By Sanjay Roy
One of the main arguments advanced by the proponents of liberalisation policies in developing countries including India is that capital would flow to the global South in search of higher rate of return. This would create new investments and hence growth and employment would increase. Also, the inflow of foreign funds would bring tangible outcomes of higher technological learning which are embodied in machines and organisational culture. It is also important for developing countries because foreign investments create large production facilities and scales of operation can be augmented using FDI.
In short, FDI is useful in enhancing production capacities, acquiring and assimilating new technology, creating employment and most importantly imparting skills and knowledge that has cumulative effect triggering a higher learning process. But foreign investment may not create new production capacities; rather they may be interested in acquiring existing capacities and exploiting the growing market of the developing countries. In such cases of mergers and acquisitions production capacities do not alter much, but the existing production organisation and labour relations are changed more in favour of capital. Also, in many cases FDI flows are modes of round tripping to take advantage of tax heavens.
In recent years because of the geopolitical conflict between USA and China, India wanted to be closer to the US marking a radical shift from its earlier policies of non-alignment. Besides the aspiration of emerging as a powerful pole in the Asian region, she had the expectation of drawing huge foreign investment because of China plus policy which many European buyers have adopted in the recent past to set up alternative sources of supply. The underlying expectation was India could mobilise FDIs which were earlier routed to China and hence take advantage of this policy and the geopolitical conflict to augment our production capacities. This seems to be a prudent stance to enhance FDI inflows towards India particularly when the world is in search of another production hub.
The recent trends in FDI flows as evident in ‘World Investment Report 2024’ is once again towards the developed north. It is also important that the quantum of foreign investment declined in two successive years in the post pandemic period and the recovery is surprisingly much faster in advanced economies particularly North America compared to the developing world. Also, the expectation of emerging to be the second largest destination for FDI in case of India suffered a jolt. The three countries who record a decline in inflow of FDI in the recent period are Hong Kong, Germany and India. In fact, China’s share in global FDI inflows declined in the post pandemic period falling from 15.2 per cent in 2020 to 12.3 percent in 2023. In case of India the share fell from 6.5 percent to 2.1 per cent. In other words, there had not been increase in foreign investment flows towards India although China’s share in global FDI flows marginally declined in the post pandemic scenario.
India‘s average growth in global FDI inflows fell in successive decades. Immediately after reforms, i.e., in the 1990 there was a huge rise in FDI flows recording an average growth for the decade of about 50.1per cent, in the 2000s it came down to 30.7 and then fell sharply in the next decade recording an average growth rate of 4.6 per cent only. More importantly the issue is the reversal of the direction of FDI inflows which is more towards advanced economies contrary to its earlier trend towards developing countries. The movement of investment was expected to be more towards capital scarce economies where return would be relatively high and there was a considerable relocation of production towards the developing countries. Particularly in the case of manufacturing, there was a considerable shift in production facilities towards the global south. However, such geographical relocation of industry is not something new. It happened earlier also as a measure of spatial fix both in textiles and automobiles. Automobile industry shifted from US and Canada to Europe and later to Brazil, Mexico and South Korea. These are primarily driven by the search for higher profits either because of low input costs or because of growing markets. Foreign investment flows were expected to grow in India because of growing middle-class market since foreign investors aim for large markets to take advantage of scale economies. The advantage of cheap raw materials and labour is another reason for which India could have been an attractive destination for FDI. All cuts on workers’ incomes had been legitimised on the ground that it will increase foreign investment flows and competitiveness for Indian industries.
There is a decline in FDI inflows globally by 2 per cent in 2023 compared to the last year and in developing countries it fell by 7 per cent. FDI flows in greenfield projects in the developed countries fell by about 8 per cent although they account for 35 per cent of the total FDI flows. Their share came below fifty per cent for the first time in 2019. However, the developed nations still account for the majority of the green field projects and project finance deals. It is also important to note that despite global slowdown with global gross domestic product growing at a rate of 2.7 per cent, profits of MNCs increased substantially.
But although profits increased, gross fixed capital formation grew slower than the growth of GDP, i.e., by 1.3 per cent. There is arise in the value of greenfield projects in developing countries by 15 per cent and in South Asia the growth was by 7 per cent. Although India is among the top five recipients of greenfield project announcements, FDI flows in India declined from 49 billion dollars in 2022 to 28 billion dollars in 2023 even though China’s FDI inflows declined from 189 billion dollars to163 billion dollars during the same period. Therefore, India could not take advantage of China’s recent decline in FDI inflows and increase her share.
The determinants of FDI inflows are not limited to lower wages, if that had been the case then FDI could have flown to countries which record much lower wages. It depends on several factors apart from the unit labour costs. Particularly in the context of developing countries, since most of them record low wage rates compared to developed economies, other factors such as growing markets, labour productivity, low transaction costs, location and logistics, infrastructure, availability of skills, regulation and protection of property rights and so on become more important.
In other words, since investors might be looking for a second option to relocate their production facilities and since average wages in India is less than that of China, FDI would not automatically flow to India. In fact, China is moving towards high value-added activities to rationalise and enhance value produced per unit of land. Hence, relatively low value-added activities would be relocated to other countries and India has options to mobilise investments. But in such activities also countries such as Vietnam, Indonesia and Bangladesh emerged to be more attractive destinations compared to India. (IPA Service)