Revisit FDI policy

Dr Bharat Jhunjhunwala
In his Independence Day address to the nation Prime Minister Narendra Modi had called upon foreign investors to “Make in India.” He has also sought foreign investment from China, Japan and NRIs in the United States. He hopes that Multinational Corporations (MNCs) from these countries and others will invest and help India become the workshop of the world. On the other hand, National General Secretary of BJP, Muralidhar Rao has recently stated that the expansion of manufacturing in India cannot be driven by foreign investments. “The Make in India campaign is not driven by foreign capital. The track that we are laying for Indian manufacturing is not led by foreign capital,” he said. The two statements create a sense of confusion regarding the precise role of FDI in the India Story.
The underlying assumption of inviting FDI is that India needs foreign capital and technology to be able to manufacture to world standards; and the impact of such foreign direct investment (FDI) will be hugely positive on our economy. I had undertaken a study of impact of FDI on Indian economy about 15 years ago. I had found that the impact is positive in the short run but becomes negative after about 15 years. FDI creates demand for cement, steel and machinery when a new project is established. This leads to higher growth rate in the short run. In the long run, however, profit repatriations start. This leads to the bleeding of our economy. Secondly, MNCs have deep pockets. They resort to predatory pricing and force domestic businesses to shut down. Having established their dominant position in the market, they start charging exorbitant prices. Thirdly, they kill domestic entrepreneurship which is the long run engine of growth.
I searched on Google Guru for recent studies on the topic and found that my assessment is confirmed. A study by University of Minnesota found that specific instances of FDI have generally had a negative impact. Study of impact at economy level found that there is no independent impact of FDI on economic growth. “Independent” here means that once the impact of education, domestic savings, free trade, etc. is removed then no impact of FDI is seen. Implication is that the alleged positive impact of FDI is actually due to these other factors and not due to FDI itself. A study done at University of Calcutta found that FDI and economic growth go together. But the causality runs from economic growth to FDI. In other words, FDI does not push growth. FDI comes to make profits one growth has taken place.
A study by University of Amsterdam found that the impact of FDI depends on the source country. FDI from UK was found to have positive impact on the host economy, that from Germany and USA was found to have a negative impact and that from Japan was found to have a severely negative impact. A study by Harvard University said that FDI exerts an ambiguous effect on growth. FDI in the primary sector has a negative impact on growth, while FDI in manufacturing has positive impact. I must confess that few studies commissioned by the World Bank and the International Monetary Fund found positive impacts of FDI. However, I have deliberately chosen to ignore them for being motivated. Conclusion is that FDI is not so good. At best it has no impact.
The Policy of attracting FDI has to be reviewed in this backdrop. It seems that FDI is beneficial where it comes along with frontier technologies. Such FDI is welcome. Problem lies with FDI that mainly brings capital. For example, Hindustan Lever had bought Indian company TOMCO. Such FDI brought only capital and no technology. Such capital-led FDI needs to be rethought. Actually the developing countries have become exporters of capital. All the developing countries taken together received 506 billion US dollars of FDI in 2006 according to statistics provided by the World Bank. Against this, an amount of 858 billion US dollars has been remitted illegally from developing countries according to the international watchdog Global Financial Integrity.  The developing countries are getting less money from FDI than they are losing through illegal remittances. If Mr Modi wants to jumpstart investment then he should focus on preventing illegal remittances. The resolve of the NDA Government to bring back black money stashed abroad is an admission of this illegal outflow.
More importantly, studies indicate that MNCs have a huge role in making these illegal remittances. A study supported by the Finnish Government estimated that only a small part of illicit capital flight is due to corruption. “A lion’s share of developing countries’ tax losses result from tax evasion and avoidance by MNCs,” it found. Another study by a Belgium-based organization has estimated that the developing countries lose more than $ 1000 870 billion each year through illicit financial flows, mainly in the form of tax evasion by MNCs. Literature available on the net is full of details of how MNCs misuse transfer pricing to make these illegal remittances. They over-invoice imports and under-invoice exports made to their principals. In this manner the developing countries are losing huge amounts. The policy of inviting MNCs to make in India is, therefore, like inviting the thief to set up the police station in the town. They may appear to bring dollars upfront but they take out much more on the sly.
The FDI policy needs to be revisited. Every FDI proposal must be closely subjected to a technology audit. Proposals involving transfer of advanced technologies alone should be welcomed. All proposals should also be subject to a social audit. Often the direct impact of an FDI may be positive in creation of jobs. But it may lead to more unemployment by displacing small producers. A proposal to make textiles may, for example, lead to unemployment of large numbers of weavers. Lastly, the character of the source country must be kept in mind. Mr Modi must direct the Finance Ministry to commission a study on the impact of FDI that has come from various countries. If FDI from Japan has been found to have a severely negative impact in developing countries in general then we should be wary of proposals coming from that country.
The Government must clear the confusion about the role of FDI in the economy that has been created by different statements emanating from the Prime Minister and the General Secretary. The Government should tell the people its assessment of the role of FDI in bringing new technology and in both generating and killing employment. Also it needs to be made clear what steps the Government proposes to take for preventing illegal remittances via transfer pricing by MNCs; and whether there will remain a need to attract FDI for augmenting our requirements of capital after these steps are taken.
(The author was formerly Professor of Economics at IIM Bengaluru)

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