The foreign hand isn’t enough

We are increasingly told that the inflow of capital — particularly the foreign direct investment (FDI) variety — increases employment levels and contributes to economic growth. In a rare interview given to The Wall Street Journal in May, Prime Minister Narendra Modi reinforced the role of FDI for India: ‘To set a strong foundation for sustainable growth, we have run the most prudent macro-economic administration in decades, reducing fiscal and current account deficits. We have made India a destination which welcomes capital by liberalising foreign-direct investment policy, increasing the ease of doing business.” Recently, the government further relaxed the FDI policy. An FDI mania appears to have gripped our policymakers.

The rationale for FDI

Investment is necessary for economic growth. It could be undertaken by domestic or foreign investors. However, there are no a priori reasons for favouring foreign investment over domestic investment under normal economic conditions. If domestic investment is not forthcoming, either because of a profitability crisis in the private sector or a self-imposed restraint on public spending (example, India’s Fiscal Responsibility and Budget Management Act), then we may be forced to attract foreign investment. In other words, in the event of a domestic investment crunch, relying on foreign investment is an option in the short term.

Alex M. Thomas

One central character of private investment makes it unreliable in the long term: volatility. Rational investors are constantly in search of countries, regions, sectors, ideas and processes which will yield higher profits. Globally, countries formulate competitive policies to solicit foreign capital/investment by proffering a variety of economic concessions — tax holidays, providing land at less-than-market prices, weakening workers’ rights, easing the patenting of ideas and processes, and so on. In India, such concessions are being given in the name of ‘ease of doing business’ and the ‘Make in India’ campaign. This “international competition for capital” tends to exacerbate income inequality, which is what Thomas Piketty rightly highlights in his book Capital in the Twenty-First Century.

Not so long ago, in 2014, Finnish firm Nokia stopped its phone-manufacturing factory in Sriperumbudur, a suburb in Chennai. One of the reasons surmised by a journalist was that Vietnam provided Nokia with an even cheaper economic landscape — higher tax concessions and lower wages. No surprises here.

A probable positive consequence of foreign investment is the inflow of new technology and its subsequent diffusion. However, technology diffusion is not at all certain, especially because it is in the interest of the foreign firm to withhold profitable technology. Moreover, the diffusion of technology is difficult in countries like India where the state of both physical and human capital is not yet on a par with advanced countries.

Therefore, relying on foreign investment in the long term is not an economically sound policy. Policies must be undertaken to revive domestic private investment. The lowering of interest rates may not suffice in the current situation of aggregate demand deficiency, a consequence of weak foreign demand as well as poor domestic rural demand because of two consecutive monsoon failures. One long-term solution is substantial public investment in education, health and environment, which will not only improve India’s socio-economic condition but also crowd in domestic private investment.

Nature of FDI in India

The contribution any investment makes to employment depends on the sector and the region. It is obvious that investment in a labour-intensive sector will generate more employment than the same investment in a capital-intensive sector. The nature of employment — skilled, semi-skilled and unskilled — will also depend on the sector. For example, the construction sector is unskilled-labour intensive whereas computer software requires skilled labour.

In 2015-16, the services sector received the largest FDI equity inflow; this sector includes services such as finance, banking, insurance and outsourcing and predominantly employs skilled workers. Of utmost concern is the stark reduction in FDI in the construction sector — the rate of decrease is close to 85 per cent. The implications for labour employment in this sector cannot but be negative.

While the overall FDI equity inflow has increased between 2014-15 and 2015-16, the changes in the composition of FDI, as expected, are worrisome. Of course, the aim of FDI is profit, not employment. Therefore, the pursuit of full employment of labour cannot be left to the private sector, whether domestic or foreign.

The employment effects of investment undertaken in an urban settlement differ from that in a semi-urban and rural settlement. Just as India competes with other countries, Indian States compete among each other to get FDI; the regional distribution is very unequal. As the U.S. Ambassador to India, Richard Verma, said while visiting Bhubaneswar in January 2016, “While private investment from the U.S. continues, Odisha has to compete with other Indian States and countries like Singapore through ease of doing business to raise the volume.”

Clearly, Mumbai and Delhi (which includes areas around them) dominate the other regions by obtaining close to 50 per cent of the overall FDI equity inflow whereas Odisha receives less than 1 per cent. FDI inflows therefore worsen existing regional inequalities by making the rich regions richer and poor regions poorer (as the workers migrate in search of employment).

Public expenditure is the key

Private investment in general is volatile. Foreign private investment is more volatile because the available investment avenues are significantly greater (i.e. the entire world). Therefore, the responsibility of providing employment cannot be left to FDI. Despite the probable gains accruing from the diffusion of new technology, the existing state of physical and human capital in India may prove inadequate for the diffusion, at least for now. As expected, the current FDI equity inflows are volatile over time and across sectors and regions, which is a necessary consequence of their search for the highest returns. The adverse consequences are unstable employment and an accentuation of income and regional inequalities. Besides these adverse economic consequences, there are others — most notably, the issues of stagnant real wages and ecological destruction. In sum, howsoever economically beneficial FDI may seem in the short period, it has long-term adverse consequences for the economy. A government committed to the long-term economic health of India must therefore increase the quantity and quality of public investment.

Alex M. Thomas teaches economics at Azim Premji University.

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Printable version | Sep 12, 2021 12:00:47 AM |

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