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Was India too timid to manage to FDI issues?

Last updated on: January 9, 2012 13:48 IST

Was India too timid to manage to FDI issues?

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Devesh Kapur

In the cacophony of debates on the wisdom of liberalising retail foreign direct investment, or FDI, one viewpoint was noticeably absent: whether and how this might affect India's strategic interests.

While retail FDI seems a far cry from strategic interests, the more pertinent question is the broader implications of FDI on India's strategic interests, as distinct from the more obvious -- and much debated -- economic effects.

The demise of the Soviet Union, the current decline of the United States and the concurrent rise of China have made abundantly clear that a country's domestic economic strength is the foundation of its power in the world.

While this view is broadly shared in the Indian policy establishment, the disagreements are about how to achieve economic strength; and there is much confusion on how to translate India's expanding economy into foreign policy goals.

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Image: An activist of Shiv Sena burns a pamphlet during a protest against Foreign Direct Investment.
Photographs: Reuters
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The strategic community believes that economic power translates into the financial ability to develop stronger military capabilities to counter perceived threats; while economic liberals feel that increasing trade and global integration would result in greater prosperity and peace through mutual interdependence.

However, there has not been a shared vision that greater FDI could possibly help in achieving both goals: greater interdependence while simultaneously building strategic capabilities.

No country has done this better in recent years than India's biggest perceived strategic competitor: China. By all accounts, FDI has played a critical role in China's rise, with volumes of FDI inflows almost an order of magnitude greater than India.

But even more surprising is that FDI into China has come principally from the three countries that are (along with India) most wary of China's rise: Taiwan, Japan, and the United States.

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Photographs: KYham/Reuters

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Over the last two decade, Taiwan has been the largest foreign investor in China with more than 70,000 Taiwanese firms operating in the mainland. China has accounted for about 80 per cent of Taiwanese outward FDI, totalling between $130 billion and $150 billion.

The final assembly of consumer electronic products for world markets (and more recently to cater to China's burgeoning domestic market) which used to occur in Taiwan has steadily migrated to China, as wages rose in the former.

The development of China's massive electronics and information technology industries has much to do with investment from a country that China does not even officially recognise.

The migration of Japanese manufacturing firms to China is more recent, but no less relentless, with more than 10,000 Japanese firms now operating in China.

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Photographs: David Gray/Reuters
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And while the economic opportunities in China have been unparalleled, the aggregate consequences of the private decisions of thousands of Japanese firms have, ironically, helped build Japan's most formidable strategic competitor.

While Japanese firms and strategic thinkers might ponder on the prudence of putting so many eggs in one basket, China has masterfully drawn in financial and technological resources, which it is leveraging to emerge as a global power.

And what of the United States, which clearly now sees China as an even greater strategic threat to its supremacy than the Soviet Union, primarily because of its underlying economic strengths?

To begin with, policy makers in the United States have had a touching faith in the power of international trade and resulting interdependence in maintaining global stability, and thereby US supremacy.

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American firms went into China believing they would rule the roost. And while they have done well, the host has done considerably better, obtaining technologies and markets that would have been otherwise impossible -- at least in such a short time.

The United States thought that the spread of IT technologies would usher in democracy in China. Instead, American IT firms have by and large conformed to China's censorship and surveillance policies as the price of doing business in a market with nearly half a billion internet users.

Its pressures on Japan and Taiwan to revalue their currencies simply increased incentives for firms in the two countries to migrate to China.

And pressures on Taiwan to tighten up its IPR regime further impelled movement across to China, in the knowledge that authorities there would turn a blind eye.

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Tags: China , Taiwan , FDI , IPR

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And now, of course, the United States is realising that, whether with regard to renminbi appreciation or IPR protection, it has little influence on China. China accounts for about half of the US' huge trade deficit and about 10 per cent of this is accounted for by the one company -- Walmart -- that is much feared in India.

It is that ability -- to see the strategic implication of the entry of entities like Walmart (and of FDI, more generally) -- that has been missing in Indian thinking. Since the 1990s, the dragon of the East Indian Company syndrome has been tamed but not slain.

With the trade-to-GDP ratio having more than tripled since the onset of economic liberalisation, there has been a radical shift in India's integration into the global economy. These changes have brought significant benefits to the people, as well as major strategic payoffs in propelling India's emergence as a global power.

However, while international trade obviously increases mutual interdependence, the fact is that in many cases there is a high degree of substitutability of products from suppliers from other countries -- unless it is intra-industry trade.

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Photographs: Shannon Stapleton/Reuters

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A major reason for increased intra-industry trade (which accounts for approximately 35 per cent of world trade in manufactured goods) is the growth of cross-country production-sharing arrangements, often among affiliates of the same firm. And what makes this possible, of course, is FDI.

The role of FDI in facilitating trade and the transfer of capital and technologies is well known. But China's leveraging of FDI demonstrates how the creation of economic linkages, through cross-border production networks and establishing physical "facts on ground", combines co-operation and competition -- while creating capabilities for confrontation.

In contrast, India's trepidation and lack of self-confidence in its ability to manage FDI for its national goals only ensure that it is tying its hands in building its own strategic capabilities.

The fact that China has attracted massive amounts of transformative FDI from Japan and Taiwan, the two countries with which it has had an extremely troubled historical relationship, while India which has no baggage with either of them has attracted so little, speaks volumes of how the two countries have viewed the strategic possibilities of FDI.

The writer is director of the Centre for the Advanced Study of India at the University of Pennsylvania.



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