The logic of retail FDI

Financial Express, December 1, 2012

The logic of retail FDI
With multi-brand retail FDI finally set to be allowed in India, it is useful to reflect on what we know and don’t know. Reviewing various surveys, opinion pieces and expert reports, one finds copious statistics on various aspects of the retail market in India, the character of potential entrants (especially Walmart, of course) and long lists of possible negative and positive impacts. But we actually do not learn too much that will help us predict what exactly will happen. The best we can do in this situation is try to clarify the logic of possible effects. Here is my attempt to take us forward in that direction. My goal is not to argue for or against retail FDI, but to sharpen the policy debate.

The primary case being made for FDI in retail is that it will increase efficiency. One source of this is improvements in the supply chain. In particular, this argument is applied to perishable agricultural produce. The claim is that increased investment will reduce wastage. Efficiency gains can potentially lead to gains for producers, intermediaries and consumers. There is some evidence that, starting out in the US, Walmart improved the efficiency of wholesale and retail distribution, and later of manufacturing, through its hub-and-spoke distribution system and use of information technology to link different stages of the supply chain. But the US story was not one of building an agricultural supply chain from scratch. In fact, groceries were a later addition to Walmart’s offerings. This kind of history does not provide a solid base for the claim.

Turning to the recent Indian experience, Walmart and other foreign firms have been involved in the wholesale trade for some years. For example, the Bharti Walmart joint venture works with over 6,000 small farmers across six states. Indian corporations have tried to create retail chains without foreign help. What do these experiences teach us about the potential for transformation? In neither case has there been a huge change in the supply chain. Logically, either FDI in wholesale or domestic retail chains could have made investments to improve the efficiency of the supply chain. There have been small improvements, but no great transformation.

One can counter that domestic retail chains do not have either the capital or the managerial quality to do what needs to be done. But that excuse would not apply to a Walmart or Tesco operating at the wholesale level. In fact, after testing the wholesale waters, Tesco decided to avoid further physical investment and instead focus on providing expertise only. The question of why wholesale FDI isn’t enough also raises a logical issue for another claim for retail FDI, that it will lead to more exporting from India, as firms like Walmart will get to know suppliers and source from the best for global markets.

The response to these objections can be that controlling the retail portion of the value chain is important for making investments at the scale required. Why could this be so? Why has Walmart not roared ahead with its entry into wholesaling in India? In fact, the typical argument that inefficiencies and market power of intermediaries hurt producers and consumers suggests that wholesaling should be where the potential profits lie. There are two possible efficiency-based arguments to counter this—one is that there are efficiencies to be gained at the retail stage through modernisation and scale, and the other is that integrating wholesaling and retailing increases efficiencies. But domestic firms have had this option forever, and have not capitalised on it. Perhaps these potential efficiencies are not easy to come by in the current Indian situation, or at least have not been in the past.

One fear of those who oppose retail FDI is that, even if efficiencies do come about through this process, they will come at the cost of employment. Another fear is that large foreign entrants will lead to the traditional groups of powerful, profit-squeezing intermediaries being replaced by another, even more powerful. In this view, gains in efficiency, if any, will be swamped by losses through redistribution of the surplus generated in the value chain. Evidence for this fear is often drawn from the history of companies like Walmart in other countries.

In my opinion, the analogies used are often too loose and the conditions too different to allow for convincing logical claims, whether for or against retail FDI. Even claims about reductions in inflation are suspect, since they do not distinguish between one-time and continuing efficiency gains. Another logical gap is the focus on food and food products, without considering the experience of food processors or restaurant chains. Yet another is the neglect of any systematic discussion of non-food items, by different categories, including fast moving consumer goods as well as various consumer durables. Maybe I have missed something, but it seems to me that policy-making in such cases needs more data as well as better reasoning. It is not too late.

 

 

Breaking the spiral of despair

 

From Financial Express, June 23, 2012

Breaking the spiral of despair

Like it or not, India is on the world stage. Its achievements are being celebrated, but its shortcomings are also being dissected as never before. India has shown enough promise as a successful example of democracy and development that the chance of failure looms larger than it did a decade ago. The Economist magazine recently had an editorial lamenting India’s lack of leadership and the immense human costs of slower growth. Soon after, the magazine’s Asia column, “Banyan”, featured reflections from an unnamed senior government official, which seemed to boil down to the need to boost growth with a surge of infrastructure spending.

Banyan also reported on a speech by Kaushik Basu, the Indian government’s chief economic advisor, which boldly stood up for economic reform, openness to the world economy, and economic growth as a path to raised living standards. Dr Basu acknowledged that India’s current problems are of its own making, and that a “spiral of despair” must be broken for India to “come out on top” in a few years.

How can that happen?

A few years ago, I suggested that India’s Prime Minister displayed “Level 5 leadership”, a paradoxical blend of personal humility and intense professional will. One saw this in the nuclear deal. One sees it in the dealings with Pakistan. Domestically, one can only guess as to the constraints that prevent such leadership being exercised for economic policymaking. Perhaps India’s new president will display the same traits once elected. On the whole, though, this kind of leadership has been sorely lacking in India, despite the amount of talent near the top. Professional will is often present, but distorted by an over certainty of views, leading to a failure to incorporate all ideas and information that may be useful or relevant. In other cases, both will and humility are absent, in politicians who are mainly concerned with personal gain. India needs level 5 leadership, right away.

Even the best leaders cannot make all decisions unaided. India has been suffering from not having the right people on board, in the right positions. If the PM has to manage the finance ministry as well, or one person has to deal simultaneously with two immensely important ministries such as telecom and education, one cannot expect that each job will receive the attention it deserves. If senior bureaucrats do not have years of specialised expertise pertaining to their positions, decisions will not be made optimally. On the other hand, fresh ideas can come in if the expertise was developed outside the “government hot-house”. India needs more of the right people in the right positions, right away.

Banyan commends Dr Basu for supporting openness, globalisation and economic reform, but suggests that India’s politicians shy away from doing so. This is not quite true. The PM and all the senior economic team have repeatedly stood up for these principles. The problems have been in implementation, in doing the deals that will move things forward. Many reforms have been creeping along in the background. But what is needed is a prioritisation and focused push. Perhaps reforms like FDI in retail, cutting fuel subsidies, and overhauling land acquisition laws are politically too challenging for the moment. But there is one single reform that can strike at the root of several problems besting India. The central government has been desperate to raise revenue, and reverted to old-style discretionary, if not extortionary, taxation methods. It should focus on the tax overhaul that would do the most good, the rapid introduction of a simple, comprehensive Goods and Services Tax. If the states need to be brought on board politically, this is an opportunity to give them a higher tax share, and the greater spending autonomy that comes with revenue authority. The states are where effective government spending decisions can be made for many things that matter, like health and education. India’s central government should focus on a few things, get them done right, and get them done quickly.

Top leadership, the right team below that leadership, and focus on one or two really major structural reforms. These are obvious ideas for India, as it battles a spiral of despair. Meanwhile, the country of over a billion will keep lurching along, with day-to-day decisions to be made, as well as long-term plans, across a wide range of economic and social issues. Whatever happens with India’s leadership and governance, it will benefit from a more concentrated, focused and interactive attention to this entire range of issues, by the top minds working on India’s economy. Under Dr Basu, the Economic Survey of India has begun to give a sense of how to bridge the gap between rigorous economic theory and empirical analysis on the one hand, and policy prescriptions on the other. This is something that needs to happen in a more general and continuous way. Ultimately, this bridge of ideas will be crucial to breaking the spiral of despair.

Where Should India Reform and Why?

To start with, I want to reaffirm that India needs economic reform, and lots of it. Reforms should strengthen governance institutions as well as the working of markets. An increased role for markets and competition will, on the whole, benefit the Indian economy. If reforms are done well, they can promote inclusive growth. With all that clearly stated, I want to question some of the reform rhetoric around FDI in multi-brand retail, and argue for making a different set of reforms a priority if we want to improve the supply chain, whether farm to fork (or fingers, really, for India), or for manufactured goods.

Certainly, Western retailers such as Walmart and Tesco can bring in knowledge that comes with vast experience, as well as large dollops of capital. If we can have McDonald’s in India, bringing in new ideas, high standards of customer service and process efficiencies, why not foreign retailers too? Certainly, it will help to increase competition and innovation in retailing. But some of the arguments being made seem to have shaky foundations.

More....

Thoughts on FDI in Retailing

Here are two columns I wrote late last year, reflecting on the political process and economic analysis associated with India's attempt to open up multi-brand retailing to FDI. The first column also has some thoughts on developmental objectives and social opportunity, based on some new work by Yale economist John Roemer.


Development and Opportunity

The furor over the attempt to open up FDI in multi-brand retail reminds us of several things about India. But the true lessons may not be the seemingly obvious ones. It is certainly possible that the government’s handling of the policy change was not the best it could have been. On the other hand, those with long memories will recall numerous occasions where policies have been floated, reversed, modified or even transformed. At one time, all FDI and disinvestment were controversial—now the discussions are more nuanced (even if political rhetoric remains strident).

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Retailing and Reform

In my last column, I mused on India’s economic reform process and inclusive growth, in the context of opening up multi-brand retail to FDI. I want to return to the question of political capital, and policy thinking about reform in the retail sector.

On using up political capital, I think ongoing events have proved me wrong. Opposition to opening up multi-brand retail has come from the same quarters as opposition to other reform measures, including the Pension Bill and Companies Bill. On all these, the government has openly looked for compromises that will lead to acceptance of the reforms. If that is the case, then moving on multiple fronts may give the government more chance of getting some changes through, not less. The government has also reset its approach to FDI in retail, marshaling interest groups that might benefit, and saying more to make the case for the positive consequences of the change. So even if it lost some political capital initially, it should recover it quickly.

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