No Magic Wand: Liberalization and Structural Transformation in India

Suranjana Nabar-Bhaduri, Guest Blogger

In November 2011, the UPA coalition government in India announced its decision to allow FDI in multi-brand retail. Proponents within the government and media argued that this decision would address the supply bottlenecks in the Indian distribution system; facilitate the transfer of knowledge and skills; generate more employment; accelerate economic growth; improve production know-how and promote exports. Following stiff resistance from some of its coalition members, and opposition parties (which was driven more by political motives, considering that the NDA, now in the opposition, had strongly pushed for FDI in retail when it was in power), which saw the Indian Parliament come to a standstill, and opposition from groups of domestic traders and retailers, the UPA government decided to suspend opening multi-brand retail to FDI in early December.  Critics of FDI in multi-brand retail argued that by endangering the survival of local stores across the country, the move would potentially result in large-scale job losses across the country. Furthermore, it is likely to result in predatory pricing by multinationals; put farmers at the mercy of big retailers; and disrupt rather than strengthen supply chains by encouraging monopolies of global retailers.

The stiff resistance of last November has seen the UPA government adopting a more cautious approach towards further reforms in 2012. In early May, it deferred a decision on raising the FDI limit in the insurance sector. Following the November volte-face and its subsequent cautious approach, the government has received severe flak from proponents of reforms, who have warned that slowing down the reform process will adversely affect economic growth, perpetuate inefficiencies in the Indian retail sector, and prevent productivity improvements.

Central to all these arguments is the belief that liberalization will improve productivity, aid higher economic growth and generate more employment.  One only has to look at the experience of the Indian manufacturing sector in the post-liberalization period to realize that there is little reason to be optimistic about these arguments.  In a recent report, I show that during the period from 1990 to 2005, labor productivity in Indian manufacturing fell by 1.15 per cent. Productivity improvements and employment growth have been concentrated in a handful of four or five manufacturing activities. Moreover, in the post-liberalization period, all of the employment generation in manufacturing has been in activities that have not shown productivity improvements. Besides manufacturing, productivity growth in the Indian agricultural sector continues to be very low. Thus, low productivity, open and disguised unemployment remain acute problems in the Indian economy in the post-liberalization period.  India’s trade balance continues to reveal persistent deficits, with the magnitude of these deficits (as a percentage of GDP) increasing perilously since the mid-2000s.

These adverse dynamics are manifestations of various challenges that have inhibited the Indian industry from competing effectively in the more competitive environment of the post-liberalization period.  In the 1990s, the major challenges included reduced bank lending to the Indian commercial sector, the disappearance of development financial institutions, an underdeveloped private bonds market and manipulations of the stock market. The persistence of inadequate infrastructure, antidumping measures and non-tariff barriers for industrial products in other countries, and the bias of the Indian government’s fiscal policies and concessions towards services are other factors that have made it difficult for a majority of industrial enterprises to make an effective transition from operating in a sheltered domestic environment to one characterized by greater competition.

Die-hard fans of liberalization are likely to argue that the solution to these challenges is more liberalization, or that India’s liberalization efforts have not been “bold” enough.  But if this were the case, shouldn’t countries in Latin America, which adopted much “bolder” liberalization measures in the 1980s and 1990s, have experienced miraculous improvements in their economic performance? Far from it. A 2002 study by Cimoli and Correa showed that economic growth in the Latin American region declined from 5.5 per cent in 1950-80 to 3.3 per cent during 1990-2000. As in India, productivity in Latin American manufacturing declined rather than increased in the 1980s and 1990s. And even in the case of East Asia, that is often cited as an example of the superiority of a strategy of liberalization, some studies have emphasized that deliberate policy efforts (e.g., subsidies, trade restrictions, administrative guidance, the establishment of public enterprises and the allocation of credit) played a vital role in helping East Asian countries to successfully pursue a growth strategy that focused on international markets. Indeed, unlike India and Latin America, manufacturing productivity in East Asia has continued to grow over time. The available evidence therefore suggests that to serve as a transmitter of structural transformation, liberalization must be complemented by active industrial and employment generation policies.

Thus, if India is to effectively address the problems of low productivity and employment generation, and persistent trade deficits, policy measures that go beyond liberalization are vital.  These must include both more employment generation programs, and efforts to accelerate the growth, expansion and competitiveness of Indian industry. Since inadequate infrastructure is a major hurdle that continues to plague Indian manufacturing, large-scale infrastructural development projects would raise efficiency in manufacturing, and also generate more jobs.  Similarly, more comprehensive rural development programs would also generate quality employment in rural areas, and foster rural development.  There is also a need for more active research and development (R&D) programs by the State, which could involve collaborations between the public and the private sector; credit policies that will make it easier for industrial entrepreneurs to replace outdated or inefficient capital equipment; subsidies to firms for investing in R&D; the establishment of more development financial institutions, and the development of specific bank lending schemes for the commercial sector.  Such policies will improve the technological capabilities and production efficiency of different industries, and generate more employment opportunities through an accelerated rate of industrial growth. They are also likely to make merchandise exports more competitive in the long-run and thus contribute towards improving India’s trade balance. Similar policies in Brazil and China played a major role in developing the competitiveness of the Brazilian aircraft industry, and in enabling China to emerge as a competitor to be reckoned with in the consumer electronics industry.

Last month, following pressures from global brands such as IKEA and Nike, Indian government officials indicated that the government was considering diluting single-brand FDI norms that would require foreign investors to source their raw materials from local industries.  However, precisely such clauses are needed to ensure that FDI will contribute to the creation of domestic linkages within the Indian economy, foster the development of endogenous technological capabilities, and promote technological diffusion. For instance, in China, requirements of joint ventures between domestic and foreign firms played a vital role in developing the export competitiveness of China in industries like mobile phones and computers. Ultimately, striking a balance between liberalization and active industrial and employment generation policies is vital to generating a long-run development path that is sustainable, inclusive and humane.

Suranjana Nabar-Bhaduri is a post-doctoral fellow at Boston University’s Pardee Center for the Study of the Longer Range Future and author of the new issue brief “Free Trade and Inclusive Development: Lessons from the Indian Experience.”

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