T C A Srinivasa-Raghavan: FDI - The method in its madness

OKONOMOS

The likelihood of barriers to foreign entry being reduced in an industry is inversely related to its concentration.

Ever since India began to allow the freer flow of FDI in 1991, people have been wondering how the government chooses an industry into which it will allow foreign firms. It is often asked if "reforms are random" or merely unequally applied.

The distinction is important. If random, it shows no previous bias. But if unequally applied, it suggests a pre-disposition to favour some industries. What drives such a pre-disposition, of course, is well known.

In a recent paper* Anusha Chari of University of Michigan and Nandini Gupta of Indiana University give us a highly proximate answer as to how the decision is made. They have used extensive firm-level data and they find that "the likelihood of barriers to foreign entry being reduced in an industry is inversely related to its concentration."

That is, the higher the concentration, the lower the chances that barriers to entry will be reduced. They use the well-known four-firm concentration ratio. It is defined as "the ratio of the sum of sales of the four largest firms in an industry to total industry sales."

From this they say that "the least concentrated industry in the sample faces an 80 per cent probability of being opened to foreign entry in comparison to a 10 per cent probability for a monopoly." This could be a very useful finding.

Not just this. The authors also find that politicians play favourites and "are more receptive to the interests of some incumbent firms over others." Just why they are so is left unsaid.

Government monopolies face a 13 per cent probability of being opened to foreign entry. The corresponding probability for industries with no state-owned firms is 52 per cent.

This doesn't sound entirely right, however. India has opened up several government monopolies such as aviation, telecoms and insurance fairly briskly, while some industries with no government presence are still not open to foreign firms.

I would be very surprised if there is a bias here. It is far more likely that the capital-intensive industries needed more capital and technology for expansion and growth and became the automatic choices for deregulation.

Their paper also doesn't seem to cover fully the case of aviation as far as the sequence of events is concerned. It used to be a government monopoly. Then it was fully de-regulated.

This led to a rush of firms, many of whom folded up after a few years. That led to an oligopoly and one incumbent successfully resisted foreign entry for almost a decade.

This leads me to wonder if the yardsticks that apply to manufacturing firms are somehow different from the ones that apply to service providing firms.

The authors also argue that entry deregulation should precede privatisation because otherwise you run the risk of merely creating a private monopoly. If that happens, entry deregulation will become almost impossible. It is interesting to view this in the context of the DVB privatisation in Delhi.

One issue that the authors could have usefully discussed is the degree of opening up to foreign firms. Indian law permits the door to be opened at different angles "" 26 per cent, 74 per cent and what not. This has had an important bearing on FDI levels.

Finally, if I may show a red rag to the Communists, "workers do not appear to have had significant influence on the policy process... capital-intensive, rather than labour-intensive industries are more likely to be protected."

All things considered most people would agree that in India deregulation has been a mix of good sense (financial sector and infrastructure) and randomness (media), and that its absence has been because of unspecifiable reasons.

*The Political Economy of Foreign Entry Deregulation http://webuser.bus.umich.edu/achari/achari.htm