. Sangeetha Pro]. R. S. Deshpande Dr. P. Thippaiah. Dr. Mahadeva, Dr.K.G.Gaythri Deoi Dr.Meenakshi ,B.P. Vani and all the other

faculti; members at [SEC. l also thank Mr. Rammapa Registrar at ISEC.

I would like to thank people who have taught me part icularly my high school teacher B. V. Subbaiah, my undergraduate teacher P. V.Rao at Kavali and my post graduate teachers at Hyderabad Central University specially Prof. B.Kamaiah. Prof. D.N.Reddy . late Prof Madduti and Prof. Somayajulu.

I am indebted to my friends at various facets oj life Jor providing a stimulating and fun environment which helped me to learn more. I am

especially grateful to Raouf, Harsha, Kranthi, Subbarao, Zebo, Satish, Steven, KK, Murali .Rama Rao and Parul.

I have lucky enough to have the support of many goodJriends and colleagues. Life uiould not have been the same without them. In this regard, I would like to thank specially to Sailaia. Pradeep, Vijay. Praoeeti, Kiran. Kumar. Ajay. Muni and Chandru.

Also I am grateful to the library and computer center staff oj the institute Jor prooiilinq technical help. In this regard. I would like to thank Mr. T.R.B Sharma. Mrs. Leela. Venkatesh. Kalayanappa, Suresh. Rudresh, Krishna Chandra and. Satish Kamath. And other supporting and administrative staff Santha kumari and Margaret. I thank Mr.Partha Sarathy and K.S. Narauona for editorial help

At this juncture, I would like to thank all the _family members qf Dr. {}aya Krishana. Dr. Ramanuneyulu, Mr. Shanna and Dr.Sridevi for providing me emotional support during the research work.

Tiionk:« are due also to several researchers and staff at other organisations that I visited in the initial stages oj the study. I would like to thank two organisations which provided me with an opportunity to work. In this regard. I thank IFIM, Bangalore and ISB, Huderabail.

Thanks are due to my student colleagues at [SEC who encouraged me to finish rru] thesis. 1 thank Srikanth, Vadi. Pratheeba, Sarala. Pattu, Prashob. Badri. Kshama, Raqhu, Mini, Deepthi and Khalid.

1 cannot end without thanking my family, on whose constant encouragement and love, I have relied throughout my academic life. I am grateful to my grand mother, my father, mother, sister and all nears and dears. The last lines oj this text should be words of gratitude to all those who directly and indirectly helped to make this thesis possible.

Contents

Chapter 1. INTRODUCTION

1 .1. Background

1.1.1. Automobile Industry in India 1.2. Review of Literature

~ .2.1. Empirical Review on MNEs 1.3. Researchable Gaps

1.4. Database and Methodology: 1.5. Organization of the Thesis

1 6 9 9

16 18 19

Chapter 2. MNES: FORMS, DETERMINANTS AND IMPACT ON DEVELOPMENT

21·50

2.1. Introduction 2.1.1. Exporting

2.1.2. Other Forms of Investment 2.1.3. Foreign Direct Investment 2.2. Theoretical Framework

2.3. Review of Literature on Determinants of MNE's Entry 2.3.1. Empirical Literature:

2.4. Impact of MNEs on Development 2.4.1. Effects on Market Institutions 2.4.2. Effects on Investment

2.4.3. Technology Effects

2.4.4. Employment Effects

2.4.5. Trade Effects

21 23 24 24 26 28 36 38 39 41 44 46 48

Chapter 3.GLOBALISATION OF AUTOMOBILE INDUSTRY

51-75

3.1 . Automobile Production Processes

3.2. Structure of Global Automobile Industry.

3.3 The Economic Geography of the Automotive Industry 3.4 The Empirical Findings

3.5 Chapter Summary

51 56 63 68 73

Chapter 4. INTERFACE BETWEEN POLICY, STRUCTURE AND GROWTH OF INDIAN AUTOMOBILE INDUSTRY

76-112

4.1. Database and Methodology:

4.2. Overview of Indian Automobile Policies

4.2.1. The Regulatory Phase (Pre Maruti) (1951-82)

4.2.2. Maruti Phase or First Phase of Liberalisation (1982-1993) 4.2.3. Globalised Era (1993 onwards)

76 77 80 85 90

4.3. Structure and Growth of Indian Automobile Industry 4.4. Growth and Performance of Industry:

4.4.1 Capacity Utilisation:

4.4.2. Trends in Production:

4.5. Chapter Summary

94 104 104 107 111

Chapter 5. ENTRY, LOCATION AND EXPANSION BEHAVIOUR OF AUTOMOBILE FIRMS IN INDIA DURING LIBERALIZED ERA: AN EMPIRICAL ANALYSIS

113-149

113

t;.1 Foreign Direct Investment in India during 1990s: Trends and Issues 5.2. Entry and Expansion Plans of Automobile Firms

5.2.1. Mode of entry:

5.2.2. Pattern of Equity Participation and Expansion Strategies 5.2.3. Location Strategies:

5.3. Determinants of FDI in Indian Automobile Industry 5. 3.1. Empirical Results:

5.4. Chapter Summary:

117 117 121 127 136 142 147

Chapter 6. PERFORMANCE OF THE INDIAN AUTOMOBILE INDUSTRY

149-175 149

6.1. Introduction

6.2. Database and Methodology:

6.3. Impact on Productivity indicators: 6.3.1. Empirical Results

6.4 Impact on Financial Performance:

6.4.1. Sources of Gross Turnover Growth in Indian Automobile Industry:

6.4.2. Trends in Growth of Gross Turnover, Growth in Assets, Wages and Selling Expenses

6.4.3. Empirical Results:

6.5. Sources of Growth in Profitability 6.5.1 Empirical Results

6.6. Export Performance

67. Chapter Summary:

152 153 158 159 160 161

164 165 170 171 174

Chapter 7. EFFICIENCY OF MULTINATIONAL FIRMS IN CREATING LINKAGES

176-200

7.1. Introduction

7.2. Globalisation and Transformation of the Indian Auto components Industry: 7.3. Database and Methodology:

7.4. Stochastic Frontier Production Function 7.5. Empirical Results:

7.6. Chapter Summary:

176 180 186 188 192 195

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Chapter 8. LINKAGE BETWEEN STRUCTURE AND PRODUCTIVITY GROWTH

201-210

8.1 Link between Competition and Growth 8.2. Data base and Methodology:

8.3 Empirical results:

8.4 Chapter Summary

201 204 205 209

Chapter 9. MAJOR FINDINGS AND POLICY IMPLICATIONS

210-220

9.1 Major Findings & Conclusions 9.2. Policy Prescriptions:

Bibliography

210 217 221-240

List of Tables, Figures and Charts

Tables

Table.2.1 Various Schools of thought on MNEs 27
Table.2.2 Determinants of FDI 35
Table.2.3 Review of Selected Studies 37
Table.2.4 Effects on Labour Market 47
Table.3.1 Home and Foreign Production of Motor Vehicles by the Leading MNEs 59
(1977 I 1989 and 2002) (I n percentage terms)
Table.3.2 Assets, Sales and Employment of the Top 14 Automobile Manufactures (In 60
1997-98)
Table.3.3 Ranking of Top 14 Automobile Manufacturers among the top 100 MNEs in 61
1997
Table.3.4 Major M &A Deals in Global Automotive Industry 62
fable.3.5 Production Share of World Automobile Industry (in per cent age terms) 64
Table.3.6 Production Determinants of Automobile Industry 70
Table.3.7 Production Determinants of Automobile Industry in 2001-02 72
Table 4.1 Some Landmark Events in the Evolution of the Automobile Industry 79
Passenger Carl Multi Utility Vehicle Segment
Table 4.2 Capacity Utilisation in pre-Maruti era 81
Table 4.3 Indigenization Levels of Various Automobile Firms during Third Five Year 83
Plan
Table 4.4 Indigenisation Levels of Various Automobile Models in 1980s 83
Table 4.5 Categories of Companies Where Vehicles Were Allowed for Importing 84
Table 4.6 Specified Economies of Scale for Passenger Car Industry 86
Table 4.7 Vehicle Prices (in Rs.) by the Type of Vehicle -1984-85 87
Table 4.8 List of Foreign Collaborations in CVs and Cars Segment 88
Table 4.9 Motor Car Exports by Maruti 89
Table 4.10 Phase-Wise Removal of Quantitative Restrictions by India for the Automobile 91
Sector by Product Groups
Table 4.11 Excise Duty Structure for MUVs and Cars 93
Table 4.12 Summary of the Globalised Era Policies 94
Table 4.13 Characteristics of Various Markets 95
Table 4.14 Models of Industrial Organization 96
Table 4.15 Producer and Seller Share of Passenger Cars & Jeeps in Pre-Maruti Phase 97
Table 4.16 Producer and Market Share of Passenger Car Segment (per cent) 98
Table 4.17 Market Share Behaviour of Car Segment during the era of liberalisation 100 Table 4.18 Producer Share of Car Segment during the Era of Liberalisation 101
Table 4.19 Producer and Market Share of MUVs Segment during the Era of 101
Liberalisation
Table 4.20 Price Based Classification of Passenger Cars 102
Table 4.21 Passenger Car Industry and Their Structure and Periormance 103
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Table 4.22 Capacity Utilisation of Automobile Industry in 1989 106
Table 4.23 Production of Vehicles Before 1970 108
fable 4.24 Decadal Growth Rates of Passenger Cars and Jeeps Production 108
Table 4.25 Kinked -Exponential Trend Rate of Growth of Number of Vehicles 110
Table 5.1 Break-up of Approved F 0 I in Transportation Industries India(01.08.1991 to 116
31.07.2004)
Table 5.2 Passenger Car Industries in India 116
Table 5.3 Details of Entry Modes of Various Automobile Firms 120
Table 5.4 Equity Pattern of Newly Entered Passenger Car Plants in India 123
Table 5.5 Details of Installed Capacity of Passenger Cars in India 125
Table 5.6 Company Wise Details of Capacity Utilization and Employment 126
Table 5.7 Approved FDI into Automobile Industry in Various States 127
Table 5.8 Distribution of Registered Working Factories of Transport Equipment Sector 129
Table 5.9 Region-Wise Infrastructure Index and Financial Incentive Index 135
Table 5.10 Description of variables 137
Table 5.11 Variables and Expected Signs 141
Table 5.12 Unit Root Test Results 142
TableS.13 Correlation Table 143
Table 5.14 Regression Results of FDI Determinants of Indian Automobile Industry 144
Table 6.1 Kinked Exponential Growth Rates of Productivity of Indian Passenger Car 159
Segment
Table 6.2 Sources of Gross Turnovers Growth: 163
Table 6.3 Regression results of profit function 170
Table 6.4 Export of Cars and Jeeps 171
Table 6.5 Export and Sales Behaviour of Various Firms in India in 2002-03 173
Table7.1 Principal Characteristics of Automobile Component Industry in India. 184
Table7.2 Sources of Components of MNEs in India 186
Table7.3 Estimates of Stochastic Frontier Production Function for Import Dependency 192
of Passenger Cars in India
Table7.4 Firm Specific Technically Inefficiency Measures 193
Table7.5 -
Details of follow source suppliers of Lancer car project in India 195
Table7.6 Details of follow source suppliers of Hyundai Motors in India 198
Table7.7 Local content commitments of various firms in India 199
TableS.l Regression Results 207
TableS.2 Variance Decomposition 209 Figures

Figure 2.1 Impact of MNEs activity_ 39
Figure 3.1 Production Sequence in Automobile Industry 53
Figure 3.2 Supplier Relations in Automobile Industry 53
Figure .5.1 Geoqraphical Locations of Automobile Clusters 131
Figure .6.1 Links between Profitability and Structure and Conduct 165 Charts

Chart 3.1: Production Share of Various Automobile Firms in 1977,1989 And 2002 57
Growth Rates of Production of Passenger Cars in Various Countries
Chart 3.2: (1991 to 2001) 65
Chart 4.4: Utilisation of capacity in five year plan period 105
Chart 4.2: Cars and jeeps as a percentage to commercial vehicles 106
Chart 4.3: Annual Growth Rates of Cars and Jeeps Production 108
Chart 4.1: : Structural Break Test of Production 109
~~
Foreign Direct Investment Approvals and Inflows into India (1991~1992
Chart 5.1: to 2004-2005) 115
Chart 6.1 Sales Trends of a passenger car industry 151
Annual Growth Rates of gross turnover of Indian passenger car and
Chart 6.2: MUV segment 162
Chart 6.3: profitability ratio of Indian passenger car and MUV seqrnent 166
Chart 6.4: Per Unit Cost anyalsis 167
Chart 6.5: Wages and Selling Expenses share to value of output 169
Chart 6.6: Export Intensity of Passenger Cars and Auto Components in India 172
Chart 7.1: Vertical integration of Indian automobile firms 2000 200
Chart 8.1: Impulse Response 208 CHAPTER ONE

INTRODUCTION

1.1. Background

The process of globalisation in the last decade has encouraged many big firms, Multinational enterprises] (MNEs) around the world to invest outside their political boundaries. In the last two decades, direct investment by multinational firms has grown significantly faster than trade flows, particularly in the developing economies. Since the 1980s, many MNEs have been investing in the developing countries through a variety of institutional arrangements. The need for foreign capital to supplement domestic resources is being felt by the developing economies, in view of growing mismatch between their capital requirements and savings capacity. It is argued that Foreign Investment from MNEs can help Less Developed Countries (LDCs) in fil1ing the gaps between the targeted and desired investment. foreign exchange constraint, government revenue-expenditure, skills, technology and entrepreneurship which inhibit developing countries' thrust for economic growth (Todaro 1994). Filling these gaps is of vital importance for developing countries to speed up their economic development. In this regard, many developing countries view foreign capital as a key clement in their development strategies and also percive that foreign capital generates employment in the host country. MNEs can play an important role in the development of developing countries by increasing the flow of Foreign Direct Investment (FDI), production and exports and efficiency through technology transfer (Siva Ramu 1994).

MNEs investment determinants are very often influenced by the interests of two players, while on the one hand it is the interests of MNEs themselves with reference to location of their foreign operations; on the other hand it is the concern of the host country as how to frame attractive policy strategies to attract these MNEs. The impact of FDI on development varies from one country to another, which can be positive or negative. The impact is dependent on how well or ill-structured the projects are, but largely determined hy the competitiveness of the host-country markets; this in turn is often influenced by the polices of host-country (Athreye 2003).

I The study has used the terms Multinational enterprises (MNE) or Multinational Corporation (MNC) Of Transnational Corporation (TNC) interchangeably. TNCs may be defined as 'firms investing in more than one country and supplying more than financial capital, for example management, technology or marketing expertise (Weiss, 1991).

Research evidence reveals that positive benefits have accrued In north-to-north investment flows, most of these benefits have failed to capitalize in north to south capital flows, which are in developing countries (Kaminski and Riboud 2000). On the contrary, there is evidence showing that the cost of these MNE activities in developing countries is relatively larger than the benefits.

With rapid globalisation of the world economy, many countries have been increasingly encouraging FDL The demand for FDI now significantly exceeds its supply. As a result, there is a fierce competition for foreign investment from the host countries. In order to capture the development benefits from foreign capital, developing countries have been resorting to various measures to attract these MNEs. These include measures such as announcement of different types of incentives, amendments to the regulatory laws etc.

An important aspect that has to be borne in mind while assessing the benefits that MNEs provide to the host country is with reference to the arguments of local industrial development through the backward linkages created by the MNE investments. Economists and policy makers generally view that local linkages are essential for the development of an integrated industrial sector in any country. The existing literature revels that local linkages have enhanced industrial growth, technology transfer and job creation while strengthening national self-reliance. It is expected that the entry of MNE into a host country will generate more linkages. Further, it is also expected that this linkage creation will be greater if the MNE is export oriented in nature.

Many studies have often concluded that the determinants of FDI often depend upon the motives of the MNEs (UNCTAD 1998). At the same time, host country's policies relating to entry and exit of MNEs, tax policy and tariff barriers also play an important role in determining the nature and the FDI flow. The emergence of MNE activity and its pervasive activity of foreign direct investment have been the focus of many research studies in economics. MNE activity in developing country is a still a hot issue. Though there are many studies, which try to explain the main motives of FDI inflow at an aggregate level (macro level) arc available, the studies addressing this particular issue at a sectoral level (i.e. at a specific industrial level) arc scanty.

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The present thesis has made an attempt to fiJI this gap by reviewing success and failure of MNEs in India with reference to the automobile sector. This study is also largely concern for identifying the push and pull factors that determine MNE operations in India, and to analyze the effect of degree of foreign participation on a particular industry i.e. Indian automobile industry-which has attracted a huge amount of FDI inflow from MNEs.

The process of industrialization in India in the last four decades has been governed by multiple objectives of self-reliance, protection of national industry and domestic entrepreneurs. This import substitution policy was intensified further after the enforcements of the legislations such as Foreign Exchange and Regulation Act (FERA) and Monopoly Restrictive Trade Practice act (MRTP)2. A number of studies has shown that the import substitution policy, while may have helped broaden the industrial base of the country, has led to resource misallocation and economic inefficiency. These policies also had a number of detrimental effects on exports (Virmani 2003).

The process of re-orientation of the policy framework began in the late 1970s, which gained momentum in the 1980s. The measures included industrial de-licensing, softening of restrictions on monopolies, liberalisation of capital goods imports with a view to upgrading the technology and modernizing the industry with some shifts from quantitative import controls to a protective system based on tariffs, greater subsidies for exports and a policy of acti vc exchange rate depreciation. From the early 1980s onwards, Indian government's attitude towards foreign investments and collaborations also began to change. As a result of this, some degree of flex ihil ity was introduced in the policy concerning foreign equity participation. Consequently, the government offered permission for the Japanese col1aborations.

Liberalisation of the industrial policy in 199] introduced a number of changes in the regulatory policies. Government of India (GOI) introduced a two-way approval process for foreign direct investment. The first is the automatic approval route. and (he second. is through the Foreign Investment Promotion Board (FIPB). which

~ For a derailed discu ""ion on gO\l'rnml'nla 1 p(lllcy and forcig n direct In\ e-..tll1l'nl I n I nd I a, "t'!.:. K u mar ( Il)l)~ I

accords approval case by case through the forma] process. These policy changes led to u good response from the MNEs. Most of the MNEs set up their plants as joint ventures and the FDI has been flowing into the country. This has been especially significant in the context of Indian automohile industry. Against this backdrop, the present study proposes to analyse the nature, extent and implications of MNEs participation in the country with special reference to automobile sector. This study assumes special significance in view of the fact that the policy changes in 1993 had led to an influx of MNEs into the Indian automobile industry, which increased the number of players from three to sixteen. Further, this has resulted in many changes in the automobile industry.

Automobile Industry:

The automobile industry consists of vehicle manufacturing, components manufacturing (anci11ary industry) and the service sectors. An automobile firm is responsible for the development of design, engineering and marketing of vehicles and it generally undertakes directly the manufacturing of several critical components of the body, transmission and engine. An automobile has a final product consisting of 16,000 to 20,000 parts. The automotive industry is often regarded as a classic example of a producer-driven commodity chain (Gereffi 1994). Characterized by large scale, capital-intensive, technology-driven product-cycles, producer driven commodity chains are networks of global production. The vehicle-manufacturing sector produces different types of vehicles. They include scooters, motorcycles, and mopeds in twowheeler segment. Passenger and goods carrying vehicles in Three-wheelers segment; Passenger cars, Multi-utility Vehicles (MUVs), Light commercial vehicles (LCVs), buses, trucks and tractors in four and six wheelers segments. In each category, there are a number of manufacturing firms and they produce different models of vehicles of varying sizes and capacities.

The automobile industry is highly capital-intensive and also influences various related sectors. The automobile industry in the country is one of the key sectors of the economy, in terms of employment opportunities that it offers. The performance of automobile industry is often considered to be a reflection of the performance of the economy as the industry's growth is closely related to the growth and economic well-

4

being of the general population and the economy as a whole. There are extensive forward and backward linkages to the final automobile product. Thus, their influences on the ancillary sectors like parts and components, sales/maintenance, materials supply i.e. steel and plastic ete is enormous. Further, the automotive sector also offers a potential study as it illustrates how growth can be achieved after the removal of entry barriers.

There have been only a few final assemblers (such as Ford, GM, Toyota, Honda, Volkswagen, Benz and BMW) who dominate the industry's main markets with their oligopolistic market structure. For many years major percent of the global passenger car production comes from three countries, viz.,the US, Japan and Gcnnany. In the Triad regions (the United States of America and Canada, i.e. North America, Japan and Western Europe), the vehicles industry is mature. In the late 80s it was suffused by overcapacity, cost pressures and low profitability. There has been an increase in the number of firms selling cars in mature markets such as the United States, Germany, and Japan. Many Automakers from this Triad region have been aggressively international ising their operations in search of new emerging markets. Slow growth, market saturation, and increased competition at home have led MNE automakers to the obvious conc1usion that future growth will occur in those emerging markets, particularly in countries with the large population, such as China, Brazil, and India.

The global auto assemblers have been expanding their world production capabilities and have recently shifted their focus towards big emerging markets like China, India, and Brazil. This has resulted in an increase in the number of players in these countries and increased competition in these growing markets. In this regard, MNEs in these regions are installing the flexihle production methods in order to exploit the scale economies. In addition, auto assemblers have started cutting the cost of platform development and encourage components sharing among the models. For example, Fiat produces its Palio car in Brazil, Argentina, India, China and South Africa. In this way, the assemblers have developed policies of 'follow design' - the same design would be made at various locations and 'follow sourcing' - the same supplier would supply a product at different locations. Thus, MNEs are reducing the design costs by allowing flexible sourcing of components to different markets.

5

Further. MNEs in developing countries mainly depend upon the assembling operations by importing Completely Knock Down (CKD) and Semi Knock Down SKD kits. For these assembling operations, the MNEs mainly depend on the imports of some critical components which can be produced at centralised locations and shipped to widely spread assembly sites. In these cases, MNEs in the emerging markets are encouraging their 'follow source' suppliers. In this regard when the global assemblers invested in the emerging markets like Mercosur (Argentina and Brazil), China, ASEAN and India in the 1990s, the major component suppliers were forced to follow them; therefore, we first examine the Indian automobile industry, which remained underdeveloped even after four decades of its commencement due to its import substitution policy.

1.1.1. Automobile Industry in India

In the Indian context, the automobile sector occupies an important place as it contributes around 4 per cent of the GOP and offers employment to a large number of people. It is highly capital-intensive and has extensive forward and back ward linkages with the various related sectors. It is one of the largest generators of direct and indirect employment. The industry directly employs close to around 0.45 million people and indirectly employs around 10 mil1ion people. Every direct job generates another 60-70 jobs through indirect employment (ACMA 2003). Government of India has been actively involved in formulating policies for automobile sector development. The first such policy dates back to early 1950s.

Indian automobile industry, however, started In early 1950s with other developing countries. But it is disappointing to note that India's growth lagged3 behind that of other countries like Korea, Brazil and Mexico. The main reasons attributed for such failure is import substitution policy adopted by Indian government for a long time. The policies on the control of capacity expansion and import of raw materials, components, and equipment through licensing, restrictions on Foreign Direct Investment (FDI), and imposition of indigenization clause, protected the domestic market but this protection continued for more than three decades.

1 Between 1'J70·71 and IlJX3-84. production grew very narrowly between O.36lakh and 0.47 lakh no. (CMJE. 1(1)6)

6

Until 1984, the passenger car market was dominated by Premier Automobiles Ltd .. (PAL) and Hindustan Motors (HM). The entry of Maruti as a joint venture between Suzuki of Japan and the Gol radically transformed the passenger cars industry and stimulated its growth, which was till then extremely sluggish. The entry of Maruti expanded the overall demand for passenger cars in India. leading to the industry growing at 25 per cent hetween 1984 and 1990. Further, the entry of Maruti also forced the existing players to update their models, by the foreign collaborations. Foreign collaborations in this period were purely technical in nature and apart from Maruti; one of them is having financial collaborations because of which the intensity of MNE presence was not there because they don't have control over the ownership.

The opening of the economy in 1993 attracted the world majors, who joined hands with existing auto majors, to start their operations. This helped in increasing the number of models available to the customer from 8 to 27 and, hence, provided a wide choice to consumer. The first real change came in 1994-95 when Korean Auto Company Daewoo and French company Peugeot entered into India with more contemporary models. Over the subsequent seven years, as more and more multinationals entered. the new entrants, mostly global giants like Honda, General Motors, Hyundai, Daewoo and Ford completely changed the market structure. This way the numher of firms increased to total 12 players in car segment and six in MUVs segment.

Concomitant to the policy changes there has heen a considerable change in the growth and structure of automobile industry in the recent past. There were five car assemblers in India - Manni Udoyog Ltd., Hindustan Motors Ltd .. , Premier Automobiles Ltd., and Standard Motor Production of India Ltd .. , Sipani Automobiles before J 990s; now the number of players has increased to 13. The decontrol, delicensing and deregulation of auto industry have changed the structure of the Indian automobile industry. After the 'new' auto policy in 1993, the automobile sector in India has been allowed the entry of MNEs into the country, which has led to the attraction of MNEs like General Motors, Ford, Honda, Hyundai and Fiat. Most of these MNEs have entered as joint ventures with Indian manufactures.

7

Since Iiberalisation, the contribution of the automobile industry to GDP has risen from 2.77 per cent in 1992-93 to 4.0 per cent in 1998-99. The automobile sector has recorded an annual growth of 20 per cent in the period from 1993-94 to 1996-97. There has been a substantial addition to instal1ed capacity creation during 1993-94 to 1998-99, in four wheelers which has increased from 5.2 lakh to 11.76 lakh vchic1es (ACMA 1999). This sector has been categorized as a priority sector for FDI. Total sector-wise break up of FDI and technical collaboration approved for passenger cars during August 1991 to January 2002 was RS. 73.101.15 Millions, which accounted for 2.66 per cent of total FDI flows into India (SIA 2002).

1.2. Review of Literature

Review of studies can be broadly grouped under two categories as empirical studies on MNEs and the literature pertaining to Indian automobile industry.

1.2.1. Empirical Review on 'MNEs

Foreign Direct Investment (FDI) has been one of the most fascinating and intriguing topics among researchers in international business. There are many studies to explain the determinants and impact of FDI. This section however includes review of only recent studies4. The theory of FDI addresses the issue concerning why a firm wants to produce in a foreign location, where indigenous firms have superior knowledge of the local condition. Shatz and Venerable (2000) identifiy two important factors as responsible for the location of a firm in a foreign country a). To serve local market. b). Reducing cost of production by making use of available low cost factors. The determinants of MNEs investment often depends on the nature of FDI; whether it is horizontal or vertical. In general the nature of horizontal investments i.e. producing same product elsewhere, which will be in search of new markets, whereas, vertical FDI i.e. adding stage in production process often will flow to minimize the production cost. Most of the developed countries attract horizontal investment e.g. Japanese investment in U.S. automobile industry. Quite often many developing and less developed countries get the vertical investments. For example, Mexico's FDI in automobile components, FDI in India in software industry. FDI into electronic

.j More studies are lis led in the bibliography.

9

industry in Malaysia etc. At the same time, several developing economies such as China, Brazil, India, and Mexico attract both horizontal and vertical investment. The investment pattern in these developing economies is determined by the set consisting of the supply side and demand side factors. Explanation of the magnitude and pattern of FDI inflows into host countries require analysis of a complex ray of factors. These factors differ from developed to developing countries in several ways. They also differ according to the level of economic development, endowment of market, political and legal institutions (Dixit 1999).

There exists a long tradition in the development economics literature that take an optimistic view of the effect that foreign direct investment (FDI) has on industrial development in the host country. In this tradition, multinationals (MNEs) are seen as agents who increase competition, transfer modern technology. and help achieve a more efficient allocation of resources. During the past two decades, many studies have focused on the effects of MNEs on the host country. through important channels such as the transfer of technology, training of workers and finally, generation of linkages. Results of these studies are inconclusive and often contradictory (Grog and Greenway, 2004). One important conclusion arrived at by the studies that have studied the effects of MNEs on host countries is that host country will benefit out of MNE presence if they are able to generate some kind of 'deep' linkages.

A plethora of literature hoth theoretical and empirical has emerged with an increased participation of MNEs in the international markets analysing The determinants for FDI or MNE , at inter-country or inter-industry and inter-temporal levels. Dunning (1973) sets the ball rolling on econometric studies with a statistical analysis of survey evidence on the determinants of FDI. His study identified three main determinants of FDI in a particular location; market forces (including market size and growth, as determined by the national income of the recipient country), cost factors (such as labour cost and availability and the domestic inflation situation) and the investment climate (as determined by such considerations as the extent of foreign indebtedness and the state of the balance of payments). Dunning's (1973, 1981) analysis has triggered more research in this feild (Agarwal 1980~ Root and Ahmed 1979, Levis, 1979, Balasubramanyam and Salisu, 1991). While there are a number of

10

studies in the context of FDI in US, Japan and Europe. similar research on FDI in India is.that 00 at an individual sector level however scanty.

The pioneer among aJl studies in the context of India is by Kumar ( 1990) that analyses the industrial distribution characteristics and performance of affiliates of MNEs in India. This study has examined how far the postulates of the theory of international framework of the intemalisation paradigm and government policy factors were able to explain the inter-industry pattern of MNEs presence as observed in Indian manufacturing industries. The study concludes that the MNEs are likely to be concentrated in the industry where they have an edge over their local counterparts. The study strengthens the findings of Hymer (1960), Caves (1971,1974), and Dunning ( 1993).

Dua and Rashid (1998) examine the relationship hetween foreign direct investment and economic activity in India in the post liberalisation period. The study measures FDI in two ways i.c. by the amount approved as well as the actual flows, whereas economic activity is measured by the index of industrial production. The study has used the. Granger causality tests and innovation accounting analysis. Further, the study has found that FDI flows (both approvals & actual) responded to the level of industrial production.

Kathuria (2001) has tested two hypotheses, namely (a) whether liberalisation has improved the productivity of local firms; and (b) whether the spillovers from technology transfer have increased in the liberal regime. By using production frontier approach for 487 firms helonging to 24 three-digit manufacturing industries for the period 1989-90 to 1996-97 has been used. The study has found that after liberalisation. the productivity of Indian industry, especially the foreign owned firms, has improved. The econometric results suggested that only 'scientific' non-FDI firms have benefited from Iiberalisation. For 'non-scientific' firms, the impact is found to be productivity depressing. With respect to spil1overs, only those domestic firms, which invested in R&D to decode the spilled knowledge, could benefit.

Feinberg and Majumdar (200 1) have found that restricted policy environment towards FDI and weak property protection rights were descrihed to cause significant

I 1

RandO spillovers in Indian pharmaceutical sector. Nagaraj (2003) has documented the trends in foreign direct investment in India in the 1990s, and has compared them with those in China.

Though studies discussed above try to explain the main motives of FDI inflow at an aggregate level (macro level), the studies addressing this particular issue at a sectoral level (i.e. at an industrial level) are scanty. Hence, the present study focuses on the sectoral study, which tries to explain the magnitude and nature of FDI inflow in the Indian automobile industry.

1.2.2. Review of Literature Pertaining to Automobile Industry:

Studies pertaining to automobile industry can be categorised into the ones dealings with different issues related to productivity, investment and restructuring, liberalisation. differential behavior of firms and labour.

a. Studies Related to Productivity and Growth

Narayanan's (1988a) study observes the presence of oligopoly structure in automobile industry. The study finds that most of the firms were enjoying large profit margins, high growth rates and large market share and there was little motivation for diversification and technological upgradation. There was hardly any introduction of new products and models involving technological upgradation. However, substantial technological learning had taken place in some firms (especially Telco, Bajaj) in the process of indigenisation and as a part of their efforts to adapt their products to suit the local conditions.

Kathuria (1996) has studied the economies of scale aspects in the Indian commercial vehicle producing firms during the period from 1978 to 1988. The study finds that among the existing five firms four namely Standard Motor Products India Limited (SMPIL), Mahindra and Mahindra Ltd. (MML), 8ajaj Tempo Ltd. (BTL), and Tata Engineering and locomotive company Ltd. (TELCO) had economies of scale in production .and the Ashok Leyland (ALL) had diseconomies of scale.

12

Panda (1996) has examined the changes in the rate of growth of total productivity of the automobile firms between regulated period and liberalised periods. The study has also analyzed other aspects such as market structure, exports and incentives for technical progress of monopoly firms and profitability for the time from 1960-90. The study finds that there was not much growth in profitability in Iiberalised era.

b. Studies Related to Foreign Capital and Restructuring:

D'Costa (I <.)95) has examined the restructuring In the context of state intervention and Japanese capital. The study shows that MNEs had not diluted the domestic capital. However, economic liberalisation had not resulted in withdrawal of the state from the industry. The study has explained the positive and negative aspects of industrial restructuring. Further, it has explained that Japanese participation and State intervention had changed the structure of the industry. The study is theoretical in nature and no empirical evidence has been provided to support the arguments.

C. Studies Related to Differential Behaviour of Firms:

Siddharthan (199R) studied the differential behaviour of firms, classified them as Japanese affiliates and non-Japanese affiliates. The main objective of the study was to analyse the differential behaviour of these two groups in terms of in-house R&D, licensing technology, import of capital goods, exports, advertising expenditure, and profit margins. The study revealed that Japanese affiliate behaviour was significantly different from the western affiliates. Similarly, Narayanan (1997) also finds the differential behaviour of firms in the two periods, Iiberalised and regulated.

Mukherjee and Sastry ( 1996a) analyse the developments and future prospects in the Indian automotive industry in early 1990s. The study observes that new entrants would have to deal with uncertainty of demand, different and evolving customer needs a relatively poor supplier base, a competitive market and industry-wide capacity shortages. The supplier industry is also going through massive growth, although from a small initial base. Except for Telco, indigenous product development capabilities are very low, and the industry has some way to go before it becomes world class. The study focuses mainly on demand side aspects.

13

d. Comparative Studies of Automobile Industries of Different Countries:

The study by Mukherjee and Sastry (1996 b) has attcmptd a comparative analysis of automohile industries in Korea, Brazil, China and India and finds that the Korean industry, a later entrant than Brazil, had progressed very well. Government support, a clear vision of becoming an export oriented world class industry, retaining management control, investing in R&D, and acquiring product development capabilities have helped it to grow and develop fast. The other three countries have not invested in capability development to the same extent. Brazilian plants were simply overseas plants of MNEs. Indian plants were joint ventures with MNE control. In Brazil. China and India, the small car segment lead in industrial growth.

e. Labour Related Studies:

Okada. ( 1998) examines the effects of globalisation on the Indian economy and In particular the growth of FDI on employment and the quality of jobs for local workers, in the automobile industry. Globalisation had a generally positive, but relatively modest, employment effect on the Indian automobile industry, particularly at the assembler level. Employment growth has slowed down in the 1990s, even though their sales grew remarkably. The quality of jobs has improved considerably in recent years, at both the assembler and supplier levels. as measured by a) increases in wages; b) worker participation in production processes; and c) increased skill-training opportunities.

Panda (200 I) studied factor substitution and employment generation at the finn level in the pre and post-Iiberalised period. It shows how the labour is substituted for capital in Light commercial vehicles LCVs and Medium and high commercial vehicles MHCY segment in different sectors by using the error correction mechanism. However, the study considered only old and established firms up to 1960-89.

Okada (2004) in his paper empirically examines changes in the patterns of skills development for Indian workers in domestic firms, particularly in small firms in the globalisation era. In doing so, 50 component suppliers were selected from the two leading auto assemblers in the Indian automobile industry for the propose. This

14

analysis reveals that dynamic industrial transformations in the 1990s significantly changed the nature, content and extent of skills development at domestic suppliers. Further, the paper also argues that various institutional mechanisms created by assembler firms played a critical role in upgrading skills at suppliers, transforming the supply chain into a learning chain.

f. Infrastructure Related Studies:

Gulyani (200 I) argues that infrastructure availability in India like electricity, transportation proved to be hottlenecks in the adoption of lean production techniques in Indian automobile industry which in turn has increased the production costs in India. This study was on urban planning perspective than the economic perspective.

g. Studies Related to Liberalisation of Automobile Industry:

Narayanan (1998 h) examines the impact of the deregulation policy, introduced in India during mid 1980s, on the competitiveness of automobile firms. The study attempts to give answers to some important questions like, why do some firms perform well in terms of changes in the domestic market share while others do not. The study finds that asymmetry among firms in terms of technology acquisition through technology imports and in-house efforts explain much of the inter-firm variation in competitiveness. The study also finds that new firms with R&D efforts, to accomplish paradigm shifts, appear 10 be more successfu1. Yet this study did not measure the technology spillovers generated by the foreign firms.

The objective of Piplai (200 1) was to critically examme the effects of liberalisation on the Indian motor vehicle industry, how it affected the product gradation and profitability at industry level. It has shown that in post-liberalisation period, the rate of growth had fallen down, which has declined compared to 1970s and 1980s and the profitability had fallen during 1970s and 1980s.

Singh (2004) has examined the export performance and prospects of the Indian automotive industry. The study finds that some critical elements to enhance export performance like the technology factor being critical, the in-house,

15

collaborative and sponsored R& D needed greater encouragement. The study recommends an early up gradation of testing facilities. and moving towards uniform standards; establishment of auto component zones / parks, and window showcasing centres; the industry government partnership in manpower training; institutional provision of export marketing information, market development funds and branding assistance.

1.3. Researchable Gaps

The review of above studies reveals that though there are some studies on the automobile Industry, studies that are trying to analyse the impact of MNEs on the performance of automobile industry are lacking. Further, some studies which try to explain the liberalisation issues are also addressed that issue immediately after the announcement of the liberalisation policy which is again has not examined the actual liberalisation process. Though some studies analysed the government policy it has not really examined the impact of government policy on the structure and growth of the industry was not mentioned in many studies. There are some research gaps in this area such as

.:. The factors that are motivating the multinational enterprises to operate in the Indian automobile Industry .

• :. How the industry is restructured after the entry of MNEs in India .

• :. How the MNEs participation has changed the strategic behaviour of firms .

• :. How the automobile industry productivity in the changed scenario .

• :. How effective are the MNEs in creating the backward linkages

While these are the important research gaps, the present study would address the following issues only.

Researchable Issues in the Present Study

It is observed that government policy pertaining to automobile industry has undergone considerable changes ever since Indian independence. Since, the governmental policy has a considerable bearing on the performance of industry there is need for a detailed

16

review policy. The present study aims at reviewing recent changes in the government policy and analyse its implications ion the growth of automobile industry. As it IS observed elsewhere in the study, Indian automobile industry has undergone a considerable change in terms of the number of firms, installed capacity etc. ever since India's independence, there is a need to track the structure and growth of Indian automobile industry in a systematic manner under different phases, such as regulated and liberalized regimes. These phases could be. (a). The pre-Maruti phase of protection licensed technology and State ownership of production works. (b). The Maruti phase (or) first episode of openness. (c). The era of globalisanon and intensified FDI.

There is need to identify the endowments and incentives for the MNEs to enter into the Indian automobile industry. The flow of FDI into any economy guided by vanous factors, the prime factor being the endowments of the country under consideration. In addition, the host countries try to attract FDI by way of announcing varied concessions. Indian government has started attracting MNEs by giving many incentives after the new economic policy. All state governments are giving different kinds of sops to attract MNEs. Every state is trying to give some kind of incentive, be it exemption of stamp duty on land, exemption of sales tax, electricity tax duty to capture development benefits from MNEs. The state governments are hoping to generate more jobs, boost exports and upgrade local skiIJs and technical capabilities. It is important to examine as to how far these incentives are helpful in attracting the MNEs into the rcspecti ve sectors.

There are other important issues, which need to be carefully addressed. They include an analysis of the impact of foreign collaboration on the output turnover, productivity, profitability and exports. How the MNEs participation changed the output, investment and exports levels. In order to understand the impact of foreign collaboration on the pcrfonnance of automobile industry the important issue that needs to be addressed here is whether these MNEs were creating linkages; if they are creating how efficient they are in creating these linkages. In the light of the above researchable issues, the following objectives have been formulated for the present study.

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Objectives of the Stud),:

I. To critically review the automobile policy in India before and after the liberalisation.

2. To present an overview of the growth and structure of the Indian automohile industry under different phases.

3. To examine the nature and growth of the FDI In Indian automobile industry.

4. To investigate the endowments and incentives that attracted the MNEs into the Indian automobile industry.

5. To analyze the impact of foreign collaboration on the performance of the Indian automobile industry.

6. To draw poJicy conclusions for the automobile industry in India.

1.4. Database and Methodology:

The study is based mainly on the secondary data collected from the published (printed and electronic) sources including some data collection by visiting selected firms and government offices and other research organizations. The main sources of data arc Center for Monitoring of Indian Economy (CMIEL Annual Survey of Industries (ASJ), Society of Indian Automobile Manufactures Association (SlAMA). Automobile Components Manufactures Association (ACMA), SIA newsletter and various annual reports of automobile firms and capital online database. Further. global level auto statistics have been collected from Motor Vehicle Manufacturers' Association (MYMA) motor vehicle data and International Organization of Motor Vehicle Manufacturers (Olf.Al and World Investment Report, Global Competitiveness Report and UN Statistical Yearbook and various other sources. The basic data are available in different units and for different time span. Hence. adjustments for the data arc essential for the estimation purposes and were carried out to suit the studies requirements.

The methodology adopted for each of the objectives is as follov . .,. In order to answer, the first two objectives analyzed the current state of industrial policy and structure in comparison to the earlier stages. :\" a part of thi ... exercise. the xtudv

IX

analysed the historical time series data from 1971 to 2002 in order to highlight the differences under different stages of industrial development. The growth performance for the entire time period was compared with the previous periods hy using kinked exponential growth rates. For the next two objectives (i.e. third and fourth) with respect to - explaining the nature and pattern of FDL the study tested the determinants of FDI by using the quarterly time series data for the variables for the period January 1995 to December 2003. In order to explain the impact of foreign collaborations, the study used the ASI data to examine the time series variations in different periods by estimating the various productivity indicators. At the same time, the study also analyzed the financial ratios of aggregate industry using CMIE data to understand the sources of profitability and gross turnover of the industry. Further, the study also compared the performance at the disaggregate level by examining the efficacy of various firms in creating backward linkages hy using the unbalanced panel data of seven firms for the time period 1993 to 2003.

For the last objective, the overall policy was examined in order to investigate whether the exogenous polices framed by the government arc intended to influence the structure of the industry or the performance of the industry. Further, the analysis also focused on the lessons drawn from other developing countries like China in order to make Indian automobile industry globally competitive. During the process of the studyhas used econometric tools ranging from simple ordinary least square regression to dummy variable vector auto regression model and stochastic frontier analysis of unbalanced panel data were used. Necessary diagnostic tests have been performed based on the nature of data. Where ever cross sectional data were used they were corrected for hetcroscadasticity, and for the time series unit roots and auto correlation diagnostic tests were performed.

1.5. Organization of the Thesis

The thesis consists of nine chapters including the Introduction and conclusions. Chapter two gives an overview of multinational enterprises; a theoretical exposition about the determinants of their entry and their impact on host country, particularly the linkages they create in the host country. The process and pattern of Globalisation of automobile industry in the world has been discussed in Chapter three In addition, the important issue of factors responsible (pull and push) for growth of automobile production in developing countries have been examined. The overview of

19

policy, structure and growth of automobile industry in India has been presented in Chapter four. Further. the chapter has also examined the issue of interface between policy. structure and growth of automobile industry in India. Chapter five has examined the nature and growth pattern of FDI (MNE presence) in the Indian automobile industry by examining the entry, expansion and location strategies of MNEs that have entered in India after liberalisation. The chapter has also examined the important issue as to whether the FDI in Indian automobile industry is market seeking or cost cutting in nature'? Chapter six has focused on the major implications of foreign collaborations on the performance of automobile industry: wherein the first section has focused on analyzing the various productivity indicators by using the ASI data. Section two mainly analysed the various performance indicators like gross turnover, profitability, export performance and local content usage by using financial indicators at an aggregate level. Performance measures presented in this section are reviewed over time and, where available, at the disaggregate leve1. Seventh Chapter has mainly focused on explaining the efficacy of MNEs in creating linkages (particularly backward) and comparison has been made with the domestic and other joint venture firms. Chapter eight analyse the effectiveness of the important issue which examines the polices pertaining to the sustainable development of automobile industry. Final1y ninth chapter mainly focuses on the major findings and policy implications.

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CHAPTRER.TWO

l\tfNES: FORMS, DETERl\1INANTS AND IMPACT ON DEVELOPMENT

2.1. Introduction

A Multinational enterprise IS defined as an enterprise that controls and manages the production establishments - plants located in two or more countries (Cav es, 19(6). It is an agency of direct investment as opposed to portfolio investment in foreign countries, holding and managing the underlying physical assets rather than securities based upon those assets. Though every large enterprise has some kind of foreign involvement in terms of sending its agents abroad, importing foreign material, exporting some products, employing foreign nationals, borrowing money from foreign banks, having a foreigner on its board of directors, none of these circumstances however would make an enterprise a Multinational (MNE). But none of the involvements require direct investment in foreign countries, or entail a responsibility for managing organisations of people in alien societies. Only when an enterprise ventures into the prohlems of designing, producing, and marketing and financing its products with foreign nations, it becomes a real MNE. MNEs are global profit-seeking organisations which have their own objectives and strategies. Their main ohjective is to maximise their returns on capital. For this purpose, they seek out the best profit opportunities in a wide range of activities in host countries and they deal rarely with issues, such as poverty, inequality, and unemployment reduction. They usually come to the host country with a package, including capital, technology, and management and marketing skills.

On the whole, the existence of MNE is best explained by identifying it as a mu1tiplant firm that sprawls across national boundaries. One can apply the transaction cost approach to explain why dispersed plants should fall under common ownership and controls rather than simply trade with each other (and with other agents) in the open market (Caves, 1996). Multinational operations by private firms are comparatively of recent origin. The companies of merchant traders of Venice, British, Dutch, and French are forerunners but not true prototypes of today's Multinational corporations. In 1920s and 1930s, international cartels controlled some of the industries like petroleum and chemicals, which are now dominated hy MNEs.

21

Therefore, there has been a substitution, to some extent, of one form of international control of production by another. MNEs have replaced cartels of post war period.

In recent years, foreign direct investment (FOI) and foreign portfolio investments in developing countries have risen sharply. For example, while the average annual net inflow of FOI to developing countries was US$ ] 1 billion during 1980-1986 period, it reached US$ 35 billion in 1991 and US$ 43 billion in 1992 (World Bank, 1995). Recent estimates suggest that there are about 65,000 Trans National Corporations today, with about 850,000 foreign affiliates across the globe. Their economic impact can be measured in different ways. In 200 1, foreign affiliates accounted for about 54 million employees, as compared to 24 million in 1990; their sales of almost $19 triI1ion were more than twice as high as world exports in 2001, compared to 1990 when hath were roughly equal; the stock of outward foreign direct investment, reached $6.6 trillion as compared with $].7 trillion in 1990. Furthermore, foreign affiliates now account for one tenth of world GOP and one-third of world exports (UNCTAO, 2002).

The rapid increase in FOI throughout the world has been accompanied by a marked change in its sectoral composition, from the primary sector and resourcebased manufacturing (WIR, 1993). The primary and extractive sectors in ] 950s and 1960s were attractive areas for FDI, but in the 1970s there was a shift towards manufacturing and services sectors (Weiss, 1991 ~ Todaro, 1994). Capital-intensive manufacturing branches, such as chemicals, machinery, electrical goods and transport equipment, are attractive areas for TNCs. FOI was heavily dominated in 1950s and 1960s by American-based enterprises worldwide. It continued to expand in 1970s but during later stages, the European and Japanese firms overtook the American dominance. Recently, multinational companies also started emerging from the developing countries I ike South Korea, China and India.

Characteristics of MNEs:

• MNEs are associated with high ratios of R&D relative to sales.

• MNEs employ large numher of scientific, technical and other white-collar workers as a percentage of their work forcc.

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• MNEs tend to have a high value of goodwill and a high value of tangible assets like plant and equipment.

• MNEs are associated with new and/or technically complex products.

• A minimum or threshold level of firm size seems to be important for a firm to he MNE, but above that firm size is of minimal importance.

• MNEs arc associated with product differentiation.

Due to the above charectraistics one can argue that MNEs can improve competition, efficiency and provide additional jobs. MNEs generally have world leadership in innovation and product differentiation; they can access directly and easily to the world's largest markets; and have the managerial, entrepreneurial and financial resources to develop viable production bases in developing countries (Vernon 1977, Lall 1985). They operate within oligopolistic market structures and are characterized by rapid product process, innovations, product differentiation and heavy advertisement. MNEs have the ability to view the world as a single economic unit and consequently can plan, manage and organize their operations on a global scale.

Process of Internationalisation

Any MNE in the process of internationalization may use different forms of

foreign operations, which can be classified as follows. (a) Exports

(b) Other forms of investment. (c) Foreign direct investment.

2.1.1. Exporting

Firms can export directly or indirectly. Direct exporting involves direct contract with foreign customers and however, entails long-term commitment in developing the foreign market. Indirect export involves the use of intermediaries like export agents and/or export trading companies. It minimises the commitment of resources thereby reducing the exposure to risk while allowing the firm to concentrate on its core competitors. However, the returns from indirect exporting are less. The firms would not have a proper control over the distribution channels.

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2.1.2. Other Forms of Investment

These other fornix of investment may he different from international activitic ... of the firm, namely. wholly/majority-owned foreign direct investment and exports. Oman's taxonomy ( 19R4) of other forms of investment gives us the definition of this term. As the new lother forms are heterogeneous. and perhaps he defined most simply by distinguishing them from what they are not. They arc neither majority owner investment nor portfolio lending in which there is no direct creditor involvement at all. E.g. joint ventures (less than 40 percent equity hy home country). licensing arrangements, franchising, management contracts, turnkey contracts, production sharing contracts, international subcontracting.

2.1.3. Foreign Direct Investment

Foreign direct investment may be defined as 'the investment that is made to acquire a lasting management interest (usually of 10 per cent voting stock) in an enterprise operating in a country other than that of investor (defined according to residency), the investor's purpose being an effective voice in the management of the enterprise (World Debt Tables, 1993-1994: xivj.Foreign manufacturing involves greater deployment of resources than direct exporting. Here foreign manufacturing means amounting to direct investment in alien countries and involvement in manufacturing activities on its own. A multinational is a firm that undertakes direct investments in foreign countries, either through a new investment (100 percent or Greenfield investments) or through the joint venture of an existing foreign firm called Mergers and Acquisitions" (M&As),

The choice between serving a developing country with exports versus direct investment also depends on the level of economic development and market institutional conditions. In a country that lacks minimum labour ski lis hut has good

"\ Greenfield investment: direct investment in new facilities or the expansion of existing facilities. Greenfield in\ estments are the primary target of a host nation' s promotional efforts because they create: new production capacity and jobs, transfer technology and know-how. and can lead to linkages to the global marketplace.

(> Mergers and Acquisitions occur when a transfer of existing assets from local firms to foreign firm" takes place. this is the primary type of fDI. Cross-border mergers occur when the assets and operauon of firms from different countries are combined 10 establish a new legal entity. Cross-border acquisitions occur when the control of assets and operations is transferred from a local 10 a foreign company. with the local company becoming an affiliate of the foreign company,

intellectual property regime, production of knowledge intensive goods is not viable. In such a case, MNE will serve by exports rather than local production. (Patibandala 2001). Once a firm decides to go for foreign production then the FDI will replace the exports of MNE. Implementation of FDI-based entry strategy provides a much greater challenge to the management of MNEs and deserves careful analysis of the subsidiary's financial, legal, and organizational tasks. If the firm opts for FDI, several tasks would have to be completed.

a. Assessment of host country's general business environment and identification of the risk factors

b. Deciding on the scope of activities that will be set up in the host country.

c. Assessment of financial viability and related matters

d. Deciding on the organizational structure, systems, process and identification of human resources required for managing in the host country.

Firm's expansion into a new geographically segregated production facility can take any of the following three forms. Determinants of FDI often depend on the types of FDI. whether it is horizontal or vertical in nature.

1. Horizontal extension (producing same product elsewhere). Caves (1996) describes horizontal FDI as establishing factory facilities in different countries in order to produce same or similar goods.

2. Vertical extension (adding stage in production process) Caves (1996) mentions vertical FDI as establishing plants abroad to produce output that serves as an input to its other parent company or subsidiary plants. It takes two forms:

.:. Forward vertical FDI: in which an industry abroad sells the outputs of a firm's domestic production processes

.:. Backward veri cal FDI: where an industry abroad provides inputs for a firm's domestic production process

Often, the developed countries attract horizontal investment, e.g. Japanese investment in U.S. automobile industry. In general, less developed! developing countries attract vertical investment, e.g. Mexico attracting investment in automobile components, FDI from industrial countries to Bangalore in India in software industry, FDI into electronic industry in Malaysia etc, attract both horizontal and vertical investments. Several developing economies such as China, Brazil, India, and Mexico etc attract both horizontal and vertical investment. Furthermore, vertical integration can be classified into two types based on flow of integrated production process

25

functions, i.e. downstream and upstream. Downstream integration is when a foreign subsidiary performs an assembly function by using inputs supplied by the parent firms or other sister subsidiaries. Whereas, in the case of upstream vertical integration, the role of foreign subsidiary is to produce inputs and to supply them to the parent or other sister subsidiaries.

The rest of the chapter focuses mainly on reviewing the theoretical and empirical literature pertaining to the determinants of MNEs entry and their impact on the development of host countries. The factors intluencing the entry and exit and various other issues have been reviewed using different theoretical constructs. In this regard as a part of the review of literature the first part deals with the literature pertaining to the determinants of MNE entry into a host country and the second part mainly focuses on explaining the debate of the role of MNEs in the development of the host country.

2.2. Theoretical Framework

The economic theory of MNEs lies at the interface of three separate disciplines (1) The theory of the firm; (2) International trade theory and (3) International finance. The rapid growth of foreign direct investment (FDI) and its overall magnitude had resulted in numerous studies dealing with the channels of transmission from FDI .The rich literature on FDI flows, causes, and effects (see for e.g. Hymer 1960, Buckley and Casson 1976) suggest that the applicable theories lend themselves to organization into three schools: the two traditional schools of development thinking -the dependency and modernization schools and flowing from those traditional schools, what may be termed the integrative school. The dependency school comprises neo-Marxist and structuralist theories. The modernization school is reflected in the perfect market approach as represented by the neoclassical and other perfect market theories; its imperfect market approach is embodied in industrial organization theory as well as in the theory of the firm and internalization theory. The integrative school is represented by the eclectic foreign direct investment paradigm, negotiation theory, and integrative theory.

26

The studies relating to MNEs have their origins in four prinicpal theoretical traditions, namely nee-liberal (neo-classical) economics, development economics, international political economy and strategic management. These schools of thought differ fundamentally in their perspective on foreign investment. (Pradeep 2000).The entire theoretical analysis pertaining to the impact of MNEs on the host country can be classified into Marxist approach and Non-Marxist approach, which can be further grouped on their negative or positive approach to the MNEs (Jenkins 1987).

v

Table.2.t

S h I f th ht

MNE

arrous c 00 S 0 oug on S
Pro-MNE MNE Critics
--
Non- Neo-classical (Vernon, Rugman, Development economists
Marxists Dunning, Balasubramanyarn et.al.i (Lall, Streen, Helluiner)
Marxists N eo- fu ndamentali sts (structural ists) Neo- imperialists
(Warren, Emmanuel) (Baran, Sweezy, Frank) (1) The Neo-Classical contributions are non-Marxist in orientation and pro-

MNEs.

(2) The development economics (global reach) school is also non-Marxists in the orientation but are anti- MNE

(3) The nco-imperialists are Marxists and anti- MNEs

(4) The Nco-fundamentalist school which is Marxists and is pro-MNE.

In the nco-liberal tradition, the free enterprise system has assumed most efficient means of providing global welfare and hence, it is assumed that MNEs presence would increase the global welfare. It argues that developing countries benefit in the presence of MNE and will bring the unused natural resources in developing country into use. In addition, the FDI influences a host country economy in areas such as trade balance, technology, competitive structures and employment generation. MNEs are the "engines of growth" in developing economies. The presence of MNEs will increase the efficiency of developing country production process. In the neoliberal perspective, the positive aspect of MNEs has been overemphasized.

The Development Economics literature has examined how the MNEs affect the host country through important channels of transfer of technology and generation of

27

linkages. Scholars like Lall (1978), Stewart and Strceten (1991) have examined the issues by using international trade theories. They have attempted to identify the positive contributions of MNEs and the accompanying social cost to see how the former can be maximized and latter minimized. Development Economics has highlighted the importance of government policies in determining the MNE operations in developing countries 1ike India. It is argued that Iiberalisation of traditional import - substitution industry policy regimes in protection era have served as the main means to attract MNE activity to developing countries. Economic Liberalisation has made the MNE entry easier and procedures less obstructive. This has made the inflow of investment towards countries that offer a large internal market, internationally competitive skills, support systems and infrastructures to MNEs.

The international political economy schema consists of two groups; Structuralists and Neo-Marxists. Both have viewed FDI from the standpoint of a developing country rather than from an international firm. The Structuralists desire creation of wealth hy efficient combination of factors of production. At the extreme left, the Marxist approach portrays the dangers of dependence and highlights the dangers of exploitation. The development of developed part, under the Marxian analysis is the result of the underdevelopment of underdeveloped part (Sweezy 1972).

2.3. Review of Literature on Determinants of MNE's Entry

The theory of FDI addresses the issue concerning why a firm would want to produce in a foreign location, where indigenous firms have superior knowledge of the local condition. Shatz and Venerable (2000) have identified two important factors which were responsible for the operation of a firm in the foreign locations. (a). to serve the local market b). Reducing cost of production by getting factors for lower costs. The literature pertaining to the determinants of foreign direct investment will explain two important elements. They are: determine the areas and sectors where foreign investment will flow and (ii) It will also determine the minimal acceptable terms and conditions on which the foreign investors will be likely to come to the host country.

The investment pattern in the developing economies is determined by the set of supply side and demand side factors. Explanation of magnitude and pattern of FDI

28

inflows into host countries requires the analysis of a complex range of factors. These factors differ from developed to developing countries in several ways. They also differ according to the level of economic development, endowment of market, political and legal institutions (Dixit, 1999). Though there are a number of theoretical works explaining the determinants of foreign direct investment which has been widely used, the works of Dunning (198]) using eclectic (OLI paradigm) provides a basic framework for most of the empirical works in explaining the determinants of FDI. Dunning (1993) has proposed that FDI could he explained mainly by three categories of factors, they are viz., ownership advantages (0) such as intangible assets; locational advantages (L) to investment in the host rather than the donor country and the benefits of intcrnalisation (I). It is widely agreed that MNE activities (or) FDIs take place when the above three sets of determining factors exist simultaneously (Dunning 1993).

The most relevant theoretical basis for analyzing FDI determinants in developing countries originates from the bargaining approach developed by Anderson (] 989). This framework is easy to identify the magnitude and nature of the FDI because the main advantage in this approach is that the strategies of both parties are revealed, from which the motives of MNEs and host country are identified. Once the information on the motives of both parties is available it is easy to find the nature of FDI. Then the game starts with the conflicting objectives of MNEs and host countries and the outcome of these strategies determine the nature and flow of FDI (Lecraw and Morrison, 1991). Most often, MNEs are interested in enhancing their global competitiveness in order to achieve lower taxes and lower real estate prices. Further it requires strong intellectual property rights protection. On the other hand, the host country's industrial polices play an important role with the strategies of MNEs in determining FDI. Many studies have often concluded that the determinants of the FDI often depend upon the motives of the MNEs (UNCTAD 1998). It is generally acknowledged that motives of MNEs are of three types.

• Market secking'': The large size of the domestic market.

7 The firms choose to exploit their ownership advantages hy direct investment rather than by licensing them to other unrelated firms.

8 Market seeking investment requires not only a sizeable population, hut also an ability of the market to support (within a reasonable timcframe) the expected demand on which the investment is based.

29

• Resources/assets seeking: The natural resource base and raw materials availahle in the host country.

• Efficiency seeking'>: Labour costs are low or where a trained scientific manpower is available relatively cheapJy.

These motives can be broadJy divided into two types; the first two represent the motives, which are primarily asset- exploiting in nature. i.e., the MNE prime purpose is to generate economic rent through the use of existing firm-specific assets. The second is the case of asset-augmentation wherein the MNEs wish to acquire additional assets or protect the existing assets in one or other way. In general, these motives are not mutually exclusive categories. MNEs usual1y invest abroad under a combination of these motives, with varying tones of emphasis.

There arc many studies both theoretical and empirical, which have examined the determinants of FDI by using various methodologies. Most of the studies reveal that the variables that determined FDI are not one and the same for al1 the regions and all times. Hence, it can be concluded that determinants of FDI are industry-specific country- specific and time-specific. In this section, an attempt is made to develop a conceptual framework, which explains the pattern of FDI flow. This is based on Anderson's work (1991), which defines direct investment (FOI) as a good traded in a market where it is supplied by MNEs and often demanded by the host countries. Essentially, the basic concept is that relative bargaining position of the two parties is based on the opportunity costs as perceived by the MNEs of their '0' advantages, and that of the 'L' advantages offered by the countries in which they are contemplating an investment.

The determinants of FDI are the outcome of the game between the multinational enterprises (MNE) and a host country. This model starts with the basic question, why the firms wish to engage in international business I why they become an

') In the case of efficiency seeking investment the role of sub national clusters and the agglomeration of related activities arc significant In general. this type of investment countries need to be home centered for agglomeration, possess the necessary science and technology infrastructure to attract these assets augmenting FDI. But efficiency seeking investment in the least developed countries is an ambiguous concept

30

MNE'.> The answer for this is that a firm wants to maximise its profits over a period ()1'

. 10 Th' b .1

I line IS can e expresseu as

U. = max (Fl), where U, is the Util it)' of firm n = Profit of the firm.

The first condition for most of the MNEs. which wish to have foreign opcr.nion is the size of host country's market (A) as measured hy its consumer population. which is expected (by all firms) to grow over a period of time. This is assumed to gnm to gA. Where g is the growth of consumer population it has to be positive.

11 > 1 6-

( 1 ).

As stated elsewhere MNEs quite often choose between exporting or of foreign production in the host country (Buckley and Casson (1985), Rob and Vettas (2003). Quite often, this choice of MNE will depend upon the trade related measures of the host country. In this regard the choice mode depends mainly on the trade policy adopted by the host country in the case of free trade or in the case of restricted trade,

A). Free trade regime

Let us assume that MNE decides to invest in a host country then the cost of production in the host country of establishing the productive capacity to produce a good amount X is KX. This establishment of production plant includes the SLInk cost!'. Then production cost in host country becomes KX+S. In contrast, if the firm wants to export from the home country itself then the production cost of X is ex. (Cost of exporting from the home country), this exportation also results in transport costs t (shipping costs) and other costs (risks). The total cost for exporting X is CX+t. Then the MNEs decision to have a foreign production depends on the condition if and only if

(KX+S)< (CX+t) .

(2 ).

In free trade regime FDI takes place only if the cost of setting up a plant in the host country including the sunk cost is lower then the export cost from the horne country. If the condition (2) is not satisfied then it will go for export only.

III Here. profit maxi mization means taki ng t he Baurnol s notion of firm S object i H: i.e. it is the re cnue nux i misation (Set' Hood and Young 11)79)

II The degree of this risk differs across different industries depending on the c vtcnt of sunk costs of investment which means exit from a country involves writing off a large amount of investment.

31

B). Restricted Trade Regime

But many countries both developed and developing protect their countries with tari If barriers 12 and other non- tari ff barriers (NTB s 1) for various reasons. In this case, suppose the host country imposes an ad volorem rate of tariff en on imports of a commodity then the export cost eXH will become CX+t+T. In this context, the finn wishes to have a foreign production only if

KX+S<CX+l+T .

(2a).

One argument is that due to presence of the tariff barriers, MNEs always prefer to FDI, rather than exports, for two reasons. First, FDI puts the investing firm under tariff umbrella and it makes it difficult for its exporting rival. Second. FDI often enables the investor to expanding the market share of the investing firm by producing at lower cost.Then it is the game between MNEs and host countries. Often, the host country's industrial polices play an important role in influencing the strategies of MNES in determining FDI. The game starts with the conflicting objectives of MNEs and host countries. Quite often. the MNEs are interested in enhancing their global competitiveness in order to achieve lower taxes and lower real estate prices, further it requires strong intellectual property rights protection.

From the perspective of the host country, the quest is to attract the FDI. In general, the host country will allow the MNEs expecting to benefit out of their presence. Always the host countries expect that MNEs will bring FDI, which is an effective component in the development process, and it is an acknowledged channel for the transfer of technology and human skills. It is also a supplier of new ideas and a source of capital. However, while the FDI may be associated with a number of positive externalities. The FDI can also have a number of negative effects on host country's economic development. The entry of MNEs disturb the existed equilibrium in the host country by crowding out domestic capital and other things. (Benign model and Malign model of development). In general most of the host countries tax the profits of MNEs. As it has been stated by Dehajia and Weichenrieder (2001) in the presence of tariff jumping FDI, capital taxation will benefit to a small receiving

11 Where tariff harriers on the final good arc high, tariff barriers on the components have to be low.

11 In Indian and Chinese context instead of tariff barriers we have a quantitative restrictions (QRs) are there on import of the final consumer goods for a long time.

32

llllllltry, otherwise such tariff jumping FDI is likely to he harmful til [he cconoruv. Against the above backdrop the host country' s utility function Uh. can be expressed as

U, = f(¢>n,~, Xg, Xb). . (3a)

Where $= corporate income tax rate.

Il = Profit before lax.

IJ. = Lump-sum taxes other than corporate tax.

Xg = goods of MNEs (Direct and positive externalities). Xh= bads of MNEs. (Direct and negative externalities).

Expressing (3(a» in the discounted gain of the host country as a money value,

rewriting (3(a)) as U, = ofl+ ~+ Xg- Xb (3b)

The firm's objective function Uf

Will become like this U, = ((n).

Within host countries, polices on taxing, then I] will become now as

LJr =n- ¢>Il- 11 (4a)

This can be written as

Ur =(l-<P)fl-Il (4b)

From the host country's perspective, which seeks to attract FOL it is interesting to know what polices (~ql,t) are necessary to induce FDI. And from the firm's perspective the host country policies on the above variables playa role in magnitude of FDr. The host country, in order to maximise its Xg (increase its linkages) always uses certain performance requirements. Such requirements entail minimum export ratios, import ceilings. local-content specifications. With this we know from (2) that KX is the variable cost of production of a MNE if all inputs are hrought from the home country (parent company) or from its subsidiary. Now. with the local content specification (8) variable cost of the MNE may increase to KX +0. Because the local contents costs may be high in that host country. For a MNE it may get these contents cheaply from other place where it has networks. Since a restriction imposed by the host country on the type of inputs used by the foreign firms implies a cost to the latter, 0 can be interpreted as a kind of t3X on the output of foreign firm .... In the presence of restrictions on local content usagc and profit taxation in host countries the MNE will look for location choice with minimum cost. Now MNE will locate a place where it can set up a foreign production. However. the Mf\"E invc ... h

only to the extent that its expected return is higher than its best alternative bidding on the requirement for a firm to undertake the direct investment FDI in an ith nation only if.

E [«I-$i)[(i) (I-8i)- }.ti] ~ E [«(l-q>j)Oj) (l-Dj)- ~j] where i:t:j (5)

That is. the firms are ready to take the FDI only if the expected profit in i" nation is greater than the expected rate of profit in j'h nation. This always makes MNE in selection of location to produce. Here, the endowments and incentives of a host country actually determine the location decision of the MNE. All supply-side factors play an important role in determining the location of production. Many host countries in order to maximise Xg quite often reduce the rates ono.u. This is one way that the host country facilitates MNE to decide about location. Host countries quite often may reduce the sunk cost for MNE by providing land and infrastructure facilities. In addition, quite often there is an assorted set of incentives offered by developing countries to attract FDI. These include tax holidays, tax concessions and subsidies of various sorts. Developing countries may be compelled to offer such incentives only because their competitors for FDI offer them. Competition between the host countries can be observed from, preferential treatment of foreign firms and initial incentives. In general the Governments use three main categories of investment incentives to attract FDI. These are financial incentives (such as outright grants and loans at lower interest rates), fiscal incentives (such as tax holidays, reduced tax rates and direct subsidies) and other incentives (such as subsidised infrastructure or services, market preferences and regulatory. concessions, including exemptions from labour or environmental laws) (UNCTAD 1996).

As stated elsewhere in the study, the bargaining power of the host country and MNE often depends on the nature of the investment. In the case of import substituting investment (tariff jumping investment) the MNE cannot substitute its investment in one country to that of another. In this case, the host country's bargaining power will be more than the MNE. In the case of export-oriented investment, MNEs can choose between countries, which have a greater bargaining power; in this case, host countries bargaining power will he weak. Most of the developing countries are not able to guess the main mati ve of investments and then they will compete for attracting that MNE.

34

The host country policy often plays an important role in determining the FDI flow, polices relating to entry and exit of MNEs, tax policy and tariff barriers also play an important role. Further, it often depends on economic and political stability of the host country and investment climate, which includes fiscal and financial incentives. From the above framework, it is clear that when a firm is likely to have foreign production, several factors affect FDI.

Market seeking investment requires not only sizeable population, but also the ability of the market to support (with a reasonable time frame) the expected demand on which the investment is based. There is often a " follow - the leader" strategic response by the MNEs. In general, the resource seeking FDI in the ease MNEs needs only the abundant natural resources. However, resource-seeking investments generally (but not always) imply low value adding activity and low capital expenditure on plant and equipment. In this case, the FDI is less sticky in other words

more footloose. Whereas in the case of efficiency-seeking investment, the role of sub national clusters and the agglomeration of related activities are significant. In general, these types of investments in countries need to be home centre for agglomeration, possess necessary science and technology infrastructure to attract these assets augmenting FDI. But efficiency seeking investment in the least developed countries is an ambiguous concept. From the above, it can be stated that the main determinant that depends on the motives of MNEs have been summarized in the table below.

Table 2.2 Determinants of FDI

Nature of FDI Determinants of PDI
Market-seeking • Market size and per capita income
• Markel growth
• Access to regional and global markets
• Country-specific consumer preferences
• Structure of markets
Resource seeking • Raw materials
• Unskilled labour
!Asset-seeking! • Low-cost unskilled labour
Efficiency seeking • Skilled labour
• Technological. innovative, and other created assets (for example, brand
names). including those embodied in individuals. firms, and clusters
• Physical infrastructure (ports, roads, power, telecommunications) cost
of resources and assets listed above, adjusted for labour productivity
• Other input costs. such as transport and communication costs to/frnn
and within host economy and other intermediate products
• Membership of a regional integration agreement conducive to the
establishment of regional corporate networks Source: UNCTAD (1998).

35

2.3.1. Empirical Literature:

In general, the empirical work on the FDI determinants are mainly based on three approaches (i ) Investor surveys (ii) Micro Econometric studies and (iii) Aggregate econometric studies. Regarding the first approach, the most noteworthy survey is the World Bank survey in 1994 wherein the World Bank conducted a survey of 173 Japanese manufacturing investors on the likelihood of investing in East Asian countries and found that favorable determinants are the size of the market; the cost of labour; and FDI polices. Further the survey also found that restrictions on repatriation of earnings, local content and local ownership were serious disincentives to FDI flow. The econometric works both at micro level as well as macro level used time-series, cross-sectional and pooled data to explain the determinants of FDI.

Some studies are listed in the Table 2.3. In many cases, the results are inconclusive. This can he attrihuted partly to lack of reliable and accurate data on FDJ. Further, the problem might be also due to the differences in methodology adopted. Further, the studies have suggested that the empirical results may differ significantly for the country groups that are significantly different, in the same vein the elasticity estimates differ markedly for countries at different stages of development also. The present study will be more insightful when we try to explain these determinants at a sectoral level. From the review of some noted studies one can see the variables like the market size, political stability of the host country and wage rate of host country labour emerge as the common factors which explain the potential determinants of FDI inflows. Further, the review also found that the differences in the endowment of supply and demand side and institutional factors determine the differences in the level and type (pattern) of FDI inflows among developing economies.

36

Table .2.3

Review of Selected Studies

uthorls Methodology Country/s Study Data
period Potential Determinants
Root & j\ hmed Multiple Across56 I Yfl6-J970 Annual Gross Domestic Product.
( 1\)79) discriminate developing economic growth. urbanization
analysis countries and infrastructure
Lucas ()99~) OLS Select East 1960-1987 Annual Wages. export and political risk
and Southeast
Asian
countries
Hafbauer et.al. OLS America. 1980. 1985 Annual Regionalism. openness and rate
(J (94) Japan and and 1990 of return
Germany
Sharnsuddin OLS ~6 LDCs 198:' Annual Market size. wage rate and
(1994 ) Political Stability
Chatterjee & Multiple Thailand I Y78-1990 Annual Markel size. Wages and
Praj untaborai Regression urbanisation
( 1995)
Jun & Singh Multiple 31 developing 1970-1993 Annual Political factor. exports and
(19%) Regression countries industrial disputes
Gopinath ( 19(7) OLS India 1980-81 - Annual Gross fiscal deficit and debt
1994-95 service ratio
Christian ( 1(9)-\) OLS 21 Countries I YHO-199_1 Annual Tax variation, gross domestic
product and wages
Nishat and Aqccl OLS Pakistan 1960-1994 Annual Political stability. Skilled labour
( 1998) and Mineral resource
exploitation
World Investment OLS 142 countries 1980-1995 Annual Market size, Politica1 stability
Report (1998) and location
Yang (2000) Multiple Australia 1985-1994 Quarterly Interest rate, wages, openness
Regression and industrial disputes
Howard & Banik OLS Caribbean 1 Y7~-1997 Annual Openness
(200) ) 37

The present work has examined whether this influx of the MNEs into India is mainly due to huge Indian market size, which has no potential to grow [as for NCAER (2003) estimates the auto industry would grow at around R% in coming decade.] or it is due to the dynamic clusters in terms of auto component industry (which is large and wel1-developed in India as compared to other developing countries like Vietnam). availability of skilled and unskil1ed labour and infrastructure facilities in India. Hence, the main question addressed is whether the FDI in Indian automobile industry is market seeking or cost cutting in nature.

2.4. Impact of MNEs on Development

It is well recognised that the entry of multinational firms has important positive and negative effects on domestic firms in the same market segment. In this brief review, the study only outlines the important channels of influence in order to set the stage for the analysis of the Indian case study.There are two contrasting development models explaining the impact of FOlan the economic development of the host country. The first is known as the Benign Model of FDI and Development describing the impact as positive. The second is the Malign Model of FDI and Development describing the impact as negative. The Benign Model of FDI and development argues that under reasonably competitive conditions, the foreign presence may enhance efficiency, expand output, and lead to higher economic growth in the host country, first, by breaking vicious circle of underdevelopment and second, by complementing local savings and finally, by supplying more effective management, marketing, and technology to improve productivity.

The Malign Model of FDI and development argues that the augmentation of profits might drain capital from the host country. The tight control created by the MNEs over technology, high management functions, and export channels may prevent the beneficial spillovers and externalities from occurnng. In the worst scenario, instead of filling the gap between savings and investment by extracting rents, they might drive domestic producers out of business and substitute with imported inputs. (Cardoso and Dornbusch 1989).

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An important question that arises from the debate is which of these models describes the role of FDI in the less-developed countries today? The main answer for this question lies in the competitiveness of the host-country markets, including the competitiveness of input and output markets, which are often influenced by hostcountry regulatory policy. The basic arguments for and against the developmental impact of foreign investment in host countries, has been evaluated in the following

areas:

I. Effect on market structure

2. Effect on investment

3. Technological impact

4. Employment effects

5. Trade effects.

Figure 2.1 Impact of MNEs activity

structure

effects

Investment

MNEs ACTIVITY

2.4.1. Effects on Market Institutions

The competitive effect of multinational firms refers to the outcome of competition for market shares between multinational and domestic firms. This process of competition can yield virtuous cycles of innovation, competition and productivity if domestic firms are able to compete with multinational firms. If multinational entrants

39

are vastly superior to domestic firms it is also possible that multinational firms wipe out the domestic sector, and establish monopolistic positions in the domestic market.

The neo-classical theorists argue that markets have an important role to play in the functioning of an economy. Earlier researchers like Hymer and Kindleberger have emphasized the negative effects of multinational entry on domestic firms and the hostcountry competitive environment. While more recent researchers believe that FDI will increase the competition in the host country; the entry of MNEs with various internalised markets for intangible assets and for physical products can powerfully affect the development of markets Lall and Streen (1977) study has observed significant correlation between the degree of presence of MNEs and sellers competition in the cases of India, Colombia and Malaysia .On the other hand, a number of recent studies conclude that multinational entry improves the productivity of local firms, and increases the competitiveness of the local business environment. Kokko (1994) reviews the effects of multinationals on competitiveness and industry structure in the developing countries. Substantial evidence seems to exist that multinationals put competitive pressure on local firms, forcing them into more efficient work practices ("X-efficiency") and more modern technology.

Whereas, Zhang (200 I) reveals that FOI did have a positive effect on the Chinese economy as it had diversified the ownership structure and helped in establishing market- oriented institutions, the FOI in Chinese economy also helped in creating competitive pressure by breaking China's State monopoly. In contrast to the above, Graham and Krugman (1995) have noted that in sectors where domestic industry had a comparative disadvantage, allowing inward FDI into these sectors might crowd-out local firms, and generate significant market power and pure profits to foreign firms without necessarily increasing the competitive pressure.

The neo-Marxists argue that local firms are wiped out of the market because of competition by leaving the foreign markets more powerful. The FOI leads to oligopolistic competition, leading to net welfare loss and increase in selling costs. Foreign entry also leads to a fall in the number of firms in the industry and the domestic companies arc forced out of business, This raises the fear that foreign MNEs may displace all local firms and establish monopolies that are even worse than the domestic oligopolies they replace. In addition to competition, there is a risk that MNE

40

monopolies also repatriate profits and avoid taxation through transfer pricing!". Whereas the development thinkers emphasized on the competition policy that in order to promote a healthy competition between local firms and MNE affiliates, at the same time it also should offset the monopoly power of MNE affiliation and foreign brands through fiscal measures or assisting the national firms to build their own brands and developing their technological capability.

This idea of a competitive process between domestic and multinational firms that is open-ended in terms of the eventual result also accords well with the mixed evidence of the influence of multinationals on industrial concentration. Differential

productivity is closely related to the distribution of market shares and therefore to industrial concentration. In separate studies, Lall (1982) finds that multinational presence could be de-concentrating in the short-run (when it adds to the number of competitors) but also be concentrating over a longer time-span as it steals market shares from other firms.

2.4.2. Effects on Investment

Investment is a key factor In economic growth. It is evident from many country studies that high growth is associated with high investment rates. Neo classical economists argue that FDI will increase the prosperity of developing countries. FOI will add to the net stock of capital, which will increase the national income. Further, it abo enhances the growth and efficiency with the bund1e of assets that MNEs deploy with their investments. Indeed, domestic investment (Id) plus investments undertaken by MNEs (10 ought to add up to the total gross

I Id + If

investment (I).

FO] will impact on the Private investment of host country by three ways (Jansen 1995).

,.. As FDI a part of private investment, any increase in FDI contributes to increase in private investment by changing the investment climate.

J~ Transfer prices are the dues that MNEs set for intra-firm exports and imports across national boundaries.

41

,. The increase in investments provides a demand impulse with future multiplier and accelerator effects on the income and investments

)0> In case of joint ventures, the FDI may also effect the local private investments.

However, a key question IS whether MNEs crowding in (CI) domestic investments (when their presence stimulates new downstream or upstream investments which would not have taken place in their absence) or crowding out (CO) [by displacing domestic producers or pre-empting their investment opportunities] domestic investment. UNCT AD (1999) tested the CO and CI among 39 developing countries by using the panel data from 1970-1996 and found mixed results. CI was found in Korea (republic), Pakistan, Thailand, and Senegal. And CO was found in Zimbabwe, Nigeria, Poland and Jamaica. But neutral effect was found in Malaysia, Indonesia and Sri Lanka.

The neo Marxist argue that FDI docs not always crowd in domestic investment but at times also crowds out. Buffic (1993) has presented an analytical model, which, under rather restrictive assumptions, shows that FDI in a protected domestic market oriented manufacturing sector is likely to crowd out domestic investments. So, the policy makers need to ensure FDI flows more in to export oriented manufacturing, as it would not only crowd in domestic investments but might also lead to higher income and employment. Capital inflow may influence not only the amount of capita] stock but also the efficiency of investment; (i.e. the incremental capital output ratio may change). Because FDI is not only a simple transfer of funds but also consists of bundle of elements like new technologies. managerial skil1s and marketing channels etc. So, an important issue is how FDI enhances the efficacy and efficiency of the investment.

In traditional neo classical growth models of Solow (1956) type, the ex tent to which FDI effects growth is limited, given that, with diminishing returns to physical capital, FDI can only affect the level of income, leaving the long-run growth rate unchanged. The advent of endogenous growth models (Barro and Sala-l-Martin 1995) has encouraged research into the channels through which FDI can be expected to promote growth in the long run. If growth determinants are taken as endogenous, and

42

FDI is thought of as a composite bundle of capital stocks, know-how and technology, there are different ways in which FDI can he expected to affect growth. The studies start from the general form of the production function

Y=f(A, K, L)

This shows that, in general, the levels of production depends on available capital (K) and labour (L) and on a factor (A) that represents the technology. When we express it in growth rates it leads to

g= ! (a, I1Y, gL)

Where gl. is the growth rate of labour force and an appropriate indicator for technical progress (assume it as exports/output), (X/Y)

I = Id + If

We know that this lead to the general form

s= !eX/Y, IdlY, IjlY, gL)

Where:

g= growth rate of out put X= exports

Id =domextic savings If =foreign capital

This way the studies have established the link hetween capital inflows and growth through the equation derived from production function, which can be tested on time-series data or for a group of countries. The studies by Borenszetin et.a/. (1998) have tested the FD I on economic growth in a cross-country regression framework, utilizing the data on FDI flows from industrial countries to 69 developing countries for 20 years and have found that FDI is an important vehicle of growth but the increase in growth always depends on the absorptive capacity of advanced technologies of developing countries. In terms of development implications, FDI inflows in the form of Merger & Acquisitions (M&As) are generally of an inferior quality compared to Greenfield investments. This is because; M&As do not always augment stock of productive physical capital in a host country that contributes to the growth. Some of the acquisitions are actually funded by locally raised resources and

43

lead to pretty little inflows. The inflow of knowledge per unit of capital in case of FDI through M&A is also likely to he smaller than for a Greenfield investment. The latter also has greater prospects of knowledge spillovers.

2.4.3. Technology Effects

A large body of empirical research is available on the impact of foreign investment on a host economy technology frontier. The literature distinguishes between 'direct' and 'indirect' effects of technology on a host country. The direct effects as we1l as indirect effects [spillovers] can be either positive or negative.

Direct Effects

The direct effects arc in the nature of increase in capital, technology and skills (Lall 2000). The important and long-run effects of FDI are generation of technology and transfer of technology. Technology generation involves the process of production and implicit knowledge. The most conventional measure is by seeing the R&D spending or patents registered.

FDI also involves technology transfer (TOT) in terms of training, ski1l acquisition, new management practices and organizational arrangements. FDI directly raises the level of technology in the host economy through a variety of mechanisms like diffusion of knowledge of production methods, product design and new and organisational managerial techniques. In this context, imitation becomes a crucial element. FDI may also enhance the productivity of domestic research and development [R&D] activities. The major issue in the debate over MNEs is whether they will transfer the technology? If it is transferring, then what type of technology will it transfer? In general the pro-MNE writers highlight that technology diffusion plays a central role in the economic development. They argue that the rate of economic growth of a backward country depends on the extent of adoption and implementation of new technologies that are already in use in developed countries. FDI by MNEs is considered to be a major channel for the access to advanced technologies by developing countries. FDI increases the rate of technical progress in host country through "transmission" effect from the more advanced technology, management practices, etc. used by the foreign firms. Wang [1990] has icorporated this idea into a model more in line with the neoclassical growth framework; by

44

assuming that the increase in 'technology' applied to production is determined as a function of FD I.

Borensztein et al. (1998) has found that FDI is an important vehicle for the transfer of technology and contributes relatively more to growth than the domestic investment in developing countries. Recently Campus and Kinoshita (2002) have tested the technology transfer effect of FDI in 25 central and Eastern European (former Soviet Union) transition countries between 1990 and 1998 and found that FDI have a positive and significant impact on economic growth. On the contrary NeoMarxist writers have argued that the MNEs do not transfer appropriate technology at all. They have argued that the ToT does not always benefit the host country. Krugman (1998) has noted that FDI is not only a transfer of ownership from domestic to foreign resident but also a mechanism that makes it possible for foreign investors to exercise management and contra] over host country firms. The main conclusion arising from their argument was that the asymmetry of information in ToT leads to adverse selection or cxcessi ve leverage for developing countries.

Spill over effects

The externalities or side-effects arose due to diffusion of imported skills efficiency both horizontally and vertically and the creation of dose links with 'home' economies. The spillover effects occured mainly in three ways by the linked economic agents (who had direct link with firms) or by other firms and institutions (those included local technology institutions) or by domestically competing firms. It has been observed that domestic firms become more competitive as they become suppliers of foreign firms "Upstream" and buyers of products "down stream" from foreign firms. The Neoclassicists argued that workers employed in foreign firms with accumulated knowledge and skills left the foreign firms and joined the domestic firms. This helped in an increase in human capital and the productivity of labour in domestic firms. Foreign affiliates brought with them capabilities. know-how, new products and processes that embodied technological innovati veness that could be transferred in different ways, e.g. by means of labor turnover. This influenced the local science and technology and training and trade promotion and resulted in more general effects on the formulation of economic policies.

45

These effects could be positive if they stimulate local technological effort, improved standards and quality assurance, systems intensified linkages between industry and R&D institutions, improve the quality and relevance of education and training and enhance the effectiveness of export promotion. The studies by caves ( 1974) on Australia, Globerman (1979) on Canada and Kathuria (l 99g) on India found positive spill over effects. Similarly there are negative spilJover effects. In the pres~nce of foreign firms the competition wipes out the local firms. As the MNE critics argue, since the main motive of MNEs is to exploit the resources by using their ownership and internalization advantages, they might not "leak out" their expertise to local people because this expertise is a key to their competitiveness. Resulting in no spillovers. Aitken and Harrison (1999) on Venezuela and Koko et al. (1994) on Uruguay have found the negative or no impact of foreign firms. Domestic firms are not prepared enough to receive brand new technologies coming from abroad, they were not able to upgrade their "information set" for using the technology transferred into their production process.

The empirical studies in this respect have used independent variables such as capital/output, labour/output ratios and the extent of foreign presence and different dependent variables, like growth in per capita income, value added per worker (Kokko 1994), labour productivity (Blomstrom 1998), total factor productivity and over all firm sales. In this regard, Aitken and Harrison (1999) have used panel data on Venezuelan plants to locate spillovers from foreign firms to domestic firms and found that foreign investment negatively affected the productivity of domestically owned plants. The competition leads to a decrease in the local firm's production and to an increase in its average costs. If any positive spillovers were present, they should have reduced the local firm's marginal and average costs.

2.4.4. Employment Effects

The pro-MNE writers argue that FDI brought jobs to a host country that would otherwise not have been created. Employment effects are both direct and indirect in nature. "Direct effects" arose when a foreign MNE directly employs a number of host country citizens. "Indirect effects" arose when jobs are created in local suppliers as a result of the investment and when jobs were created because of the

46

increased spending in the local economy resulting from employees of the MNE. The indirect employment effects are often as large as, if not larger than, the direct effects. The effects on labour market are listed below.

Table.2.4

Effects on Labour Market

Direct effects Indirect effects,
Area of Positive Negative Positive Negative
impact
Quantity Adds to net capital f'OI through Creates jobs Reliance on
and creates new jobs acquisition may through forward imports or
in expanding result in the and backward displacement of
industries rationalisation ofjob linkages and existing firms
loss multiplier effect resulted in job
on the local loss
economy
Quality Pays high wages and Introduces practices Spillovers of best Erodes wage
have higher in hiring and practice world levels as domestic
productivity promotion that arc organisations to firms try to
considered domestic firms compete.
undesirable.
Location Adds new and Crowds already Encourages Displaces local
pc rhaps better jobs congested urban III igration of producers adding
areas and worsen supplier firms to to regional
regional imhalances areas with unemployment if
available labour foreign affiliates
supply. substitute for local
production or
rczional imports. Source: World Investment Report 1994.

Neo classical economists have argued that employment creation by MNE is an important benefit derived by the host country. Further they also argued that the positive impact of employment creation by FDI extended beyond direct employment growth. Through input-output linkage effect MNEs would create new demand for domestically made products which delivered a strong stimulus to the local firms. Consequently the output and employment of domestic sector would increase by a multiple of FOL Blomstrom and Kokko (1998) have shown that MNEs have benefitted from training of local employees by transferring both technical and managerial skills to local employees. Chen's (I 983) study on Hong Kong finds that training of workers was more important than the introduction of new techniques and products and noted that many managers of local firms received training in multinational corporations. Feenstra and Hanson (1997) find that investments by US multinational firms raised the demand for skilled labor in Mexico and also found that multinationals generally pay higher wages than local firms do.

47

Okada, (1998) examines the effects of globalisation on the Indian economy and, in particular. the growth of FDI on employment and the quality of jobs for local workers, in the automobile industry. It finds a generally positive, hut relatively modest. employment effect on the Indian automobile industry, particularly at the assembler level. Employment growth slowed down in the 1990s, even though their sales grew remarkably. The quality of jobs has improved considerably between 1985 to 1995.

On the other extreme, the nco Marxist economists have highlighted the negative impact on employment hy MNEs. Germidis ( 1977) has finds that there is no evidence of spillovers to local competitors. The lack of spillovers to domestic firms was attributed to a number of factors, including limited hiring of domestic employees in higher level of positions, very little labour mobility. There are however, some important issues yet to be addressed, such as, are MNEs creating jobs? Do they increase labour productivity? Do they increase skills and management? How does it affect the bargaining power of labour.

2.4.5. Trade Effects

The activities of MNEs have an important impact on international trade. FDI by MNEs would increase the volume of international trade. To enter a foreign market and to become a successful exporter, a domestic enterprise needs to manage the international marketing, distribution, and servicing of its products - tasks that are typically connected with high fixed costs. But MNE parent or affiliate is likely to be in a better position to establish export operations. since it can benefit from the existing international network of the entire corporation.The presence of MNE provides access to international market for domestic firms. The pro MNE writers have argued that the presence of MNE would enhance the international competitiveness and increase in exports and also impact upon

• local raw material processing,

• conversion of import-substituting industry to exporting,

• Labour-intensive processes and component specialization within vertically integrated international industries.

48

The study hy Sibunruang (1992) has estimated that foreign firms accounted for at least 25 percent of manufactured exports by the end of the 1970s, and that by 1990 that share had risen to 30-40 per cent. Similarly, Sun (1998), in the case of China found that exports had grown rapidly during the period 1979-19Y6. Chinese exports increased by 16.4 per cent annually. On the other hand, Anti-MNEs authors have argued that FDI would increase the import dependence. Although the initial impact of FDI was to improve the foreign-earnings position of the recipient nation, its long-run impact may reduce foreign exchange-earnings on both current accounts (as a result of substantial importation of capital and intermediate products) and capital accounts (overseas repatriation of profits, interest. royalties, management fees, and other funds). As Borroman and lung Nickel (1992) have stated that the recent trend towards the interregional networks of foreign firms and trade has strengthened the import dependency.

The study undertaken by Lall and Streeten in (1977) has used data from ] 59 MNEs with investment in six developing countries between 1970 and ] 973. They have examined the direct balance of payments effect for each firm, which they defined as

Bd=(X+K- (Ck+Cr+R+D)

Bd; net surplus (or) deficit of balance of payment. X = value of exports.

K= inflow of capital

Ck =value of capital goods imported. Cr =value of recurrent goods imported.

R = royalties a technical and managerial fees paid to Foreign countries. D= divendes +interest accruing to investing countries.

Using this measurement the authors found that these MNEs affiliates recorded a net deficit on their external transactions. The MNE affiliate is likely to import more finished goods than local enterprises and the MNE affiliate is likely to be less exportintensive than the local enterprise. Although FDI contributed to public revenue in the form of corporate taxes, their contribution is considerably less than it should be as a result of liberal tax concessions, the practice of transfer pricing, excessive investment allowances, disguised public subsidies, and tariff protection provided by the host government. And the most important thing is MNEs would opt for transfer pricing!".

15 Transfer pricing refers to the pricing of goods and services within a multi-divisional organization. particularly in regard to cross-border transactions. For example, goods from the production division may he sold to the marketing division. or goods from a parent company may he sold to a foreign

49

The motivation for MNEs to go for transfer pricing is to maximize their global profit and minimise the total cost by avoiding or reducing taxes and tariffs in their home countries and in host countries where their subsidiaries operated. As it becomes evident from the above discussion assessment of overall impact of MNEs is very difficult because of the complexity of issues involved in it. Most often development depended on the level of development already achieved in the relevant country. From the past two decades many studies have focused on the effects of MNEs on the host country, through the important channels such as transfer of technology, the training of workers and finally the generation of linkages. Results of these studies were inconclusive and often contradictory (Grog & Greenway, 2004). Further, most of these studies were carried out at macro levels by using cross-sectional and panel data.

The present study's focus is mainly on one particular industry by USIng an industrial organizational theoretical framework to explain the impact of MNEs entry on the performance of Indian automobile industry. At the same time, the study has also included the other important issues dealt in other studies and results there from are discussed in the subsequent chapters. For example the impact of MNEs on market institutions has been examined in the sixth chapter by comparing the structure of the automobile industry before and after MNEs entry i.e. liberalization. And the other aspects like its impact on growth are examined in the sixth chapter by comparing various productivity indicators. However, the employment aspect has not studied in a great deal. Further, as it is stated elsewhere in the study that the local linkages are essential to the functioning of normal industrial market, and they can stimulate the development of the linked activities (forward and backward) and industrial diversification in less developed countries. In this regard, there exist a few theoretical studies on backward linkages (Markusen and Venables, 1999 Rodriguez-Clare 1996). The present study has limited its analysis to study the generation of vertical backward linkages because the indirect linkages as measurements of effects are time consuming and difficult. However, this offers a very good potential area for future research.

subsidiary, with the choice of the transfer price affecting the division of the total profit among the parts of the company

50

CHAPTER - THREE GLOBALISATION OF AUTOMOBILE INDUSTRY

The present chapter mainly focuses on explaining the globalisation aspects of the automobile industry in the developing countries. The earlier studies, which are theoretical in nature derived that production shifts to developing countries were mainly due to their large market size and low production costs (particularly labour cost). In this chapter, this proposition has been tested empirically in order to find the determinants of passenger car production. Here the focus is on finding out the factors, which were responsible for the production shift towards the developing countries, by using cross sectional data of 24 countries at different points of time (i.e. 1975, 1985- 86, 1992-93and 2001-2002). This in a way explains the stages in globalisation of automobile industry.

The current chapter is divided into five sections, first section focuses on various issues related to automobile production process; section two, focuses on the structure of global automobile industry in order to find out the major players time frame under reference. Third section focuses on the Economic Geography of production and fourth section focuses on the empirical determinants of passenger car production by using cross sectional data at different points of time and final section presents the chapter conclusions.

3.1. Automobile Production Processes

The automobile Industry comprises of vehicle manufacturing, components manufacturing (ancillary industry) and service sectors. The vehicle-manufacturing sector produces different types of vehicles. They include Scooters, Motorcycles and Mopeds in Two-wheeler segment. Passenger and goods carrying vehicles in threewheeler segment; Passenger cars, Multi-Utility Vehicles (MUVs), Light commercial vehicles (LCVs), Buses, Trucks and Tractors in Four and Six wheeler segments. In each category, there are a number of manufacturing firms and they produce different models of vehicles of varying sizes and capacities. Here the focus is largely on passenger car and Multi Utility vehicles (MUVs) segment.

51

The auto industry is often treated as one of the most globally integrated when compared to industries. Its products have spread all over the world, and it is dominated by a small number of companies with worldwide recognition. However, in certain respects the industry is more regional than global, in spite of the globalising trends evident in the 1 990s. The nature of automobile industry should be noted because it is highly capital-intensive and also influences various reJated sectors. There are extensive forward and backward linkages to the final automobile product. An automobile as a final product consists of 16,000 to 20,000 items. Hence, it influences many ancillary sectors. sales/maintenances, materials supply i.e. steel and plastic etc. Also the automobile industry is considered as one of the largest generators of direct and indirect employment - every direct job generates another 60-70 jobs through . di I If,

In }feet emp oyment .

An automobile firm is directly responsible for the development of design, engineering and marketing of vehicle and it directly undertakes the manufacturing of several critical components of the body, transmission and engine. It has undergone significant changes since Henry Ford first introduced the assembly line technique for the mass production of cars. Production concepts, processes and the associated technologies have changed dramatically since the first cars were built. Car assembling was primarily manual work 70 years ago. Today, the process of car assembling is almost fully automated. In the olden days, firms attached importance to the production of virtually every part in a single plant, while today, car makers concentrate on only a few specific production stages (i.e. car assembling). Parts and module production, services and related activities have been shifted to other, specialised firms (outsourcing of production steps). This not only gives the producer greater flexibility and lowers capacities and costs. but also causes increased dependence on suppliers. The production sequence in the automobile industry is depicted in Figure 3.1.

Characterized by large scale, capital-intensive, technology-driven productcycles, producer driven commodity chains are networks of global production where small numbers of final assemblers (such as Ford, GM, Toyota, Honda, Volkswagen,

16 For example, Maruti Udyog Limited. the largest company in lndia, employs about 5,500 persons directly, but the secondary employment in their suppliers I ancillary units is about 250.000. including transportation of the cars. Likewise, there is huge additional employment in organisations which supply fuel, luhricants, accessories, music systems, service centers etc. (A report for Asia-Invest 2(01).

52

Benz and BMW) dominate the industry's main markets with its oJigopo1istic market structure.

Figure 3.1

Production Sequence in Automobile Industry

Components

JIl8Iterials Material processing ____. Body manufacturing
Sub assembling Final
f

,)n and steel Forging, casting.
.. ~ Subsystem Final
\ILlminum p stamping - and -+ ProdUl·t
Silicon Components ...
.. ___. painting
Plastics - Mechamcal and
Jbber Alloys electronic components
like brakes spark plug.\
ell' and
1
F . ... d I---
_n~lnrs an
transsimissions
, Source. Quandt (1992)

The major players are MNEs, which organize their activities around internationally integrated lines and worldwide sourcing of components and parts, The presence of a high level of concentration in the world motor industry is due in part to increasingly competitive global market, which demands economies of scale in design, production and marketing. and consequently, requiring high investments in R& D and machinery. The major automobile companies (in terms of employment, production and market share) are located in the United States, Germany and Japan, followed by Italy, France and the Republic of Korea. For more than 50 per cent of the component requirements, the car industry depends on independent manufacturers. The automotive industry is often regarded as a classic example of a producer-driven commodity chain (Gereffi , 1994). Assembling of automobiles globally is a hierarchal structure. In this structure, the vehicle manufacturer is at the apex, and the suppliers are organised in the following manner:

Figure 3.2

Supplier Relations in Automobile Industry

l~blers

Lba I mega- 15lJPI'liers

First-tier suppliers

Second-tier suppliers

53

1. Assemblers. This is comprised of vehicle design and branding of passenger and commercial vehicle. Innovation and design capabilities remain critical.

2. Global mega-suppliers. Also known as Original Equipment Supply (OES), these firms supply major systems to the assemblers. They are sometimes referred to as "Tier OS' suppliers, because they are closer to the assemblers than the first-tier suppliers. These companies generally have global coverage in order to follow their customers to various locations around the world. They need design and innovation capabilities in order to provide "black-box" solutions for the requirements of their customers. Black-box solutions are solutions created by the suppliers using their own technology to meet the performance and interface requirements set by the assemblers.

3. First-tier suppliers. These are firms. which supply directly to the assemblers.

Some of these suppliers have evolved into global mega-suppliers. First-tier suppl iers require design and innovation capabilities, but their global reach might be limited.

4. Second-tier suppliers. These firms will often work on designs provided by the assemblers or global mega suppliers. They require process-engineering skills in order to meet the cost and flexibility requirements. In addition, the ahility to meet quality requirements and obtain quality certification (IS09000 and increasingly QS9000) is essential for remaining in the market. These firms may supply to just one market, but there is some evidence of increasing internationalization.

5. Third-tier suppliers. These firms supply basic products. In most cases, only basic engineering skills are required. At this point in the chain, firms compete predominantly on price.

Changing Assembler-Supplier Relationship in the Globalised era

Globalisation refers to an evolving pattern of cross-border activities of firms involving international investment, trade and cooperation for purposes of product development, production and sourcing, and marketing. Complex patterns of crossborder activities increasingly characterize the international economic system and distinguish it from the earlier predominance of arm's length trade in finished goods. The main driving force behind globalisation strategies of firms is no different from

54

that which drives international trade. Firms seek to maxirmze profits, given the constraints they face. Changing or vanishing constraints imply new profit opportunities and thus require new strategies of firms. In a way, globalisation is nothing more than the entrepreneurial response to a changing environment, while the motive of firm behaviour constrained profit maximization remains unchanged. (UNIDO 2000).

Ti1l the 1970s. automotive assemblers in the developed countries had two kinds of suppliers: subcontractors and catalogue suppliers. The former were given specific tasks to carry out following detailed instructions provided by the assemblers. Contracts were short-term, and awarded predominantly according to price. The assemblers drove down costs by sourcing the same part from a number of different suppliers. This meant ensuring that alternative sources of supply were available through keeping design capability in-house and placing orders for easy-to-make parts that were subsequently assembled by the assembler.

When automotive companies internationalised their production in the 1950s, 1960s and 70s, they created new supplier networks at each new location. In part, this was because they produced models specific to particular markets. However, when Ford began to produce identical vehicles at different locations in Europe in the 1970s, it combined central production of certain high value products (engines, gear boxes, etc.) with local supply networks for each plant. When the multinational automotive assemblers expanded into developing countries, they replicated locally based networks there too. In many cases, automotive assemblers were obliged to source a large part of their inputs within the domestic economy. They were able to do this because they were used to providing sub-contractors with designs for simple, easy-tomake parts. For simple components, the local manufacturer could work from an assembler's drawings and meet its requirements. Fur more technically demanding components, the local suppliers could link up with a component manufacturer in a developed country in order to acquire process technology. Even though multinational companies began to play a significant role in the components industries of many developing countries, the automotive industry provided many opportunities for local companies as long as they could compete on price and meet certain minimum quality standards.

S5

3.2. Structure of Global Automobile Industry.

Globally the automobile industry. as stated earlier, has small numbers of final assemblers (such as Ford, GM, Toyota, Honda, Volkswagen, Benz and BMW), that dominates the industry. The auto industry has remained concentrated ever since 1950s. with a small number of companies accounting for a significant share of production and sales. While there were some new entrants to the assembling sector in the last 20-30 years (including firms like Hyundai from the Republic of Korea), altogether, there are only 13 fi rms 17 like General Motors group (OM), Ford group Volkswagen group (VW) .Toyota group, Daimler Chrysler group, Fiat group, Honda, Nissan, Renault, PSA, BMW, Suzuki and Mitsubishi, which account for around 87 per cent of the world's vehicle production. Overall, the industry structure is oligopolistic in nature.

The major automobile companies, measured In terms of employment, production and market share are located in the United States, Germany and Japan, followed by hilly and France but recently the Korean firms have also joined in the list. So these firms have operations not only in their home countries but also in the other countries (foreign operations). For example, OM motors is the firm originated from USA but it has operations in over 60 countries. Over the years the share of production of top four MNEs, General Motors and Ford from USA, VW from Germany and Toyota from Japan remain on the top. The production share of these top four MNEs accounts around 50 per cent of world auto production. These shares have not yet changed till the date. Incrementa] changes that have taken place among the four players are of Toyota and VW, whereas OM and Ford's shares have marginally decreased

17 In the late 70s and early 80s. more than 90 per cent of the global automobile industry output was generated by 22 MNEs. all of which had foreign operations by licenses or by their own affiliates: among them 13 firms had the foreign production plants (UNCTNC, 1983) . So, for analysis only 13 firms have been considered.

56

Chart 3.1:

Production Share of Various Automobile Firms in 1977, 1989 And 2002

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
FJ-:-
-, , 1089

2002

years

I GMJOpel I Ford

• Peugeot/Citroen I Mazada

o Toyata

o Mitsubishi

o Chysler/ AMC • Nissan

[] Honda • Suzuki

I!IVWJAudi IBMW

.Fiat

I Hyundai

IJ Renuh lothelS

---------- -------

From the Chart 3.1 it is clear that 50 per cent of the world automobile production is coming from only four firms i.e. General motors, Ford, VW group and Toyota group and the rest of groups are having insignificant shares. From this we can say that an automobile industrial production is highly concentrated and fully dominated by a few players. Further, the above chart also explains that the firms have been maintaining the market shares over a period of time. The most interesting aspect which gets revealed from the above chart is that the Japanese firms have really acquired more shares as compared to US firms in late 1990s. The interesting aspect at 2002 is that many old firms are acquired by the other firms. The pace of consolidation has accelerated since 1998 (see Table 3.4 for mergers and acquisition details) when Daimler and Chrysler merged. Daewoo acquired Samsung and Ssangyong, Hyundai purchased Kia, General Motors increased its stake in Suzuki to 10 per cent, Toyota raised its interest in Daihatsu to 51 per cent and Renault took a 37 per cent share of Nissan in 1999. Whereas a dozen firms produced 80 per cent of the world's passenger cars in the early 1980s, by the beginning of the 1990s 11 firms made three-quarters of the total, and in 1998 only seven major companies (General Motors, Ford, Toyota,

57

Renault/Nissan, Volkswagen, DaimlerChrysler and Fiat) accounted for 72 per cent of the market OLO 2000).

It is also clear from the above graph that although GM remains the world leader, there have heen important changes in the share of the most major automakers where the big three automakers lost a significant proportion of world markets since the late 1970s. In 1977, they commanded half of the worldwide production by 1989 these shares have dropped down to 38 per cent of car production. But during the same period Japanese and European carmakers had increased their share. By 1999, the smaller companies are merged or taken over by larger ones (Daimler Chrysler merger, Ford's acquired of Volvo Cars, Renault's link-up with Nissan, Volvo's bid for Scania, Fiat's strategic alliance with Mitsubishi and GMs take over of Daewoo). At the same time the share of major players like GM, Ford, Toyota and VW maintained 50 per cent share.

Table 3.1 explains the pattern of foreign investments in the motor vehicle markets.

It is clearly evident that over a period of time MNEs foreign production percentage has heen increasing, and at the same time, their home production has heen declining. In internationalizing process the Japanese firms are more internationalizing their production markets as compared to European and US firms. In 1977, US firms dominated the foreign share production and at the same time Japanese and European firms had very Jess foreign production. This explains that in 1977, US firms are more involved in foreign production as compared to others. But, in 1987, many European firms also started having a foreign operation and then Japanese firms also started foreign operations. Over the period, the share of foreign production is increasing in all firms. Among all, the growth was more in Japanese firms as compared to European and US.

58

e ea m~ s , an ( n percentage terms)
Years
1977 1989 2002
Firm Country of Share of Shan:: Share Share Share Share
Orig: n foreign llf of of of of
home# foreign home foreign h () me'
r-------
European Firms
Renault France 10.63 8:1.37 19.68 XO.32 42.68 57.31
Peugeot/Ci troen france 9.32 90.68 20.09 79.91 38.87 61.13
VW/Audi Germany 22.09 77.91 31.86 68.14 62.29 :n.71
Daimler Benz* Germany 11.53 88A7 12.01 B7.99 N.a N.a
BMW Germany 0.00 100.00 o.oo 100.00 31.10 68.90
Fiat Italy 26.84 n.lo 11.68 88.32 4139 58.61
Volvo Sweden 39.23 60.77 29.01 70.99 82.50 17.50
Japanese Firms
Toyota Japan 0.98 99.02 7.06 92.1.)4 39.33 60.67
Nissan Japan 1.60 98.40 19.15 80.S) ·-Hum 51.20
Mazda Japan 0.00 100.00 14.59 8SAI 26.03 n.Y7
Mitsubishi Japan 0.00 100.00 0.00 100.00 52.17 47.83
Honda Japan OJ)O 100.00 24.78 75.22 53.61 46.39
Isuzu Japan 0.00 100.00 0.00 I ()O.OO 47.02 52.Y8
Suzuki Japan n.oo 100.00 0.00 100.00 41.28 58.72
American Firms
GM/Opel USA 26.17 73.83 36.70 63.30 39.49 60.51
Ford USA 38.17 61.83 47.51 52.49 48.49 51.51
Chrysler/ AMC* USA 24.88 75.12 29.06 70.94 30.31 69.69 Table 3.1:

Home and Foreign Production of Motor Vehicles by Th L di MNE (1977 1989 d 2002) ]

Source: Lall ( 199 1 ): MVMA motor vehicle data ( 1991): OICA # HOME refers to plants located in the same country where the firm \ headquarters are located,

'" Daimler Benz, and (,hry~ler have been merged and became Daimler Chrysler recently.

From the table 3.2 the top 14 automotive companies have total assets equal to US$1,038 billion, of which 504.3 billion belongs to the United States-based companies. US$ 309.2 billion to European companies and the rest, US$ 224.2 billion to the Japanese companies. The same ranking is found in total sales, with American companies in the lead with US$ 331.8 billion, followed by Europe with US$ 307.2 billion and Japan with US$ 211.9 billion. Foreign sales show a completely different

59

scenario in this regard; Europe comes first with US$ J 93.1 billion, followed by Japan with US$120.6 billion and the United States with US$ 99 billion.

Table 3.2.

Assets, Sales and Employment of the Top 14 Automobile Manufactures (In 1997-98)

Automobile Country Foreign Total Foreign Total Foreign Total Number
l\1NE Assets Assets Sales Sales Employm Employ of
(US$ .uss IUS$ (US$ ent (Nos) ment countires
billion) billion) billion) billion) (Nos)
Honda Motor Japan 21.5 3o.S 31.5 4SA n.;} 109-1.00 22
Co. Ltd.
Renault SA France I R.3 34.9 I R.5 35.6 45860 141 315 29
Peugeot SA France 12.9 30.9 In.l 31.2 :'1 100 140200 n.a
BMWAG Germany 20.3 31.8 lnA 35.9 52 149 117624 22
Volkswagen Germany n.J 57 42.7 65 l:n 906 279892 D
group
Robert Bosch Germany I) 19.5 17.7 27 ~9 071 179719 25
Daimler-Benz Germany 3~.\.} 70.2 46.1 69 74802 300068 38
AG
Fiat Spa Italy 30 ol). I 20.2 50.6 94 ~77 242322 43
Nissan Motor Japan 26.5 57.6 n.R 49.7 n.a 137201 L'
Co.
Toyota Japan 41.8 105 50.4 88.5 n.a 159015 34
Mitsubishi Japan 9.1 25.1 10.9 28.3 19600 75300 14
Motors
Volvo AB Sweden n.a 20.7 21.5 24.1 29500 72900 :n
Ford Motor United 72.5 275.4 48 153.6 174 105 363892 46
Company States
General United I) 228.9 51 178.2 n.a 608000 59
Motors States Source:_World investment report 1998: Trends and determinants (Geneva. 1 Y9R). pp. 321-322.

The average ratio of foreign sales to total sales is 63 per cent for Europe, 57 per cent for Japan and 30 per cent for the United States. The top 14 companies have employed a total of 2,786,668 persons, of whom European companies accounted for 480,936, Japanese companies share 48 J ,936 and United States companies 971.892, General Motors had the largest workforce at 608,000, followed by Ford with 364,000 employees, almost half of whom worked in foreign branches of the company. Considering the fact that foreign assets represent only 26 per cent of its total assets, it

60

could be inferred that domestic branches of this company were much more efficient than the foreign ones.

Table 3.3:

Ranking of Top 14 Automobile Manufacturers among the top 100 MNEs in 1997

MNE Foreign
Automobile MNE Country asset TNI*
ranks assets
- ... -_
Honda Motor Co. Ltd. Japan X 2.+ n.a
BMWAG Germany !) 25 JX
Volvo AB Sweden 12 62 .:to
Volkswagen group Germany 4 X 50
Robert Bosch Germany 14 72 5~
Nissan Motor Co. Japan 7 17 hi
Renault SA France 10 33 6H
Daimler-Benz AG Germany 5 10 71
Fiat Spa Italy () 12 74
Toyota Japan -' 6 7'5
Peugeot SA France II 53 77
Ford Motor Company United I 2 XO
States
Mitsuhishi Motors Japan 13 70 XI
General Motors United 1 4 91
Stales .;.. * * Transnationality index (TNI): average of three ratios: foreign/total assets, foreign/total sales and

foreign/total employment .

Source: UNCT AD: World in vestment report 1998. op cit., p. 318

According to this index Honda Motor Co. Ltd. ranks first in the automotive industry, although compared to the other industries. it comes 32nd among the world's top 100 MNEs. It can also be seen from this table that all the companies come from Triad 18 countries.

18 The Triad region consists of North America, the European Union and Japan.

61

Table 3.4

_.~~~,- ~,-~,-a~~o_r __ ~ __ &_A __ D __ ea_l_s_in __ (_;I_o_b_a_I_A_u_t_o_m~o_t_lv~e_I_n~d~u~s~tr~'Y ~

199K • US $40.5 billion merger of Chrysler and Daimler Benz

• US $6.5 billion acquisition of Volvo's car business by Ford

• Volkswagen (VW) of Germany added Bentley and Lamborghini to irs brand portfolio.

VW also has the rights to the Rolls-Royce brand from Vickers of Britain. BMW had offered Vickers US $560 million, hut VW threw In a hid for US $790 million.

However. Rolls-Royce PIc .. which held the rights to the Rolls-Royce name. awarded the same to BMW.

• General Motors (GM) increased its stake in Suzuki from :LJ,pcr cent In l Opcr cent

1999 • Daimler Chrysler acquired an influential stake in Mitsubishi Motors of Japan with an option to acq uire all of Mitsuhi shi in three years (the curre nt stake is :17 .3per cent)

• Volvo signed a cross-shareholding alliance with Renault of France. acquiring the laner"s heavy truck operations

• Renault of France paid US $5.4 billion to take control of Nissan of Japan

2000 • Ford acquired Land Rover from BMW. The Rover Group of the UK had been bought by MBW in I ~93 for US $4 billion but the investment did not fructify with BMW making huge losses at Rover.

• GM acquired a 20 per cent Slake in Fiat Auto of Italy. Fiat, in turn. picked up a 5.l) per cent stake in GM.

• In August 2000. Daimler Chrysler announced that it would acquire a 10 per cent equity stake in Hyundai Motor of South Korea for US $42H million. providing itself a vital stepping stone in Asia.

2001 • GM further increased its stake in Suzuki Motors of Japan hy I Oper cent

• Toyota Motors Corp of Japan bought 1l).5per cent stake in Hino Motors of Japan

• Mitsubishi Motors of Japan acquired 50per cent stake in Nederland Car EV (Ncdcor ) of the Netherlands

2002 • GM of USA acquired Korean carmaker Daewoo Motor Co.

• Fiat disposes 5.7 per cent stake in General Motors and $760 million in Ferrari SPA.

The later was bought over by two banks in Italy and Denmark.

• Renault and Nissan further consolidated their alliance

• Suzuki Motor Corp of Japan increased its stake in MUL of India by 4per cent to 54per cent

Source: INGRES (2003)

The global automotive industry has witnessed a spate of mergers in the recent past. The mergers were driven by the following reasons: Carmakers needed to achieve scale economies in a situation of excess capacity. Whi1e the automotive industry

62

capacity was around 75 million units a year, the production in 2002 amounted to just 56 million. Of the estimated 19 million excess capacities, Europe and North America alone accounted for 8 million units in 2002.

3.3 The Economic Geography of the Automotive Industry

It has been discussed in the previous section that automobile industry is characterized by large scale, capital-intensive, technology-driven product-cycles, producer driven commodity chains are networks of global production IS technologically advanced and relatively human capital-intensive ( Vickery 1996). Due to this nature of innovativeness, the automobile production continues to be dominated

~

by high-income countries, accounting for about 90 per cent of world production.

During the last two decades or so, the global geography of the industry is being transformed by rapid growth of automotive consumption and production in emerging markets. Globalisation has forced traditional automobile producing countries to explore for new production base. In this regard, most of the multinational automobile firms have established their new production bases in countries like Mexico, Spain and East Europe and some Asian countries.

By the early 1990s, there were a large number of self-contained vehicle industries in Latin America, the ASEAN 19 region, India and China, with hmited imports of vehicles, components and with a few exceptions (most notably Brazil and Mexico), limited exports. Trade liberalisation began to change this situation in the 1990s. Quantitative restrictions were phased out and tariffs reduced, while TradeRelated Investment Measures (TRIMs) like local content requirements and foreign exchange balancing were under increasing attack. At the same time, the global production and sales strategies of leading multinational auto companies were also changing and the developing countries were becoming more integral to their plans. The history of the foreign investments by the motor vehicle industries reveals significant changes of global patterns of trade and investment. Until 1950, American firms focused on Latin America, and to a lesser extent on Europe, and European firms limited their foreign sales to their colonial possessions. Otherwise, each producer was

19 Association of Southeast Asian Nations (ASEAN) (viz. Indonesia, Malaysia, Thailand and the Philippines)

63

mostly limited to its own home market. In 1970s firms started penetrating into each other's national market. This strategy became necessary in order to succeed in the increasingly competitive international scene, and then forced to look for low production cost base. When several countries in Latin America initiated import substitution polices, the MNEs that had assembling plants in those countries were partially forced to initiate manufacturing operations, in order to ensure their participation in the local market. In the 70s and 80s and in the recent times MNEs arc entering by getting attracted towards the huge potentia] markets and the trade barriers are forcing them to have assembling operations in those countries.

Global vehicle production rose by nearly 7 million units between 1990 and 1997, although the increase in sales over the same period lagged considerably behind this, at just under 4 million units. Much of this growth was concentrated in developing countries. In the Triad regions (the United States of America and Canada, i.e, North America, Japan and Western Europe), the vehicles industry is mature and has been plagued by overcapacity, cost pressures and low profitability. In contrast, vehic1e sales in both Western Europe and Japan were less in 1997 than they had been in ]990. Overall, vehicle sales in the three Triad regions rose by only 0.6 per cent between 1990 and] 997, and production rose by 4.2 per cent. (Humphery & Olga 2003)

P d

Sh

Table 305

f W Id A t bOI I d t C

t

t ms)

ro ucllon are () or u orno I e n us ry m per cen age er
Year Share of developed count rics Share of developing countries
production production"
1975 )1,6.34 13.61
1985 )1,6.41 13.85
1992-93 )1,3.55 16.44
2001-02 54.84 45.15 * Here the centrally planned economies also considered as developing countnes. Source: calculated from UN Statistical yearbook various issues.

Table 3_5 illustrates the shift in the share of world production of motor vehicles. in the 1975 share the share of developed countries is around 87per cent (USA, Japan, West Germany, France, Canada, UK, Italy. Spain, Austria, Australia, Finland, Netherlands and Sweden) . this trend continued into 19R5, hut from 1993-94 onwards the declining trend started. By 2002 the share of developed countries dropped

64

substantially to 55 per cent. At the same time. the share of the developing countries and transition economics (USSR, Poland. Argentina, Brazil, Mexico, Yugoslavia and China and others) increased. Initially, it was 13 per cent in 1975 and the share of this increased up to 45 per cent in 2002. According to Sturgeon (1998). production locations that were available to autornakers in the world have been divided into three

hroad categories: I) Large Existing Market Areas (LEMAs), such as the United States and Canada. Western Europe (excluding the Iberian Peninsula), Japan, and Australia; 2) Peripheral to Large Existing Market Areas (PLEMAs) such as Mexico, Spain, Portugal, and Eastern Europe; and 3) Big Emerging Markets (BEMs) such as China, India, Vietnam. Russia, and BraziJ.These emerging markets can be classified into two groups. The former group lies at the periphery of the industrial1y advanced countries like Mexico, which is being integrated into the North American auto production system. The second groups of emerging markets are BEMs, which are constituted primarily as independent production and consumption spaces. In these countries, domestic production is oriented dominantly towards the domestic market, whose requirements are met predominantly by local production. The local content requirements have encouraged the automakers to be directly involved in the domestic production of auto parts and to develop suppliers' networks regionally.

Chart 3.2

Growth Rates of Production of Passenger Cars in Various Countries

(1991 to 200 I )

( )0.00

"10.00

( )0.00

"(:)0.00

1.00 T~ '-- '-T- --r- - '-T-
~ :;t> ;:t> rn o o o Jl "T1 o :::J 5 ~ L A- s: Z s UJ I c c c -<
~
In c: C ~ ~ ~ N ::J i» (1) Q. a. "0 0 (1) !P. D .z::: (f) (f) 0
CD \!l \!l ::J ::J ~ Pi ::J ..... iii 0 -c ~ iil x zr ~ ai. l> (f) c:
s ::J. ::J. III III ::J 0 @ ::J ::J OJ o· (() ::J rn :IJ \0
III ill a. tr a. (1) (1) 0 :::l. Q. :J &:
::J III ::J IJ) (1) to
III ~ '< iii s ::J ill JJ ~
fit ::J ~ III
2: S
n ~
I • decadal change 65

From the Chan 3.2 it is clear that the growth rates of production in developed countries are negative and they were not growing like the emerging countries like China. India and Korea, The stagnation of production and sales in the Triad regions was in marked contrast with the growth of industry in the rest of the world resulting in production shift towards the developing countries. As shown in Chart.3.2, the auto industry had substantially changed in the last decade. The rate of change in production over the period from 1991 to 2001 the countries like China, India, and Brazil had picked up vehicles production whereas the production in Triad economies like Japan, Italy, and USA had come down. This clearly explains the production shift from LEMs to BEMs. A considerable part of this rapid growth was concentrated in a small number of developing countries.

Most of the developing countries and transition economies have started liberalising their economies with sweeping policy changes .The protective instruments that once shielded most of the developing countries auto industries from international competition have been partially dismantled. However, the governments have remained active promoters of the auto industry through investment incentives, local content regulations and tariffs. But these polices were different for all the countries. After 1990 vehicle production and sales grew rapidly in the emerging markets, while the vehicle markets of Triad economies stagnated. This rapid growth of vehicle production is mainly due to increasing trade and economic liberalisation in non-Triad countries. The countries like China, India, Brazil and other ASEAN countries continue to use some son of quantitative restrictions, high tariff rates and local content regulations to limit imports of built up vehicles and oblige assemblers to setup assembling plants (in some cases manufacturing also) and made them to source some components domestically.

The governments promoted local assembly and local production of vehicles and components in order to generate employment. develop technical capabilities through spillovers in local economy. In this connection, different countries used different measures. These policy measures had direct implications on the entry and expansion strategies of automobile MNEs. In this regard, Spatz and Nunnenkamp (2002) found that the increasing integration of developing countries into the global division of labour had put severe competitive pressure on various sectors in high-

66

Income countries and triggered far-reaching restructuring processes which made MNEs to shift production base from developed to developing countries in the 1990s.

The shift in automobile production location has been caused by many factors.

Freyssenet and Lung (1999) have found that the main reasons for selection of these production locations are to optimize the economics of scale and to minimize the production costs. In addition low wage rates and exchange rates of developing countries also continued as main factors in attracting MNEs.Hence, most of the MNEs in early 90s started to investing largely in developing countries. Measures adopted also vary from one country to another. These various policy measures had direct implications on the entry and expansion strategies of automobile MNEs. After 1984, China's major autornakers began to form technical tie-ups or establish joint ventures with foreign auto companies, accumulated and digested the production and management technologies, and promoted localisation gradually. This eventually led to the establishment of the "Big 3, Small 3, and Mini 2" system toward late '80s and '90s. At the same time, Brazil, on the other hand, sought to increase efficiency by using access to the domestic market as a key to promote domestic investments hy MNEs. In this regard, the Brazilian government abolished Quantitative Restrictions (Qk land reduced tariffs. Further, it formed a regional automotive production system developed in MERCOSUR20 based on a division of labour in vehicle and components production between Argentina and Brazil.

On the surface. escalating glohal competition appears to produce two seemingly contradictory corporate strategies. First is the increased intcrnalisation and market expansion and product homogenization: and the second is towards greater regional product differentiation. In this regard most of the firms are concentrating on the world cars ", which are different from the internationalization strategies of 1970s and 80s where MNEs used to produce a car for that market. For example, GM used to produce different cars for Australian market and European market. But now GM has come up with its global brand OPEL-ASTRA. As global competition increased and developing countries began to liberalise their industrial sectors, the liberalising polices of developing countries converged with the pressure of MNEs to reduce

20 Regional trade agreement between Brazil and Argcntina : which was signed in1995;

21 World car has a large number of critical components in common. which are produced in plants scattered throughout the world, though the final product will have certain styling and performance differences in different market.

67

p reduction costs and optimize economies of scale in (he world production system. T his has resulted in the shift of production to BEMs.

l.4 The Empirical Findings

From the earlier debate it was found that production shifts to developing countries were mainly due to the huge market size in developing countries and the I·ow production cosh (particularly labour cost). In this section, this theory has been tested empirically in order to find the determinants of passenger car production. There are certain pull factors in host countries, which always attract MNEs to produce in t hat particular location which can he termed as location specific factor. At the same time, there are some push factors. which influence the firms to produce the goods elsewhere. The Present work uses market size as pul1 factor and labour costs as push factor. For example. In Germany. Japan and USA labour costs have increased over t he last 20 years, and at the same ti me, labour cost in low income countries have remained much lower which made auto MNEs to shift production base in foreign operations. For example. low-income countries taken together hosted almost half of total FOI stocks held by the German automobile industry (Spatz and Nunnenkamp, 2(02). This study has used the world share of number of vehicles produced as the dependent variable. Infact, the appropriate dependent variable will be the FDI flow into automobile industry in a particular country. Since the data on this variable is not available, production of vehicles in a country has been taken as a proxy. Selection of t his variable however can be justified on the grounds that because the FDI flow into the automobile industry will increase the production of vehicles in a particular country undo the entry of new firms will establish new capacities.The emergence of new producers and exporters of automohiles was largely due to foreign direct investment

(FDI) in low-income countries by multinational companies. So the determinants for

aunornobilc production have been tested empirically by using the cross section data of 24 countries+'. And the time period covered in the study are 1975-76. 1985-86 and

22 There are ahout 30 countries, which produce passenger cars. For consistency purpose, only 24 countries have been selected. The countries like East Germany, Romania and other countries have been left for the anyalsis because of inconsistency in the data. As for the UN statistics only these countries are manufacturing the passenger cars whereas, rest of the countries are involved in assembling process. (For details, see, LaB 1980).

68

1992-93 and 200 [-2002 to explain the decadal changes?~. Variables used in the study are as follow.

Dependent variahle:

Production share (Pshare): it explains the production share of that particular country in the world cars production. This is obtained by calculating the ratio of production of cars in a particular country up on the world production. For example India's share in 1991 can be obtained as

Production Share of India

Production of cars in India 199]

Production of cars in the world 199]

Independent variables:

From the theoretical discussions presented earlier it is clear that main factors that influenced auto MNEs to shift their production base from developed to less developed economies were market size and labour costs and the level of country's development. In order to capture the effects of above-mentioned factors: market size, labour cost and per capita income were selected as explanatory variables for the study. Data for these variables were collected from various issues of UN statistical yearbooks (for production and market size) and world development indicators (for per capita income and labour costs).

Log value of market size (Lms): Here, market size of the country was calculated by taking the difference between the number of registered passenger cars of particular country at two points of tirne". For example, Market Size (MS) for India in 1991 was obtained by taking the difference of the number of registered cars in 1991 from the number of registered cars in ]990. This has given the actual sale of passenger car in that country in that period.

MS in 1991 = 1991 registered vehicles - 1990 registered vehicles. Lie: log value of labour cost of manufacturing in dollar terms::!)

23 The selection of time is not based on any logic: it is considered to look at the differences of production in last four decades. Hence. the time period is selected according to the availability of data on labour costs. For consistency purpose, the averages of the five years data have been taken for the rest of the variables.

24 Many research organisations like research and markets and other international agencies arc using this as a proxy for the demand for automobile industry. The idea of using registered vehicles data explain demand basically thai depicts the true market size, which includes the domestic sales and imports of vehicles from other markets.

2.~ Data on labour costs have been taken from World Development Indicators. Study has considered the labour cost per worker in manufacturing $ per year. Whereas for the 1975-76 period hourly wages of labour has been taken as a proxy due to data unavailability.

69

.Lpc: log value of the per c a pita income of the country in dollar terms

Dummy is taken to show the difference between the production of Triad economies to non Triad economies which explains like this

Dum= I for Triad economies and 0 for non-Triad economies.

Interaction variable: Labour costs in Triad economies have also been considered to see how the labour costs in Triad economies were playing a role in determining the production share. The logic here to include this variable is to examine if the labour costs in the Traid countries were more when we compared with the non-Triad. Which might result in the production shift towards the developing countries.

PShare = a/+ a1dum + /l/Lmsj +/32 Lpc, +fJ3 Lid +/34 duml.lc, +Jli

The above equation was empirically tested for four points of time in order 10 understand how the share of passenger car production in the country is explained by the push and pull factors. In this regard the simple OLS was used to test the determinants of production at various points of time periods 1975-76, 1985-86, 1992- 93 and 200 1-2002.

Regression results:

Table.3.6:

Production Determinant" of Automobile Industry

Variables 1975·76 1985-86 1991-92 2001-02
Constant -6.8 J:H -2.05H -I H.977 -15.151
(0.985)* (4.980) (5.HO)* (9.171)***
Dum 0.561 90.n 7.072 -13.5529
(0.2724)** (25.596) * (16.73) (28.451 )
Ims 1.()X2Y 3.6 1.900 1.874
(0.1775) * (1.1012)* (0.H93)** (0.9425)***
lie -0.012 -2.5 0.266 -0.937
(0.01708) (1.I3Y)*** (0.5716) (1.1459)
0.1165 0.716 1.484 1.761
lpe ( J. 121 )
(0.118) (0.6308)** ( 1.(7)***
-0.0523 -X.7850 -0.484 1.792
dum*lIc (2.672)*
(0.228) ( 1.669) (2.87)
R2 0.88 o.n 0.65
F· Statistics 23.8* 9.52* 6.68* 0.52
4.06* *. **. *** Shows significance at I per cent. 5 per cent, 10 per cent level respectively. Values In parenthesis are standard errors Note: all the estimations are after correcting for hetroscadasticity

70

From the results in table.3.5 it can be inferred that market size is significant

for all periods. And the other variables like labour cost. per capita income and dummy were found to he significant at various points of time periods. In this regard, dummy was found to be significant at only 1975-76 and 1985-86 time periods and IIc was found to be significant at only 1985-86 time periods and Ipc was found to be significant only at 1991-92 and 2001-2002 time period. For 1'-)75-76 regression model's R2 explains around 80 per cent of the model and F statistics was highly significant at ] per cent level. Further. the significance of Dummy variable in the 1975-76 time periods explains that there was a significant difference between the production share of Triad and non-Triad economies. Among the other explanatory variables only market size has been shown a:-. significant and other variables like labour costs and percapitu income have not been found to he significant. From this one com infer that at this point of time i.e. in (1975-76) the market size in the developed nations are more than the developing countries. Thus, more production has concentrated only in these countries. Further. the labour cost was not very high in the Triad nations and therefore. the labour cost didn't become a problem in this period.

During I YR5-X6 period the dummy was found to be significant with the other variables like lms, lie and dum* lie. In this period. the most interesting aspect was that only per capita income was not found to he significant. This result clearly explains that in this regime market size was more in developed countries as compared to developing countries; so production concentrated mainly there. Further it was also true that from the existing literature on globalisation the actual problem of labour costs started only in the 1980s. The contrasting results were found for the period of 1992-93. In this period market size and percapita income were found to be significant. As explained earlier, by this period the manufacturing labour cost had become high in Triad economies and at the same time, labour costs in non-Triad economies were less.

So, the firms started searching for new locations. Another reason may he due to the fact that most of the production in this period had come from the PLEMs where the labour cost was relatively cheap compared to Triad economics; for instance there was more production from Mexico, Spain and Korea. These results also fall in same lines with the Freyssenet and Lung (1999) results discussed earlier. Then, hy 2001-02, the second phase of globalisation of industry had started. In this period, MNEs started production in BEMs like India, China and Brazil. Market size in these economies

71

increased as compared to developed nations. And as discussed earlier. a large amount of production share was coming from the developing countries.

But the interesting part was that the significance of the model was declining during the later part of the study periods. This explains that apart form the traditional factors like market size, per capita income and labour cost, there were some nontraditional variables which influenced production in the countries. These factors were mainly the policy variables, which had gained significance over a period of time. After ) 990, vehicle production and sales had grown rapidly in the emerging markets, while the vehicle markets of Triad economies stagnated. The countries like China, India, Brazil and other ASEAN countries used some sort of quantitative restrictions and high tariff rates in the process of local content regulations. These measures were intended to limit imports of built lip vehicles and oblige assemblers to setup assembling plants (in some cases manufacturing also) and made them to source components domestically. Significance of these factors has been examined by re estimating the model for 2001-02. This included variables like average tariff rate and quality of infrastructure from the global competitiveness report. By doing so the model looks like this

Pshare i = ul+uzdum + ~1 Lms, +~2 Lpc, +~-' Llc, +~4Linfrai +~5 Ltariff i +Jlj Table.3.7

Production Determinants of Automobile Industry in 2001-02

Variable Cocltll'lt:nt t-Statistic
C -0.071246 -0.019
DUM 1.53* 2.66
Lrn ... 0.43** 2.29
Lpc 0.98** 2.29
LIL: -0.14 -0.42
Linfra -3.04* -1.97
Ltarif 0.28 O.oK
R-r 0.62
F -statistic 4.62 *, **, *** Shows significance of I, ::; per cent, 10 per cent respectively.

The above model explains the determinants of passenger car production in the context of globalisation. The model has shown that along with the traditiona1 variables like market size, per capita income and labour cost, the non-traditional variables like quality of infrastructure and tariff rates (trade barriers) have also gained

72

Importance in determining the production process. The variables like dummy, market -ize percapita income and infrastructure were found to be significant. But, the interesting aspect here was infrastructure, which was significant but had a negative ~ign. which explains that most of the non-Triad and developing economies, where production has increased in recent times do not have good quality of infrastructure. Further, hy inclusion of these variables overall explanatory power of the model had increased lip to h2 rer cent.

From the above results it is found that Globalisation of automobile industry which made MNEs belonging to the large existing markets to shift their production base to big emerging markets has been mainly explained by large market size which was growing in developing economics. To some extent, the high labour costs in the Triad economics were also responsible for this shift. MNEs pressures to attain competitiveness internationally were also responsible for this production shift.

Another feature of the auto industry in the 1990s was the way in which leading vehicle manufacturers extended their operations in developing countries. For the global producers, rapidly growing markets in developing countries were meant to provide for spreading vehicle development costs: for establishing cheap production "ites for the production of selected vehicles and components; and for access to new markets for higher-end vehicles, which would still be produced in the Triad economies. From the above analysis it was clear that the automobile production was mainly determined by the market size. But, it was also clear that recently MNEs look towards regions across the world for relocation opportunities, seeking new resources, cheap skills and new markets. At the same time, the governments of developing countries across the globe are competing for these investments with the hope of generating more jobs. boost exports and upgrade local skills and technical capabilities.

15 Chapter Summa ry

From the above backdrop, it is clear that over a period of time there is a clear cut shift in automobile production from developed (Triad) nations to non Triad nation's. In the past two decades, the auto industries of developing countries have

73

been transformed by trade and investment Iiberalisation policies and the global expansion of the auto industry. The protective instruments (tariffs, quantitative restrictions. investment controls, etc.) that once protected most developing countries auto industries from international competition have heen partially dismantled. However, the governments have remained active promoters of the auto industry through investment incentives, local content regulations and tariffs. Government promotion of the auto industry has interacted with the globalisation strategies of the major auto assemblers. These firms have looked to the big emerging markets IASEAN China, Eastern Europe, India, Mercosur and Mexico) for both low-cost production sites (particularly for low-end cars) and for growing markets to offset stagnation in the industrially advanced countries. As a result, after 1990s, the vehicle production and sales have grown rapidly in the emerging markets.

To sum up, MNEs have different strategies in investing in different markets For example; companies tend to invest in Mexico to provide a proximate low-cost "peripheral" location from which serve the United States market in the context of ~orth America Free Trade Agreement (NAFf A) Trade liberalisation. Automakers based in Europe (including the European divisions of American firms) tend to invest in Spain for the same reason. The motivation for investments in "big emerging markets" such as China, India, on the other hand, was very different. Here, the main reason was to grab market share in places where populations was huge and car owners are less, and autornakers have been anxiously building new assembly plants in the countries like China, India, Vietnam, and East Europe.

Over the past two decades, direct investment by multinational firms has grown significantly faster than trade flows, particularly from the world's most developed economies. International economic activity increasingly takes the form of non-arm'slength trade, and instead takes the form of foreign production by multinational firms and intra-firm trade by those same companies. Global production capacities and international competition have increased, and so have the opportunities to exploit emerging markets. This process, gained momentum after the large markets of the People's Republic of China, India and Central and Eastern Europe, which represent roughly one half of the world's population, are trying to fully integrate into the world

economy.

74

Globalisation is driving the industry into consolidations, the results of these autornakerx, along with their largest suppl iers, are in the process of creating enterprise and supply-base structures that function at a truly global scale. Humphrey and Olga (2002) have highlighted the way in which the impact of globalisation processes on the auto industry of developing countries in the 1990s was influenced by changes in trade and investment policies of developing countries and the globalisation strategies of leading companies,

In the past decade, trade and investment liberalisation policies and the global ex pansion of the automobile MNEs have transformed the auto industries of developing countries. However, governments of developing economies have remained active promoters of the auto industry through investment incentives, local content regulations and tariffs. Government promotion of the auto industry has interacted with the globulisation strategies of the major auto assemblers. which started exploring big emerging markets (ASEAN China, Eastern Europe, India, Mercosur26 and Mexico) for hath growing markets and low-cost production sites (particularly for low-end cars). As a result, the developing countries have attracted considerable foreign direct investment (FDI) and thus the prospects of the automobile industry in these economies have heen transformed,

:', MERCOSUR currently consist of Argentina, Brazil, Paraguay, Uruguay as well as a number of associate members.

75

CHAPTER FOUR

INTERFACE BETWEEN POLICY, STRUCTURE AND GROWTH OF INDIAN AUTOMOBILE INDUSTRY

The government's policy pertaining to automobile industry has undergone considerable changes ever since independence. Since the government's policy has a considerable bearing on the performance of the industry, there is a need to review this policy. The present chapter has made an attempt to review the recent changes in the ~O\'ernment policy and analyze its impact on the growth of the automobile industry. As evident from the earlier discussion. Indian automobile industry has undergone considerable changes. in terms of the number of firms, installed capacity. In order to explain the interface between policy. structure and growth of Indian automobile industry in a systernat ic manner the analysis has been carried out under the phases identified as regulated and liberalized regimes. These phases are: (a) The pre-Maruti phase of protection. licensed technology and State ownership of production works, (b) The Maruti phase (or) first episode of openness. and (c) The phase of liberalization and intensified FDI inflows.

~.1. Database and Methodology:

The analy..,i.., presented in this chapter is based mainly on the secondary data collected from publ ivhcd (printed and electronic) sources. The basic data are available in different units and for different time- .... pan. Hence, adjustments for the data are essential for the est: mation purposes. The main sources of data are Centre for Monitoring of Indian Economy (CMIE), Annual Survey of Industries (ASI), Society of Indian Automobile Manufactures Association (SlAMA), and Automobile Component- Manu factures Association (ACMA).

The Methodology adopted for this chapter is as follows- The present chapter addresses the first two objectives specified for the thesis viz., - J) to critically review the automobile policy in India before and after liberalisation: 2) to present an overview of the growth and structure of the Indian automobile industry under different phases. Historical time-series data from 1971 to 2002 has been analyzed for this purpose. In order to show the difference between the different stages of industrial

76

Jevelopment, the growth performance has been compared with the previous periods by using various kinds of growth rates. In this regard, annual average growth rate, linear trend growth rate and kinked exponential growth rates have been used.

I J) The annual average growth rate is

?I=~ «v - Y I I Y )rr where Yt is the relevant variable for year t

I I 1- 1 I-I

[2) The linear trend growth rate is g" = b: where b is estimated separately for each period by using the relation:

/Il (Y )=a+ht+£'r I

Where t=O ... T denotes time and e denotes error term.

I

[)) Following Boyce ( 19S6). for example the kinked exponential growth rates g and 31

g;2 for the tv .. 'o sub-periods are

L=b: where b 's (b and b ) are estimated together using

'J JI I 2

In( Y )=a+b (dl+( I-d)k)+b « l-dut-k jj+e,

t 1 2

where d is a dummy variable (d=1 for sub-period I and 0 for sub-period 2), k is the break point between the two sub-periods and e denotes error term. It should be noted I

ihar estimates using the kinked exponential do not provide a growth rate for the whole period. In order to find the validity of sub periods (i.e. structural breaks) the study also used the Cumulati ve Sum27 (Cusum) Charts.

4.2. Overview of Indian Automobile Policies

The term industrial policy has broad canvas which includes "principles, policies, rules and regulations and procedures, guiding and governing "the industrial undertakings in a country. Industria] policy in a country is broadly made up of two components. First is the philosophy of a given society to shape industria] growth and the other is the implementation, which gives concrete shape to the philosophy. In the Indian context from the heginning of independence the policy included principles, procedures, rules ami regulations which were intended to control and regulate

2, Cumuliltivc Sum (Cusurn) charts display cumulative sums of subgroup or individual measurements from a target value. Cusum charts are graphical and analytical tools for deciding whether a process is in a -tate of statistical control or for detecting a shi ft in the process mean.

77

industrial undertakings of both public and private industries in India. In pursuit of these objectives, a series of policy instruments were developed, including the pervasive licensing of industrial activity; the reservation of key areas for state activity; an inward focused trade policy; controls over large domestic firms, foreign direct investment (FDI) and technology transfer; interventions in the labour market; and policies designed to protect the small scale industry. The Government of India defined all these policies from the first to seventh five year plan periods strictly between 1951 and 1990. After half a century of supported policy industrialisation, the global trend towards greater liberalisation and openness has forced the industries sector to confront new standards of price and product competition.

The ideology of planning has been changing over a period of time. In this regard, one can classify these changes in different phases in industrial development. These can he classified broadly as, (1) Regulatory phase (from 1950-1980). (2) First phase of libcralisation (early 1980 to 1991). (3) Era of globalisation from 1991 onwards. On the same lines, the Government of India (GOI) has been actively involved in formulating policies for automobile sector development. The government considered the passenger car as a luxury item, and imposed very high tariffs and used to regulate industry from all aspects. The Indian automobile industry was governed by regulations since the country became independent in J 947. Imports, collaborations and equity ventures were severely restricted by the government. Capacity expansion was restricted and required licences were issued by the government, and technology transfer from foreign companies was subject to government approval.

The Evolution of the Passenger Car and Multi Utility Vehicle Segment:

The Indian passenger car segment has come a long way since it saw the first motor car ply on the streets of Murnbai in 1898. The subsequent fifty years saw the domestic market resorting to imports to satisfy the demand. The first assembly plants in the country came up in the period between 1910 and 1920s in Mumbai, Calcutta and Chennai. However, the import/assembly of vehicles continued unabated to cross the 30,000 mark in 1930. In 1946. the industry saw the first car manufacturer in the country in Premier Automobile Ltd (PAL). The company assembled the 'Dodge DeSoto' and 'Plymouth' cars at its Kurla plant. Hindustan Motors (HM), which was

78

In auto component manufacturer, started manufacturing cars in I ().,f(). In I (»)4. ,Ill' government's indigenisation initiatives caused it to impose ..,1 itl rq~u l.u ions for assembling units. Those assembly units that had no plans to -ct up m.mutacturinp [aci liticx were asked to close. This saw the ex it of manv multinutional-, I ike General \1otors and Ford. This was a critical juncture in the evolution of the Indian pas .... cngcr car segment.

Table 4.1:

Some Landmark Events in the Evolution of the Automobile Industrv PC'

assenzer 'nr! Multi Utility Vehicle Segment
1898 The first nu uorcar - -
plies on Ihl' qrel'ts of Mumbai
1910-20s The first a~sellloly plants in
the countrv came up in Mumbai.
Calcutta and Che nnai.
1954 Imposition llf Still indigcnization
Norms hy the Government cauxing
global auto majors like Genna]
- Motors and Ford to exit the countrv
1983 Government enters the car business through
Maruti Udyog. a joint venture with Suzuki of Japan
19X5 Government announces its famous broad
banding policy. which gave new licenses
to broad groups of automotive products like four-wheeled
vehicles
1991 Government announces new industrial
policy marking the death of the Licence Raj
2002 Government disinvest- its stake in
Maruti ULlyo,g III favour of Suzuki to Become a minoritv
partner. The year 1983 marked the beginning of a series of liberal policy changes which can be considered as another juncture in the evolution of Indian passenger industry. The government entered the car business with 74 per cent stake in Manni Udyog Ltd (MUL), the joint venture with Suzuki Motors Ltd of J aran. In 1985, the

government announced its famous broad handing policy which gave new licences to broad groups of automotive products like two and four-wheeled vehicles. The delicensing of auto industry in 1991 saw the entry of a number of MNC.., into the country. The strict regulation of the governmt.'nt with regard to indigenisation CJLN~d many of the entrants into the segment increasing their indigenisation levels oyer the years. From 1993 onwards the government permitted foreign car producer'> 10 invest in the automobile sector in India and hold majority stakes (up to 51 per cent J. From then on many companies han: entered the car-manufacturing .... ector. tll tar the middle and premium end of car industry. New entrants are Daewoo t Matiz i. Telco (Indica) J[1d Hyundai (Santro) at the upper end of the economy of the car market {i\1. l ord.

II

Peugeot, Mitsubishi, Honda and Fiat also entered the mid-sized car segment and Mercedes-Benz is in the premium end of the market.

The objective of this section is to critically review the automobile policies in India preceding and following the liberalisation in order to examine how policy objectives changed over a period of time. The India's auto policy history can be precised roughly under three regimes:

• Pre-Maruti phase (or) regulatory phase from 1951 to 1981.

• The Maruti phase (or) the first phase of Iiberalisation from 1982 to1993.

• The Post-Maruti Phase is era the of globalisation from 1993 onwards.

For making the entry of Maruti as the benchmark in development of industry was mainly due to two reasons. First, after independence the government used to control and regulate automobile industry without entry into the industry and after the establishment of Maruti Udyog limited (MUL in 1982), the government entered into the market as a direct player. The second reason was by collaborating with Suzuki Corporation of Japan the government allowed the first MNE to operate in India, which led to severe restructuring of automobile industry.

4.2.1. The Regulatory Phase (Pre Maruti) (1951-82)

Though the automobile sector has been reserved for private sector since its inception, the government regulatory" policy has played an important role in determining the structure and growth and performance of the motor vehicle industry in India. The interventionist industrial and import substitution policies pursued by India had led to the domination of a few firms. The government used to regulate industry by way of framing polices on capacity-licensing, price control, restricting foreign collaborations and imports including foreign parts and reserving the components for small scale industry (Narayana 1988). The main control on the industry at this juncture was government's regulation of a number of firms by entry and exit policies (Kuthuria 1996). In the Indian context, entry and ex it '" policies

~~ Here, we mean regulation as both antitrust regulation and direct regulation, and the former deals with e~tablishmenl and enforcement of laws governing the nature of firms' competitive behaviour and the market structures within which the competitive behaviour takes place, and later. is a situation under which the regulatory body itself sets prices. output levels, quality and other variables that are

~etermined by management. . . ..

.9 Exit policies are in such a W:JY that uneconomical firms have to continue. Since It IS extremely

difficult to retrench labour, the employers tend to be cautious about expansion. Interestingly. in 4 wheeler sector, there is no evidence of any firm having made exit once it has got established

80

played an important role in determining the number of firms in industry where ~flvernmenl product licensing and capacity licensing restricted entry measures. The Government of India also had a right in what type of vehicle each manufacturer .hould produce.

Capacity licensing

Capacity licensing includes product licensing, production capacity and distribution licensing .The government restricted the capacity in all product linestrucks and heavy vehicles for Telco, buses and trucks for Ashok Leyland (ALL), passenger cars for Hindustan Motors (HM), Premier Automobile Limited (PAL) and Standard Motors (SMPL). Here, capacity licensing means that the industries are -upposcd to produce according to plan targets of the government. The government policy in licensing of capacity was in favour of Commercial Vehicle (CV) manufactures like Buses, Trucks etc. than cars and jeeps. The main reason for this favoured treatment was that for public transport vehicles have some public purpose to -crve in comparison with the personal transport vehicles like cars and two-wheelers that are meant r only for private use. The capacities of cars, commercial vehic1es and two wheelers had been restricted from first plan onwards. Table 4.2 clearly explains the capacity utilisation of licensed capacity.

Table 4.2:

Capacity Utilisation in pre-Maruti era

Pbn Licensed Actual Actual ref cent Utilization
Capacity Capacity Production of Licensed Capacity
Fifth Plan ( 1974)*
I. CVs 98,000 ?lAOO 4X.OOO 48.98
2. Cars 51.000 47 AO{) 42.000 82.33
3. Two-wheelers 7.77.000 2. ()O. ooo 1,84.000 23.69
Sixth Plan (I tiS) J*
1. CYs 1.57,450 S4.UOO 57,400 36.45
2. Cars 54,O(X) 52,000 :,5,O(X) M.81
3. Jeeps 15,000 13,000 12.5(X) 83.:r~
4. Two-wheelers 12.33,000 4,93,000 3.07.000 24.89 * Plan starting year.

Source: compiled from various Plan documents and ACMA reports.

While discussing capacity licensing in India one can perceive its two aspects: (a)

licensing capacities in existing lines of production, and b) rigidity in shifting from one

rnanufal:turing operation. SMPL virtually Slopped making cars by late 70s only to take up a new luxury IlMJd in the J 980s.

81

rWdULl to another within i.l broad product group. Further, strict regulatory mechanism

. d 7 l(l

.ontinuec up to II.) 3 . Later, there was some change in capacity licensing.

Price Control:

The government in this phase used to control prices of vehicles based on periodic evicw of costs. The government then felt that rigid price control would hamper the healthy environment Dr industry. In this regard, the Gol changed its policy from rigid .ontrol to "informal price control" wherein manufacturers were ohliged to avoid th)rging excessive prices and to give advance notice of any intention to raise prices. Ihe-,e controls were virtually decontrolled for CVs and jeeps in 1967. for passenger .ar ... and two wheelers. it was removed in 1975.

Foreign Collaboration:

The Government of India pursued a selective policy towards foreign .ntcrpriscs ever since its fir\t industrial policy in accordance with development lbiecti\c\. The policy towards foreign enterprises" has been changing over a period If time. Initially, in the early 1940s, vehicles were allowed to he imported in ~'oIl1plctely Knocked Dow n (CKD) condition and were assembled in India by \1:--JE.,'~. After the recommendation of ] 953-tariff commission reports, the Gol made j rule that only the firms with a programme for manufacturing components Jomesucully w()ulJ he allowed to import vehicles in knock down conditions. In this regard, only) companies were recognised by the GOI as manufacturers i.e. HM, PAL, SMPIL. AP(L ami ALL. During this period, there were two important phases. Firvt phase, which ended in I Y68 encouraged foreign collaborations", and in the -econd phase where some restrictive policies were introduced after Mudaliar Committee ~4rcrurts. Further, this became more restrictive with the introduction of FERA in 1973. Under the FERA, the maximum amount of foreign equity came down

;, The non ficaiion on September S. 1975 allowed 15 specific engineering industries In expand licensed/ registered capacity by 5 per cent pcr annum or 25 per cent in five year plan period. Automobile ancillaries, commercial vehicles, tractors, diesel engines, etc had been in that list. However, passenger lars had been not included In the 11,,1.

11 For a comprehensive review olthc policy towards foreign investment before 1991 see Kumar (1990). 1~ Firms like GM and l-ord Motor ... pf USA are involved in this type of activities.

1) Foreign collaboration call he both of technical and financial nature bUI most of the Indian firms are having technical collubor.uions (e.g. PAL with Fiat Italy, Telco with Daimler -Benz Germany, M&M whh Kaiser Jeep Corporation of USA etc.)

)4 Recommendations from Mudaliar Committee on foreign cnllahoratiunx (1966) resulted in the

creation of Foreign In vest me nt Board in 1968.

82

[040 per cent. In this phase. the policy of inciigenisation worked well and resulted in In indigenized industry. One can see from the table 4.3 that level of indigenisation has Increased up to 90 percent by the end of third five year plan.

Table 4.3:

Indigenization Levels of Various Automobile Firms during Third Five Year Plan

Firm Vehicle 19flJ-02 1902-63 1963-04 1964-65 1965-66 1966-67
I (CARS& JEEPS)
HML Arnhaxvador 7':+.5 76.2 77.5 80.4 90.0 95.0
PAL Fial 4(,).0 56.0 M.O 74.0 88.0 97.S
I SMPIL Standard ·U.S -l.'l.J 60.2 65.0 79.0 88.8
IMML Willy jeep 59.0 N.<I. 79.3 82.9 90.0 92.9
i
IcVs
HMl Bedford flO.t) 60.Y 60.9 73.9 80.0 84.0
: PAL Dodgl' 74.0 74.0 79.8 88.2 94.0 94.0
I rti.co B~n7 67.0 h7.0 770 86.0 91.0 93.0
IAlL Lye-comet 43.3 58.8 7n.O 81.5 85.4 89.0
BTL Tem-Swheelr 63.0 N.<l. 75.0 86.4 88.5 94.0
!
i
- Note: Rate ofIndigcnization Is defined as (I-value of imported componcntsj/ex factory price of vehicle).

Source: Panda ( 1 Yl)6).

After the FERA Act came into existence the rate of Indigenisation had increased in this regard, Agarwal (1988) has found that many companies had achieved 98 per cent indigenization.

Table 4.4:

Indigenisation Levels of Various Automobile Models in 1980s

Manufacturer Model lndiaenizution
HM Car 99.8
Fiat Car 99.6
Standard Car 99.3
Telco Truck 98.8
Dodge Truck 99.8
Leyland Truck 96.5 Source: Agarwal ( 1988)

Trade Policies

In India, imports of final consumer goods had been effectively banned, except

under special circumstances. The government in its efforts to discourage the consumption of luxury goods in the past and in this regard, most of the consumer durables including passenger cars and two wheelers were also banned from being imported. Imports of fully built vehicles had been prohibited since 1949. The various tariff commission reports (1953, 1956, 1968 and 1973) on automobile and

83

components industries had encouraged domestic production while trying to keep the cost of essential import components within the limits" Ever since the first tariff commission report on automobile industry in 1953 the quantitative restrictions (QRs) were enforced, and vehicle manufacturers were sought to be given foreign exchange illocations according to their manufacturing progress. Imports of cars were prohibited :hrough there were only a few eligible categories which can imports see Table 4.5 for details.

Table 4.5:

Categories of Companies Where Vehicles Were Allowed for Importing

Type of category where imports were allowed No of vehicles allowed
to import.
Export houses 1 car
Trading houses 2 cars
Star trading houses 3 Cars
Super star trading houses 5 cars
Non Resident Indians (NRIs) coming to settle In 1 car
India
Branch offices of India firms 3 cars
Companies with foreign equity participation more 3 cars
than 25 per cent Source: EXIM Papers (1996). No.44.

During this period, the industry remained controlled and protected in the sense that no manufacturer was allowed to enter or exit from the industry, no change in the model and no foreign collaboration (technical or financial) were allowed without the government's prior approval. The consumer's choice was limited and they were compelled to buy the poor quality vehicles at high prices. And the taxation policy also acted as one of the constraints in determining the performance of industry. Apart from it, auto ancil1ary industries were reserved for small-scale industries. Narayana (1989) has explained that the Gol had used the regulatory policy environment in India from (1948 to J 982) as an instrument in building indigenous motor vehicle industry in India. Further, he has also explained that the price controls did affect some of the firms but its adverse effect on resource generation was limited. Although capacity licensing acted as a harrier to entry, it had not acted as a barrier to growth. The policy on indigenisation and foreign collaborations did create an environment for raising the technological capability of certain segments of the industry. Conversely, Agarwal (1980) has critically examined the problems and prospects for the Indian automobile industry and has found that the restrictive government polices were some of the

84

Impediments for the growth of industry in addition to the other economic factors like low per capita income and existing infrastructure conditions.

t 2.2. Maruti Phase or First Phase of Liberalisation (1982-1993)

The first phase of libcralisation (internal) started with the announcement of 1980 industrial policy. Important changes were brought into the industrial policy in ihe form of deregulation In licensing framework, broad banding capacity, reendorsement, liberalisation of controls and restrictions and clearance for foreign Investment and collaborations and import of capital goods and components introduced In India during mid 1980s. Further, the government's attitude towards foreign direct Investment also underwent significant changes from most suspicious policy, which restricted the foreign investment possibilities to a more positive approach expecting ihcrn to playa crucial role in technological up-gradation of Indian industry. On the -arne lines, the motor vehicle industry in India also made some sea changes in the policy and development towards automobile industry. In this regard, the state which used to be a regulator had become a player in the market. The main objective of the collaboration between Maruti Udyog Limited)s (MUL) of Government of India with Suzuki Motor Corporation of Japan in 1982 was to produce a small and affordable car and 'Maruti 8(}(), in 1983 was introduced, providing a complete facelift to the Indian car industry. The car was launched as a "people's car" with a price tag of Rs. 40,000. This changed the industry's profile dramatically.

Capacity licensing

During the reference period there was a marked shift in the capacity licensing

system. In the early 1980s MRTP/FERA firms were allowed to apply for capacity expansions under the condition that the additional output was meant for exports. Further, In 1984. all types of automobiles were brought under special schedule, wherein these industries were specially regulated on the grounds of raw material shortage, possible high pollution and infrastructure constraints - this implied that none of the automobile firms had benefited from the expansion schemes. As part of 1985

i, The origin of Maruti was highly political, Initially, Sanjay Gandhi, son of the then-Prime Minister Indira Gandhi, started it as a private firm to achieve his dream of proJuci~g a "nati~nal Car.," Indira Gandhi's government nationalized the firm in 1980, after the death of Sanjay Gandhi, to achieve her son's dream. Advised that the project would not succeed without the inv()l~emcnl. of foreign lechnolo~y Indira Gandhi started searching for a potential partner. The governmenl signed license agreement WIth Suzuki in 191-;2 as a joint venture.

85

Economic Policy reforms, motor vehicle industry was delicensed" and 'broad

n (..I' • v: .

an IIlg was permitted. By 1986. controls over capacity expansions were relaxed

ihrough the specification of the minimum economies of scale 3H(MES) of production, md the government announced that firms across the spectrum of the industry should 1];J\'e a MES. The specified norm for various categories of vehicles has been specified J~ presented in Table 4.6

Table 4.6:

Specified Econemies of Scale for Passenger Car Industry

Small cars 50.000
Cars below 200cc ?>O.O()O
Tv. 0- whee lers 1.00,000
Export oriented units ) .OO,()()()
Commercial vehicles. 25.000 Source: (Kathuria, 1996)

Price Situation

By the mid 19XOs price controls were comp1ctely removed but the prices were fluctuating in accordance with the change in the excise duty and CESS levied by the government". The perception of car as a luxury good had Jed to heavy excise duty for cars. Until 1987, the GOI followed a discriminatory policy so as to charge lower duty on fuel efficient cars with engine capacity of less than 1,000cc. This helped MUL to price ih car at a lower price in comparison with others. The vechile price and the exise duty levied on the important models are presented in table 4.7, clearly account for the tax and price variations. The excise duty had doubled from 25 per cent in 19R7-RX to 55 per cent in ] 990-91. From the table 4.7 it is clear that the excise duty was less for the Maruti models as compared with other manufacturers. It was resulted in cheaper price for Maruti models.

l~ Deliccnscd industries mean firms that are no longer required to seek licenses from the State to enter the industry or expand their plants

n Broad handing meant that a firm can manufacture products related to the ones they arc currently

making without the need for a separate licence .

. l8 Economies of scale refer to a lower per unit cost arising from the increasing size of output, plant and

firm whereas MES means any output, theoretically speaking, includes higher costs.

19The motor car industry was looked as a favourite milching cow for successive finance ministers during budget limes,

86

...... S. \0' e \'pe 0 ehide ·1984·85
",,"
) Type of vehicle Exciwduly
" Net dealtr price Relail lind. Exc. Oul~'& 118 IXr
.. I<.
''t price ceet CE...'-foil
I~
WI!!
Mahindra & Mahindra
Petrol jeep universal 70.()()( ) 72.:"()() I 1.11 ~
(CJ4ANI */4 WD)
Diesel jeep universal 71 ]()() 7h1()() I 1.6415
(e.l4AJ9] */4 WD)
Peugeot Diesel jeep universal ]X()()( ) Xl:!()() 12~X~
(CJ~Al9] */4 WD)
I-
-
Cars
!:1M
I\. mhassador Max (pel) 51.457 S .... yq 1 \.741
. Ambassador Max (pel) 67.IX2 70.7X2 I X.lll
I hS.SO() hY.()()()
"Conressa I~SIIJ
~AL
Premier Padmini Dix with nylon lyres 5X.Y77 62 . .?S~ I l.I.t5
~
\·laruli XOO :W.59..t 41.)94 5.~H'l
vlarut: gOO air: 51 .:1,94 ,').'.594 5,9C1()
So.PAN)
[ )plphin saloon 5RA24 60.924 S.Y?5 Tethlc ..&.7:

Vehicle Prices (in R ) h th T f V

Source: A1AM 19R5

Environmental legislation

Unti I the year 19R8, legislation regarding safetv stundard-, and pollution

control was either non-existent or not enforced. The Motor \'l'Ilidn :\if (1/ IW'<X had set the idling emission limit for four~whc-c1cfs. I wo-whcclcr- and three- \\ heelers a_, 4.5 per cent. At the same time. vehicles thai have fuel-efficicncv attracted IL''_'" exci ... c duty and could avail of concession on customs duty. Under the Mawr Vehicles Act. ('\'cry component used had to comply with standards laid down hy the Bureau of

Indian Standards (B IS),

Foreign Collaboration:

The interactions between the ... tate and the foreign capital resulted in (he

rr .. tructuring of four wheelers ,,('~rncnt. Four Japanese collaborations under LeV segment arc: Mahindra-Nissan. Ei(hcr-\lihuhi,hl. OCM-Toyo[a and Swaraj-Mazda, But the passenger car industry \~ a' blocked Ior financial collaborations though [hey

Iiad joint ventures VIZ., HM and Isuzu of Japan, and PAL and Nissan. Further, they allowed for technical collahoration only: see Table 4.8.

Table 4.8:

L· t f.~

C II b

IS 0 orergn ~o a orations in CV s and Cars Segment
[ Indian Foreign collaborator Nature of Equity Year of
firm collaboration stake collaboration
~. HML
ISUZU. Japan Technical N.A. 1986
Engine/ transmission for Contcssa
car
.--
,
NISSAN, Japan Technical N.A. 1986
PAL Eng inc/ transmission for 118NE
CARS Technical N.A. ---
Techono-Licence ltd .. UK.
auto diesel engrne

Suzuki motors, Japan Technical & 5 I ~!( 19~:I
MUL Machinery. drawings etc. Financial
Reliant motor corporation ltd .. UK. Technical N.A. --
Sipani
Austin rovers U. K Technical N.A. 1983
Standard Design for cars
motors Technical N.A. 1979-95
ALL Leyland vehicles UK lor Cah- Technical N.A .. 198~( )
Hino flllll(lrS Japan. engine up Tc(hnical N.A. 1985
gradation Technical 0I.A. --
JVECo.FIAT SPA,ITALY
CYs and engines

HML ]SUZU, Japan Technical N.A. 1986
Engine/ transmission for CY.
BTL Daimler -Benz, Germany Technical N.A. 1979-89
OM Diesel engines

M&M Nissan motor Japan Technical & J 7(k IYX5
(Allwny- For LCVs Financial
Nisxan )
Mazda, Japan Technical & 26'1( 1985
SML Machinery. drawings etc. Financial
Miisubishi corp. Japan Technical & 15(k· 1986
EML Machinery, drawings etc Financial

TOY ATA, .Japun Technical & 26{k 19H5
DeM Machinery. drawings e1e Pinnflcial
Daimler-Benz. Germany Technical N.A. -
Telco Diesel engines for Trucks and buses.
A VL List GmhH, Austria Technical N.A. --
Modification of engines and
conversion of diesel to petrol Source: ACMA various issues

R8

Trade polices:

The government levy of import duties for luxury cars has been high. The import of passenger cars and other automotive vehicles has been restricted and an i I11pOrt licence is required for imports. By mid 1980s, the import duties ranged between 150 and 200 per cent based on the engine capacity of the car. Further. the quantitative restrictions (QRs) continued in this period .According to the DGCIS

-tatistics, there were only 294 cars which were imported in the year 1993-94. This .ccounts for the protectionist approach of GOL The exports of passenger cars commenced once MUL built up its production base in India. Table 4.9 presents that how maruti export intensities were increased after] 990s.

o or ar vxpor s .y aru I
Year Exported Total Exported!
Sales Total Sales
I YK7-88 713 91,043 0.8
1988-89 ] ,408 94,573 1.5
19XY-90 5,223 1,06,559 4.9
]l)90-91 3,631 1,06,607 3.4
1 Y91-92 23,764 1,17,506 20.2
1 YY2-93 13,499 1,]8,321 11.4
1993-94 15,693 ],47,806 10.6 Table 4.9:

Mt C r tbl\-I ti

Source: Exim paper (1996)

The visible impact of government policy was evident in many ways. The success of MUL, however, demonstrated that the firms benefited from the policies of government. While MUL had gained various kinds of concessions in the form of lower import and customs duties from the government. For example, MUL imported steel which has pre-cut and came under components attracted, of levied a duty of only 40 per cent whereas other producers used to import steel was treated as raw material and was charged up to 150 per cent duty D' costa (1995). In fact, after liberalisation, the production of passenger cars throughout the 1980s and early 1990s remained tightly regulated through licensing. This internal liberalisation indeed helped only the commercial vehicles segment. In 1991, the Industrial Policy cleared away most of the hurdles relating to expansion and foreign investment. Industrial licensing was abolished for all but 15 industries. The car industry was not delicensed but kept under regulatory regime until 1993.

89

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