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Is there any point in economic reform?

August 08, 2003

The decade of 1990s has been billed as the decade of reform. However, it is probably more accurate to say that only about a third of the decade -- 1991 to 1994 -- actually saw real reform.

Be that as it may, one important area of reform was the effort to attract foreign direct investment.

There were broadly three objectives. One was to make good the shortfall between domestic savings and the required rate of investment of about 30 per cent. The second was to increase exports by improving the quality of Indian products and the third was to improve productivity by upgrading technology.

Two recent papers from ICRIER suggest that these objectives were largely not met. One is by Rashmi Banga*, who says that "while FDI has to some extent led to diversification of India's exports", there seems to be little evidence to suggest that it has given it a special leg-up. The other paper is by Deb Kusum Das** who says that there has been virtually no improvement in productivity.

So much, then, for reform, though it could also be said that it is the absence of proper reform that is responsible. To which I would add that even if the econometric techniques are right, the data are probably flawed.

In the private sector, at least, only economists flying on data alone would have the gall to suggest that productivity has not improved. We should wait for Surjit Bhalla to prove the opposite from the same data.

Banga studies both industry-level and firm-level data for 1994-1995 to 1999-2000 and finds that the impact of FDI on exports of non-traditional exports sector is larger than those of traditional export sector.

The results show "that FDI has a significant effect on the export-intensity of industries in the non-traditional export sector and therefore has, to some extent, led to diversification in India's exports. The impact of FDI on exports, however, differs with respect to the source-country of FDI."

This means that American FDI is better than Japanese FDI because it has "a positive and significant effect on the export-intensity of industries in non-traditional exports, while the impact of Japanese FDI is not significant."

Also, it turns out that Japanese firms don't integrate very well with domestic firms. What we need therefore are the right policies that favour exports of non-traditional things, as this is where foreign direct investments concentrate the most.

Das treads on trickier ground, not least because a former director of ICRIER had exactly the opposite view.

Das says that "the TFP (Total Factor Productivity) growth rates for individual industries are either negative or in the zero to 2 per cent range. The capital goods sector is the only one to register a positive growth (1.39 per cent per annum) throughout the period, the intermediate and consumer goods sectors both record negative growth in TFP during the entire period."

A National Council for Applied Economic Research study by Vivek Srivastava two years ago also said much the same thing, namely, that there was not much difference in productivity in the 1980s and the 1990s.

Das's results suggest that productivity and trade reform are inversely related. "Productivity performance seemed to worsen as the pace of trade reform gathered momentum. This is evident from the TFP growth recorded by the industries in successive phases of trade reform."

One can almost hear the Swadeshi Jagran Manch licking its chops. "We observe that there is a marked fall in the growth rate of TFP in Indian manufacturing in the 1990s as compared to the 1980s. Further, this is corroborated by several studies covering the period of 1990s." Oh dear, oh dear, oh dear.

How can this counter-intuitive result be explained? One is my explanation: the data is bogus. But Das prefers more conventional explanations.

The first is that industrial production during 1990-91 and 1991-92 "was constrained by factors like import compression, tight-money policy, inflationary pressures and fiscal contraction initiated by the government as part of the macroeconomic stabilisation programmes."

These led to a recessionary trend in the manufacturing sector. The other is the absence of structural reform, such as in the labour market and in exit policy for firms.

For good measure, the author adds that "the beneficial impact of trade liberalisation on productivity can take considerable time to show up after structural adjustment and industrial restructuring has taken place."


*Working Paper No. 106, The Differential Impact of Japanese and US Foreign Direct Investments on Exports of Indian manufacturing, July 2003
**Working Paper No 107, Manufacturing Productivity Under Varying Trade Regimes in India in the 1908s and 1990s, July 2003

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