India needs export-oriented FDI

In his address to the joint session of Parliament, President Pranab Mukherjee emphasised three distinct but closely related economic policy thrusts — FDI, jobs and manufacturing.

The talk of encouraging investments, including by foreign investors and boosting labour-intensive manufacturing, is not new. Arvind Panagriya and others have attributed India’s poor show in manufacturing to the lack of suitable policy to make use of its abundant unskilled labour force.

Deploying the country’s labour force should not amount to subjecting them to exploitation or curtailing the democratic rights of workers; well-intentioned but archaic labour laws have, however, had a contrary effect.

The problem is one of means and ends. Current labour laws require firms to obtain government permission to sack employees, even if they are unproductive, and this law applies to all manufacturing firms of a decent scale.

Besides, firms find it difficult to exit in the face of financial loss, unprofitability or any other good reason to shut shop. These restrictive clauses discourage firms to invest in Indian manufacturing.

The way out is to reform labour laws and solicit export-oriented FDI (EFDI) in Indian manufacturing. For sufficient jobs to be created for the teeming mass of low-skilled workers, India needs to become a good place to manufacture and export. It has to become a hub for global export of manufactures, and not just domestic consumption.

EFDI has the potential to transport India to the industrial economy league: a stage which it allegedly jumped — wrongly, as we now realise — to become a post-industrial service-based economy.

In India, foreign affiliates accounted for only 5 per cent of total exports in 2001, when in China foreign invested enterprises made up 50 per cent of total exports. In fact, in China, export obligation is mandatory for foreign investors, whereas it is not so in India.

It is important that export obligation for FDI is introduced in India to enhance exports. EFDI also responds to quality physical infrastructure — and this is where we need to do some serious work. In infrastructure, massive state investments with help from private sector partners can rescue us from the present sorry state.

Given that uninterrupted power and seamless transport infrastructure are two crucial demands of the manufacturing sector, it is a good sign that energy and infrastructure form the core of the new cabinet’s economic policy focus.

Once infrastructure is in place, the trade and transactions costs will automatically reduce, giving a further boost to manufacturing and exports.

In terms of labour cost, India is not at a disadvantage relative to China or East Asia. India’s wage levels are more or less at par with these economies. India has among the best stock of raw material in the world, notably in coal and iron ore, and an abundance of workers. Hence, as far as factor endowments are concerned, India has everything that should form the bedrock of a thriving manufacturing sector.

The problems, however, have cropped up in the form of shoddy infrastructure and policymaking. The Government should focus on labour intensive manufacturing for the vast swathe of low to medium skilled populace, and simultaneously undertake a national skills mission, boost R&D spending and infuse greater quality into education at all levels.

The need of the hour is a synchronisation of India’s export and FDI policies. This can be achieved by increasing FDI in export oriented sectors such as gems and jewellery, light engineering goods, textiles and so on.

As of now FDI in India is concentrated in telecom, infrastructure and financial services. Eventually rising exports, on the back of growing EFDI, will help India address its troubling trade deficit, just as China has done.

The writers are with Observer Research Foundation and Institute of Economic Growth, Delhi