Institutional Dynamics and the Evolution of the Indian Economy

Institutional Dynamics and the Evolution of the Indian Economy

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Institutional Dynamics and the Evolution of the Indian Economy Edited by Rajesh Kumar and Murali Patibandla

INSTITUTIONAL DYNAMICS AND THE EVOLUTION OF THE INDIAN ECONOMY

Copyright © A. Desai, R. Dossani, M.W. Hansen, R. Kumar, R. Lema, A. Okada, M. Patibandla, J.D. Pedersen, A. Roland, and A. Sanyal, 2009. All rights reserved. First published in 2009 by PALGRAVE MACMILLAN® in the United States—a division of St. Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Where this book is distributed in the UK, Europe and the rest of the world, this is by Palgrave Macmillan, a division of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN-13: 978–0–230–60852–8 ISBN-10: 0–230–60852–3 Library of Congress Cataloging-in-Publication Data Institutional dynamics and the evolution of the Indian economy / edited by Rajesh Kumar and Murali Patibandla. p. cm. Includes bibliographical references. ISBN 0–230–60852–3 1. India—Economic policy—1991– 2. Economic development—India. 3. Globalization—Economic aspects—India. 4. International business enterprises—India. 5. Investments, East Indian. I. Kumar, Rajesh, 1954– II. Patibandla, Murali. HC435.3.1628 2009 330.954—dc22

2008035832

A catalogue record of the book is available from the British Library. Design by Newgen Imaging Systems (P) Ltd., Chennai, India. First edition: April 2009 10 9 8 7 6 5 4 3 2 1 Printed in the United States of America.

Contents

List of Figures

vii

List of Tables

ix

Preface

xi

List of Contributors 1. Managing Globalization: India and China Compared Jørgen Dige Pedersen 2. The Rise of Indian Multinationals: Explaining Outward Foreign Direct Investment from India

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31

Michael W. Hansen 3. Global Value Chains, Market Organization, and Structural Transformation of Bangalore’s Software Cluster in the 1990s and Beyond

63

Rasmus Lema 4. Institutional Change and Industrial Development: The Experience of the Indian Automobile Industry

83

Aya Okada 5. Corruption: Market Reform and Technology

119

Murali Patibandla and Amal Sanyal 6. Accessing Early-Stage Risk Capital in India

135

Rafiq Dossani and Asawari Desai 7. Understanding Indians in a Global Era

157

Alan Roland 8. Negotiating in India: Does Brahmanical Idealism Play a Constraining or a Facilitative Role?

171

Rajesh Kumar Index

189

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Figures

1.1 1.2 1.3 1.4 1.5 1.6 2.1 2.2 2.3 2.4 2.5 2.6 4.1 6.1 6.2

India’s export to major destinations, 1980/1981 to 2006/2007 India’s import from major suppliers, 1980/1981 to 2006/2007 Gross Domestic Product. Annual growth rates, 1986–1987 to 2006–2007 Export of selected products and services, 1988/1989 to 2005/2006 Corporate profitability in India, 1987/1988 to 2005/2006 India’s and China’s different strategies to reach rconomic prosperity Outward FDI (OFDI) from India 1980–2006 Number of bilateral investment treaties between India and other countries, cumulative Indian M&As abroad Sector composition of Indian OFDI Country orientation of Indian OFDI Positioning theories in the investment development path Passenger car production by manufacturers Investors’ industry preferences The operating environment

7 8 9 13 15 24 34 35 37 38 39 48 91 144 146

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Tables

1.1 2.1 4.1 4.2 6.1

Distribution by ownership of corporate sector assets Phases in Indian OFDI Trends in production by type of vehicle Trends in export performance by category Phases of growth of Indian risk capital

16 41 90 109 142

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Preface

India’s rise is attracting increasing interest among policy makers, global firms, academics, and above all, Indians themselves, who are proud to be part of a resurgent India. This is a far cry from the decades of the 1970s or the 1960s when the India economy came to be famously or infamously characterized as exhibiting the so-called “Hindu rate of growth.”1 In this period the economy barely grew at a rate of 3.5% per annum and the recognition that India could break out of these shackles was barely conceivable at this point in time. Much has changed in India since then. India now boasts of thriving software and an information technology industry, firms that are eagerly expanding overseas, a sizable middle class, and above all a cultural/ ideological shift that is propelling India to become a major player in the global economy. Analysts have begun to debate as to whether India might outcompete China. 2 These discussions are occurring in a context where the Indian economy has been a strong performer, Indian companies are developing global ambitions, foreign investors are eagerly seeking to enter the Indian market, and major powers, such as the United States are actively courting India, as a new geopolitical order seems to be emerging with the rise of both China and India. Without question there is much that has changed in India. India is attracting increasing international interest both economically and politically, and there is a new found sense of optimism in India, something that was sorely lacking in the early decades after Independence. That said, India is still in a transition mode, as it seeks to shake off the vestiges of the past while simultaneously embracing a more visionary future. The Indian institutional environment is imperfect in many ways, and while these institutions may be changing, the scope and the rapidity of change are no doubt debatable.3 The degree to which the existing institutions may be adequate for India is also an issue open to debate. The sustainability of the developmental process in India therefore depends very much on the degree to which the country is

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either able to reshape its institutions to correspond with new realities or alternatively to make its existing institutions operate in a manner that are congruent with the emerging realities.4 The institutional dimension comprises the regulatory, normative, and the cognitive pillars. 5 The regulatory dimension focuses on the existence of rules/laws and the degree to which they are conducive to economic activity. The normative dimension focuses on the dominant set of values/beliefs that characterize a given society while the cognitive dimension highlights the degree to which economic activity is valued and the attitude toward foreign investors. Institutional imperfections may be evaluated in terms of adaptability, integration, and ambiguity. Adaptability refers to the ability of institutions to reshape themselves in accordance with new realities, integration refers to the linkages between the different dimensions of institutions, while ambiguity refers to the degree of clarity present in institutional arrangements. Institutional imperfections impede economic activity in a number of different ways. They may affect the efficiency of the value creation process, that is, the ease by which the actors are able to consummate a business transaction. They may also affect the durability and/or the legitimacy of the value creation process. Finally, institutional imperfections, may also affect the strategic choices of the different actors involved in the process of value creation. Institutional imperfections arise out of vested interests, socio cultural and historical legacies, external parameters, and a path dependent logic that highlights the constraining influence of initial conditions. These imperfections may not change easily or overnight but by the same token they are not by definition immune to change, although such change may either not be visibly forthcoming, or by the same token, may not necessarily be positive per se. In other words, institutions could just as likely, change for the worse as they could for the better. In the Indian context, institutional imperfections have traditionally affected the ability of foreign investors to operate efficiently and effectively in the Indian business environment. Regulatory restrictions of all sorts have stifled their Indian operations, although post 1991 things look much more different than what they did before. Imperfections have also constrained the Indian firms, although it has also provided them with a safe and a secure domestic market, pre1991. The ability of India to overcome its infrastructural constraint be it in terms of power, transport, or ports has traditionally been negatively impacted by institutional imperfections.6 The infrastructural constraint has hobbled India’s ability to develop strengths in

Preface

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manufacturing on a scale that China has developed. It has also historically adversely affected the desire of foreign multinationals to use India as a manufacturing base on the same scale that they have utilized China. The institutional imperfections that pervade the Indian economy, and that have now begun to change to a degree, have historically reflected a lack of adaptability, inadequate integration, and some degree of ambiguity. Adaptability is often reflected in the time taken to effectively implement new policies, even when the policies have themselves changed. Inadequate integration has often been visible in the lack of consistency among various policies while ambiguity is a reflection of a lack of clarity in the environment. The different chapters in the book highlight the impact of the institutional dimension on Indian growth and development. They show both how institutional changes have accelerated Indian growth, and how the continuing institutional imperfections are at the same time constraining Indian development. Indian policy makers, Indian businessmen/entrepreneurs, foreign investors are cognizant both of what has been achieved and what still remains to be accomplished. The chapter by Jørgen Dige Pedersen addresses the issue of how India has coped with globalization and in particular how does India fare relative to China in coping with the globalization imperative. Pedersen notes that while India’s position in the global economy has improved in the early 1990s, India is still a marginal player in the global economy, with Indian exports constituting only 1.3% of world exports in 2005. The figures for foreign direct investment reflect the same trend. Pedersen notes that while the key problems confronting India are well known to the Indian elite, effective policy implementation is conspicuously missing. Michael Hansen’s chapter seeks to explain the surge of foreign direct investment from India. Michael notes that foreign direct investment from India has expanded dramatically in recent years. During the period 2004–2006 Indian outward foreign direct investment from India expanded by four fold, even as inward foreign direct investment doubled. Indian firms, as Michael notes, are seeking to strengthen and leverage their competitive advantage by gaining access to new markets, resources, and technologies. This is reflective of a new found self confidence that has been spurred by the rapid growth of the information technology industry. It is also a consequence of the liberalization that has occurred in the Indian overseas foreign direct investment regulations. Michael notes that the pattern of foreign direct investment from India contradicts the received theory on foreign direct investment from developing countries.

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Rasmus Lema’s chapter assesses the structural transformations that are occurring in the Indian software industry. It has been the growth of the Indian software industry that has made India prominent in the world economy, although it is fair to say, that India is also emerging as an important market in its own right. Rasmus’s chapter seeks to assess the impact of the global value chain on the structure of the Indian software industry. Rasmus notes that during the period 1991–2001 Indian firms made their mark by engaging in traditional outsourcing transactions such as application development and maintenance but that post-2001 Indian firms expanded their capabilities and are now moving away from competitive advantage based on operational efficiency to an advantage that is based on business transformation and innovation. The observation is also made that even in an environment characterized by strong national institutional imprinting, certain sectors, such as the software sector may exhibit different institutional patterns, as a function of their being intimately connected with the global industry. Aya Okada explores the impact of institutional changes on the development of the Indian automobile industry. She notes that the Indian automobile industry has grown impressively following the liberalization of the Indian economy. She notes that even before FDI inflows in this sector began in the 1990s, Maruti and Tata, had already begun to play major roles in reshaping this industry. Maruti, as she notes, continues to maintain a commanding position in the passenger car segment, while Tata, paradoxically enough, has strengthened its market position in the industry, notwithstanding foreign competition. Of particular interest is Aya’s observation that the local content policy imposed by the government of India forced major car assemblers to rely on local suppliers. This led them to initiate actions to enhance the capability of local suppliers. A major consequence of this was the emergence of both intra-firm as well as inter-firm learning. Her study is therefore in marked contrast to the overwhelming perception that Indian state interventions have often been counterproductive. Patibandla and Sanyal assess the impact of ongoing market reforms and information technology on the prevalence of corruption in the Indian institutional context. Corruption is an instance of institutional imperfection and in environments viewed as corrupt the transaction costs of doing business may be high. The authors note that market reforms may deter corruption stemming from scarcity while information technology advances will be necessary to reduce the incidence of corruption stemming from governance.

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Dossani and Desai explore the challenges that nascent entrepreneurs face in gaining access to risk capital at the early stage of the venture. It turns out that 90% of the capital goes to late-stage initiatives that are initiated by mature firms. The author/s conducted 175 interviews with capital providers, venture funded firms, and regulators and policymakers. The author/s recommend regulatory changes such as the creation of limited liability corporations that may lessen the shortage of early-stage risk capital and risk—alteration policies that may involve public funding for small and medium sized enterprises. Alan Roland, a psychoanalyst, looks at the nature of the Indian self. He highlights the importance of the familial self and the spiritual self in the Indian sociocultural context. He discusses some of the key characteristics of the Indian familial and the spiritual self and addresses some of the managerial and organizational implications of the Indian self conceptions. Kumar discusses the importance of the Indian mind set in shaping Indian’s negotiating strategy. Negotiation is critical to value creation, and therefore the ability to negotiate well is an important managerial and an organization skill. Building on the concept of Brahmanical idealism, Kumar wonders whether such an idealistic mode of thinking is constraining or facilitative in effective negotiating. He shows how such a mindset may manifest itself differently in the Indian bureaucrat vis-á-vis the Indian businessperson and outlines strategies for the foreign investor seeking to negotiate with them. The different chapters in the book focus on different aspects of the Indian institutional environment—the regulative, normative, and the cognitive, and with varying emphasis highlight the aspects that are changing and those that continue to be stable. The author/s also discuss the implications of the changing, albeit an imperfect institutional environment on industry sectors (automobile, software), corruption, entrepreneurial risk capital, negotiating, managerial behavior, India’s standing in the global economy, and outward foreign direct investment from India. It is hoped that this volume will enrich understanding of India as an evolving economy and suggest directions for further research.

Notes 1. Tripathi, S. (2006), “Escaping the Hindu Rate of Growth.” The Guardian, June 13. 2. Huang, Y., & Khanna, T. (2003), “Can India Overtake China?” Foreign Policy, 137: 74–81.

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3. Kumar, R., & Worm, V.W. (2005), “Institutional Dynamics and the Negotiation Process: Comparing India and China.” International Journal of Conflict Management, 15: 304–334. 4. Luce (2006); North, D.C. (1990), Institutions, Institutional Change, and Economic Performance. Cambridge: Cambridge University Press. 5. Scott, W.R. (1995), Institutions and Organizations. Thousand Oaks, CA: Sage. 6. Kumar, R., & Sethi, A. (2005), Doing Business in India. New York: Palgrave Macmillan.

Contributors

Aya Okada is Professor of International Development at the Graduate School of International Development, Nagoya University, Japan. She holds an M. Phil. in Development Studies from the University of Sussex, and a Ph.D. in Economic Development from the Massachusetts Institute of Technology (MIT). She specializes in regional economic development, industrial organization, and training and skills development. Asawari Desai, at the time of preparation of the underlying data study and first draft of this paper (January 2007), was a Director with The Indus Entrepreneurs (TiE) Inc., based in Silicon Valley. Her principal responsibilities at TiE included financial management, strategic planning, review of global operations, and supporting the Global Board of Trustees. Prior to TiE she worked as a Portfolio Monitoring Officer with AIG Direct Investments, the private equity arm of AIG; as a Financial Advisor and Investment Banker with KPMG Corporate Finance; and as a Fund Manager with JF Electra, a leading private equity fund in Mumbai. Desai is currently an independent consultant. Jørgen Dige Pedersen is a Political Scientist educated at the Department of Political Science, Aarhus University, Denmark. He got his Ph.D. in 1989, and has been a Lecturer/Associate Professor since 1992. He teaches International Relations and Development Studies. His research interest are North-South relations, international aid regime, India’s development, Brazil and he has recently published a book titled Globalization, Development and the State. A Comparative Study of the Performance of India and Brazil since 1990 (Palgrave Macmillan, forthcoming 2008). Rafiq Dossani is a Senior Research Scholar at Shorenstein APARC, responsible for developing and directing the South Asia Initiative. His most recent books are India Arriving, published in 2007 by

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AMACOM Books/American Management Association, Prospects for Peace in South Asia (co-edited with Henry Rowen), published in 2005 by Stanford University Press, and Telecommunications Reform in India, published in 2002 by Greenwood Press. He holds a B.A. in economics from St. Stephen’s College, New Delhi, India; an MBA from the Indian Institute of Management, Calcutta, India; and a Ph.D. in finance from Northwestern University. Rajesh Kumar is an Associate Professor of International Business Strategy at the University of Nottingham Business School. He holds a B.A. in Economics from St. Stephen’s College, University of Delhi, India, an M.A. in Economics from Delhi School of Economics, an MBA from Rutgers University and a Ph.D. in International Business from New York University. Dr. Kumar’s research interests lie in international negotiations, cross cultural management and the management of alliances and he has published widely in journals such as Organization Science, Journal of Management Studies, and Journal of Applied Behavioral Science. Much of his recent work is focused on India and he has recently published a book on Doing Business in India (with Anand Sethi) which was also published by Palgrave Macmillan in 2005. Rasmus Lema is a Social Scientist concerned with industrial organization and development. He is currently a D. Phil. candidate at the Institute of Development Studies (IDS) at the University of Sussex, UK and holds a M.A. in Development and Public Administration from Roskilde University, Denmark. Murali Patibandla is Professor at the Indian Institute of Management Bangalore India. His book Evolution of Markets and Institutions: A Study of an Emerging Economy was published by Routledge Taylor and Francis in 2006. His academic papers have appeared in journals such as World Development, Journal of Economic Behavior and Organization, the Journal of Development Studies, International Journal of Management and Decision Making, Economic and Political Weekly, and the Indian Economic Journal. Alan Roland holds a B.A. from Antioch College; a Ph.D. in Clinical Psychology from Adelphi University; and a Certificate in Psychoanalysis, National Psychological Association for Psychoanalysis (NPAP). Currently he is a Member of Faculty and Board of Directors, NPAP, and in private practice.

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Amal Sanyal is an Associate Professor at Lincoln University, New Zealand. He has previously taught at Jawaharlal Nehru University, held the State Bank of India Chair in Economics and was an Economic Advisor to the Government of Mauritius. He has authored three books and numerous research papers on Economics and Political Economy. Michael W. Hansen is an Associate Professor at the Centre for Business and Development Studies, Copenhagen Business School. Since 1994, he has worked with various aspects of MNC strategy in developing countries. Prior to his employment at CBS, he worked at the United Nations Centre for Transnational Corporations. Currently his research is focusing on the strategies of Danish MNCs in Asian developing countries, emphasizing India.

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1 Managing Globalization: India and China Compared Jørgen Dige Pedersen

1.1 Introduction In recent years India has been hailed as an emerging economic power almost on par with China.1 Much of the optimism on behalf of India stems from the gradual opening of the Indian economy since the early 1990s and the country’s present high economic growth rates. But the opening of the Indian economy to a rapidly globalizing international economy has not only offered opportunities but also a number of challenges to the economic actors. The aim of this chapter is to assess the strategy behind and the outcomes of the Indian response to economic globalization and subsequently briefly compare it to the path chosen by China. India and China are often seen as following the same basic development strategy—an open market–based liberalizing strategy—with China starting early and India belatedly following. A closer inspection reveals important differences, however, and the aim of the chapter is to highlight some of these differences and discuss the implications for the management by two countries of the challenges arising from economic globalization. The emphasis of the chapter will be on the Indian development, but the brief analysis of the Chinese development follows the same analytical structure facilitating a systematic, illustrative comparison. The assessment will mostly focus on economic parameters, thus largely ignoring essential social and political issues that would be of clear importance in a broader discussion of both present status and future prospects of the two Asian giants.

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In order to best capture the complexity of the globalization challenges and the dissimilar paths taken by Indian and China in response to these challenges, the discussion will embrace four levels of analysis, each dealing with different issues and different standards of evaluation: (1) the international or global level, where the questions mainly concern changes in the relative position of the two countries and the prospects of relative advancement or relative decline; (2) the national level, where the focus is on the performance of the national economy, often seen in contrast to the earlier pre-globalization period; (3) the sector or branch level, where an assessment will be made of the growth and development potentials of different forms of economic activity; and finally (4) the company level, where we will concentrate on how individual business actors are coping, with particular attention to the distinction between local and transnational companies. Evidently, no level of analysis can claim absolute prominence or priority in an overall assessment of how India and China have managed globalization challenges, but the analytical approach chosen will hopefully enable an overview of the most relevant issues. The four analytical levels are of course interrelated and interdependent, with the macro-levels being the aggregates of micro-levels, but they also represent different analytical approaches on the same economic realities and only by combining them can a full picture be drawn. It goes without saying that a brief evaluation like this will inevitably be selective and incomplete. It is my hope that it will, nevertheless, provide the basis for a fair overall judgment. Before we proceed with the assessment, a brief discussion of the concept of economic globalization is warranted.

1.2 The Concept of Economic Globalization Globalization is an elusive—and persuasive—term with nearly as many conceptual meanings as there are authors dealing with it. If we look specifically at economic globalization, there is only little less diversity. 2 There seems to be widespread agreement, however, that economic globalization entails a growth and intensification of international economic ties in areas of trade, investments, technology transfers and inter-company collaboration agreements and that this process has been intensified since the 1970s. 3 Critics of the globalization thesis have, however, pointed to the fact that in many instances the situation prior to World War I was characterized by large international economic flows that in relative terms equal today’s internationalized economy, which therefore represents nothing inherently

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new.4 Others have proposed that a regional orientation rather than globalization constitutes the main trend in the contemporary world economy.5 Discussions such as these focus upon the interpretation of data on various international economic flows and are essentially discussions over quantitative changes. A more fruitful way of approaching the problem of economic globalization is in my opinion to focus on the qualitative changes that justify the use of a new term (globalization) rather than older terms (internationalization, etc.) and justify an image of globalization as signifying an epochal shift in the development of global capitalism.6 The qualitatively new features include ●

●

●

the emergence of a new dominant paradigm for industrial production characterized by knowledge—and technology-intensive, flexible production systems; a “deepening” of the financial systems that has delinked the sphere of finance from the sphere of production and strongly internationalized financial flows, plus finally (and most important); and the emergence of a new global market discipline replacing the previous national systems.7 This element is constantly being reinforced by the universal adoption of liberalization policies, often driven by the World Trade Organization (WTO) and the Bretton Woods institutions.

Using the emergence of a global market discipline as a defining element of economic globalization seems theoretically attractive because it neither implies that economic transactions necessarily have to cross national borders to any specific extent nor that they should be truly global (or even regional for that matter). It rather implies that economic actors—mainly companies—operating in almost any sphere of economic activity increasingly have to adapt to global (read: developed world) standards—if they don’t, they run the risk of losing their markets wherever they may be located. In the words of a wellknown expert on multinational corporations: “Firms in a liberalized world must successfully compete with all other firms regardless of location.”8 A crucial aspect of economic globalization as conceptualized here is the assumption that globalizing impulses are emanating primarily from countries at the core of the world economy and that countries at the periphery of the world system—till now including both China and India—are at the receiving end of the globalization processes. In other words, these countries are “globalization-takers,” not “globalizationmakers.” It is further important to note that the changing configuration

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of the global economic system has come about not only through technological changes or evolutionary developments in the world’s core economies, but also as a result of policy-driven changes in regulatory regimes in and between the leading economies of the world—and especially within the United States.9 Regulatory changes have indeed been promoted globally and are often policed internationally by Westerndominated international organizations, especially the Bretton Woods Institutions (the World Bank and International Monetary Fund [IMF]) and the World Trade Organization. Much of the global regulation increasingly called for should in this context probably be seen as regulation for not against globalization.10 Although there is considerable disagreement as to whether, and to what extent, economic globalization has reduced the role of nation states and their possibilities of taking regulatory action,11 most observers seem to agree that economic globalization at least poses new challenges to the nation states.12 For developing nations these challenges appear to be of a more critical nature than for developed nations. Partly as a result of various structural adjustment programs pushed by the IMF and the World Bank, many developing countries have throughout the 1980s been exposed to globalizing influences from the developed world. These changes may indeed have made these countries even more susceptible to global influences—constructive as well as destructive—and the negative influences may have more severe impacts than they would have had on developed countries. Some observers even see an imminent threat of economic marginalization for many developing countries due to increasing economic globalization.13

1.3 The Background During the 1980s, India represented in many ways a contrast to the majority of developing countries, which underwent more or less Draconian structural adjustment processes as a result of the international debt crisis. India had experienced an economic crisis in the late 1970s and early 1980s, but the crisis was short-lived, and India subsequently withdrew from its brief engagement with the IMF. Because of its limited exposure to international short-term commercial loans during the 1970s, India managed to avoid being seriously entangled in the global debt crisis. Instead, India to some extent profited from the debt crisis during the 1980s, as the country emerged as a creditworthy international borrower of commercial loans. In 1990–1991,

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however, India itself came close to a debt crisis triggered by the First Gulf War (the collapse of remittances from West Asia, increasing oil prices), the withdrawal of funds invested by nonresident Indians and—in the background—the rapid disintegration of India’s significant trading partner, the Soviet Union. As a result, India experienced a severe balance-of-payment crisis and had to enter into loan agreements with both the IMF and the World Bank.14 The loans were conditioned on the implementation of certain reforms of the country’s economic policies, and these new policies were included in the Indian government’s economic reform program—liberalization, deregulation and (much less) privatization—which was initiated in July 1991. The reforms were sustained after the end of the acute economic crisis and after the need for IMF/World Bank emergency loans had disappeared, and the reform process continued throughout the 1990s regardless of the nature of the political coalition in power.15 As a result of the policy changes, India has since the early 1990s through international trade and investment links been much more heavily exposed to the challenges of economic globalization. The reform policies, opening up the country to stronger external influences, have furthermore been largely indigenously designed, and India may therefore provide a good example of what strong, independent developing states can hope to achieve under the new international economic circumstances. In the remains of this chapter I will limit myself to a brief evaluation of India’s economic results since the 1990s—often contrasted with developments during the 1980s. I will not deal with specific policies, and I will deal neither with India’s efforts to shape the international regulatory regime, most importantly in the WTO, nor with its management of its external financial problems during the 1980s international debt crisis and during the Asian financial crisis (and other crisis) of the 1990s, although these policies all represent fine examples of how India has tried to manage its economic affairs in the new globalized economy. After the assessment of India’s experience, a parallel, but shorter, assessment of China’s experience will be offered leading up to the comparison of the two Asian giants.

1.4

India in the Global Economy

As mentioned in the introduction, an assessment of how India has managed in the new global economy can proceed at different levels of analysis. At the global level, the questions raised concern India’s ability to avoid being marginalized and maybe even to improve its presence

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globally. A supplementary relevant yardstick would be whether India has been able to maintain or improve upon its structurally determined ability to maneuver with regard to the dominant “Triad” in the world economy: the United States, the EU, and Japan. Despite progress in recent years, India’s position in the global economy remains quite marginal. After decades of continuous decline, India’s gross domestic product (GDP) in 1980 constituted only 1.7% of world GDP. It declined further to 1.5% in 1990, maintained this position in 2000, and only very recently surpassed its 1980 position reaching 1.9% of world GDP in 2006. In world exports, India’s position has changed in a similar fashion. In 1980, India’s export of goods and services constituted only 0.5% of world exports, a position that was maintained in 1990. During the 1990s, India’s position gradually improved to 0.8% in 2000, and the latest provisional (2005) figure of 1.3%.16 In world trade in manufactured goods, India’s position has improved in similar proportions but at a slightly lower level (WTO, 2007). It is remarkable, however, that in some of the commodities in which India has traditionally been a major exporter—tea, spices, leather—its global position has slowly eroded, while in others—pharmaceutical products and precious/semi-precious stones—India has emerged as a major exporter.17 In the global market for foreign direct investments (FDI), India has also improved its position due to the liberalization of its foreign investment regime since 1991. India’s share as recipient of global investments has increased from around 0.1% before 1991 to an all time high 1.3% in 2006.18 While the rise has been dramatic, the amount of foreign investments flowing to India every year is still quite modest. In comparison, China’s global share has been more than ten times bigger since 1990. A remarkable change in India’s position, however, is its emergence during the last few years as a new source of international investment. Although miniscule by international comparison— less than 1% of world FDI—Indian companies have since the turn of the century made some noticeable investments abroad in sectors such as pharmaceuticals, automobiles, basic metals, steel, and computer software.19 It is clear from these data that India’s position in the global economy continues to be quite marginal, but also that it has managed to slowly improve its global standing since the early the 1990s and especially since the turn of the century. There is thus no evidence at the global level to suggest that India is on its way to become marginalized in an increasingly globalized world economy, but we can

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neither conclude that India has advanced dramatically nor that it is on its way to do so in the near future. After all, an export performance that in 2004 placed the country one rank behind a very small—albeit highly developed—country such as Denmark indicates just how far India has to go before it may be counted among the heavyweights in the international economy. 20 During the 1990s, however, India has in important respects increased its “room for maneuver” in global economic matters. The dominant Triad economies account for about half of its merchandise export, and India for this reason alone continues to be highly dependent upon its relationship with these economies. It is remarkable, though, that the loss of export markets in Eastern Europe and the former USSR—and those markets were critical for India’s earlier “East-West balancing” trade policy—has been offset by significantly rising exports to Asia, as can be seen from figure 1.1. India’s import dependence on the Triad economies has declined somewhat during the 1990s, and developing Asia has become a more important source of imports. The decline of Triad import dependence has been mainly due to rising imports of oil from OPEC countries, compare figure 1.2.21 This probably does not represent any significant decrease in India’s substantial import dependence on the Triad powers, and the dependence on imported oil remains and is becoming 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1980/81 1982/83 1984/85 1986/87 1988/89 1990/91 1992/93 1994/95 1996/97 1998/99 2000/01 2002/03 2004/05 2006/07 EC/EU

Figure 1.1

USA

Japan

E. Eur. & USSR/Russia

Developing Asia

OPEC

India’s export to major destinations, 1980/1981 to 2006/2007

Source: Government of India, Economic Survey (New Delhi, various years); Reserve Bank of India, Handbook of Statistics on Indian Economy 2007 (Mumbai).

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100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1980/81 1982/83 1984/85 1986/87 1988/89 1990/91 1992/93 1994/95 1996/97 1998/99 2000/01 2002/03 2004/05 2006/07 EC/EU

USA

Japan

E. Eur. & USSR/Russia

Developing Asia

OPEC

Figure 1.2 India’s import from major suppliers, 1980/1981 to 2006/2007 Source: Government of India, Economic Survey (New Delhi, various years); Reserve Bank of India, Handbook of Statistics on Indian Economy 2007 (Mumbai).

increasingly acute. It is worth noting, however, that the last few years have seen a rapid rise in India’s import from Asia, in particular from China. The overall picture of India’s position in the global economy, then, is one of small but important improvements of a largely marginal position. India is still mostly dependent on its economic links with the dominant economic powers. Trade with the rising Asian economies has increased in importance, and this diversification has slowly modified its overall trade dependence.

1.5 The Performance of India’s National Economy The economic reform program initiated by the Indian government in 1991 had as its natural immediate objective to handle the acute economic crisis at the time, but its long-term aim was to lay the foundation for future sustainable economic growth. As can be seen from figure 1.3, economic growth had proceeded at a respectable pace during the 1980s, in contrast to many developing countries who were badly hit by the debt crisis and for whom the 1980s became the “lost decade.” The crisis in the early 1990s is easily discernible, but so is the rapid recovery that followed the crisis. The period after the

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18 16 14 12

Percent

10 8 6 4 2 0 –2

1986–87 1988–89 1990–91 1992–93 1994–95 1996–97 1998–99 2000–01 2002–03 2004–05 2006–07

–4 Total GDP

Manufacturing GDP

Figure 1.3 Gross Domestic Product. Annual growth rates, 1986–1987 to 2006–2007 Note: Data for the most recent years are estimates. Source: Reserve Bank of India, Handbook of Statistics on Indian Economy 2007 (Mumbai).

introduction of the economic reforms has been characterized by quite respectable growth rates comparable to or slightly higher than growth in the 1980s. It was only after 2002 that the annual growth rates seem to have stabilized at a higher level than previously. Part of the explanation for the encouraging economic growth figures probably also lies in the absence of monsoon failures or other natural calamities impacting negatively on agricultural output. The manufacturing sector has been most directly influenced by the gradual opening of the economy and by the economic reform program in general, and growth rates in this sector have also been quite satisfactory, especially in recent years. Despite this, the gradual increase in the share of manufacturing in India’s economy, which had been a constant feature of post-independence economic change, has slowed down in the period since the beginning of the reforms. In 1990/1991, manufacturing activities had risen to 16.7% of GDP (up from 10.8% in 1950/1951), but during the reforms in the 1990s the share of manufacturing stagnated—partly due to the rise of the services sector—and it only reached 16.3% in 2006/2007. 22 In a longer time perspective, the 1990s—but starting already in the 1980s—marks a turning point in India’s economic growth. Before this period, the Indian economy generally grew at a slower rate—the

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“Hindu rate of growth” of around 3.5%. It bears remembering, however, that this modest growth rate was similar to the average growth of other developing nations. 23 To this should be added that the external balances have turned positive during the 1990s, and India has gradually accumulated significant—maybe excessive—foreign exchange reserves. The trade balance remains negative, however. In contrast to the situation in the early 1990s, the level of foreign exchange reserves combined with the fact that India has kept in place some capital account regulations today provide substantial protection against a crisis induced by speculative financial flows. India thus managed to avoid being seriously affected by the Asian financial crisis in 1997. The decent economic performance of the Indian economy has not been without problems, and these problems are regularly being debated within India. It is not possible here to refer to all the issues in this debate, but problems of external financial and technological dependency, a mounting internal debt problem and the socially exclusionary nature of the economic growth process are all important issues included in this discussion. 24 In a more comprehensive evaluation of how India has fared since the early 1990s, social issues of relevance for the country’s ability to manage globalization challenges would obviously be included. Of crucial importance here is the question of poverty, illiteracy and lack of health care. Lack of significant progress in these areas clearly threatens the long-term sustainability of the economic growth process.25 One could add that improvements in these areas will probably be of crucial importance if India decides in earnest to attempt to meet those challenges from economic globalization that are linked to the emergence of a new paradigm for industrial production, compare below.

1.6 Toward a New Economic Paradigm of Growth? Developments at the Sector Level The transition to a new paradigm of industrial production constitutes a core element of the globalization challenge for developing countries. There are a number of different but converging theoretical approaches that try to capture the essence of the new paradigm. Some approaches, associated in particular with the so-called French Regulation School and the discussion of the transition from “Fordism” to “Post-Fordism” are concerned mainly with macro-societal institutional variables such as “regimes of accumulation” and “modes of

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regulation.”26 Others within the same broad discussion are concerned with micro-oriented changes in production processes and collaborative network arrangements of firms operating under intense competition and rapidly changing technologies.27 Finally, the debate over the change toward economic activities dominated by intellectual labor and knowledge-intensive processes involving the new electronic forms of communication and information processing comes close to a similar vision of the future of global capitalism. 28 These debates have mainly been conducted with explicit reference to the developed part of the world, and only occasionally have there been attempts to relate the debate to the situation in developing countries. 29 With a globalizing world economy integrating economies of developing countries, the changes referred to in these debates become increasingly relevant for countries, such as India, that strive to benefit from the process of global integration. Instead of tracing these debates in detail I will simply summarize some of the common core elements that have emerged as characteristics of what may be termed a new paradigm for futureoriented economic activities. The new forms of economic activity that embody the “new paradigm”—it is generally agreed—are characterized by (1) flexible and specialized production processes, (2) production processes with a high proportion of technology—or knowledge-intensive activities, (3) conducted by firms that are enmeshed in network collaboration with other firms, often globally organized. Some of these characteristics are expected to be found within the production of new high-tech products in the electronics and software sectors, but they may equally well be found in more traditional sectors with the adoption of new methods for producing and marketing products, taking advantage of the new information and communication technologies. The emphasis on knowledge intensity also points to important changes within what has traditionally been labeled the “service sector,” where processing and dissemination of information, consultancy and a variety of intricate financial activities may be seen as a form of “production” closely related to the emergence of the new economic paradigm. As a consequence, the extent to which the new paradigm has been introduced in an economy is not easily captured by standard economic classifications from national accounts data and so on, and it is a complex task to indicate precisely to what degree a particular national economy has made the transition to the new paradigm.30 There is little doubt that Indian industry and the Indian economy in general far from conform to the prescriptions of the new paradigm.

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The majority of Indian industries are low-tech with few elements of knowledge intensity and a weak basis in research and development. Furthermore, India’s infrastructure is deficient and far from satisfactory seen from any perspective. What is at stake here is, however, the question whether there are discernible signs of India moving in the direction of the new paradigm for economic activity in the domestic economy as well as in its relations with the world economy during the period of economic policy changes. 31 A preliminary assessment of the effects of the economic reforms on Indian industry can be made on the basis of a comparison at the sectoral level between two industries that may be seen as examples of the new and the old industrial paradigms, respectively. The textile industry may be seen as the prime example of traditional, laborintensive (Fordist) principles of production, while the electronics and computer industry with its related activities in software production and so on. may represent the new paradigm.32 Another strong argument for focusing upon these two sectors is that the policies toward both sectors were significantly liberalized in the mid-1980s, well before the general liberalization of 1991. 33 There is thus better scope for assessing the impact of a more liberal policy environment in these two sectors. A full assessment is not possible here, but a few indications of developments in production and exports of the two selected branches combined with additional information of a related nature will suffice. The textile industry has traditionally constituted the largest industrial sub-sector within Indian industry, accounting for close to 20% of total industrial output.34 It covers a wide variety of products and producers, and its output of textile cloth forms the basis for the garment industry. The computer industry is tiny in comparison, and it forms only a small, but expanding part of total production of electronics goods. The software industry was smaller again, but has expanded even more rapidly.35 The differences in performance between textiles and computers and related products have been significant after the early 1990s. Both cotton textiles and textile products (garments) have grown at a pace similar or slightly lower than that of the overall manufacturing sector. By comparison, computer production rose rapidly until the mid-1990s, stagnated in the late 1990s and experienced an explosive growth from 2001/2002. Most impressive have been the advances of the software industry, whose “production” throughout the period has consistently outpaced any other type of activity. There are thus small but significant

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signs of a gradual transformation within Indian industry, with more advanced types of production gaining in importance. From the viewpoint of international competitiveness and future sustainability, export performance may be an even better indicator than domestic performance of the changes in the Indian economy. The data presented in figure 1.4 support the above impression from production figures. Export of textile products has grown at a pace slightly higher than another traditional item, leather products, but slower than the initially much lower export of computer software services. From around the year 2000, India’s annual income from the export of software has exceeded the export earnings of the large garment sector. The pattern of stagnating exports of traditional products and rapid growth of knowledge-intensive “products” thus confirms the picture from the different growth trajectories within the manufacturing sector. Taken together, both production and export figures indicate that there are signs of a change within Indian industry, moving in a direction that broadly conforms to what was described as a new paradigm for economic activities. Conversely, signs of any successful expansion based on a traditional Fordist industrialization strategy have so far been largely absent; compare also the relative decline of India’s 18000 16000

US$ Million

14000 12000 10000 8000 6000 4000 2000

19 8

8/ 19 89 89 / 19 90 90 / 19 91 91 / 19 92 92 / 19 93 93 / 19 94 94 / 19 95 95 / 19 96 96 / 19 97 97 / 19 98 98 / 19 99 99 / 20 00 00 / 20 01 01 / 20 02 02 / 20 03 03 / 20 04 04 / 20 05 05 /0 6

0

Leather goods

Figure 1.4

Garments

Computer software

Export of selected products and services, 1988/1989 to 2005/2006

Source: Government of India, Economic Survey (New Delhi, various years); Electronics and Computer Software Export Promotion Council (www.escindia.com).

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exports of traditional items mentioned in section 1.4. One should, of course, be careful not to overstate the significance of the changes in industrial activities. Within the rapidly growing software industry there are significant elements of low-end services with less intellectual content, and within the textile industry there has emerged a significant element of advanced high-value garment production.36 In addition, there is the question of how the changes will affect the overall industrial structure in India. There is an obvious danger of establishing enclaves of future-oriented, high-tech economic activities based on imported technologies and intimately linked to global economic networks managed essentially by large transnational corporations, but with few links to the domestic economy. Signs of such a development can be found in both the strongly export-oriented software industry and within the equally strongly export-oriented garment industry. But while collaboration agreements involving foreign technology have increased, the direct control by transnational corporations over these activities via the direct investment route is probably still confined within reasonable limits, compare also below.37

1.7 Company-Level Challenges and Changes Private companies have generally had good times in India since the early 1990s. Corporate profitability rose during the latter part of the 1980s, and they continued to rise during the first half of the 1990s, compare figure 1.5. In the second half of the 1990s, profitability declined somewhat, probably reflecting the lower growth of the manufacturing sector during those years. With the booming economy after 2000, corporate profitability has increased once again, and it has stabilized at a level higher than that of the 1980s. The period after 1990 has also witnessed a substantial rise in trading volumes on Indian stock markets, where share prices of the new “infotech” companies have gone up dramatically. Rising stock prices have resulted in the owners of some of the new computer and software companies becoming the new “industrial moguls” of India. In June 1999, the U.S. magazine Forbes reported that the world’s richest Indian now was the owner of Wipro, one of the most successful Indian infotech companies, replacing almost symbolically owners of steel, petrochemicals and textile companies.38 The bursting of the IT “bubble” in combination with a restructuring and resurgence of a broad spectrum of companies engaged in traditional manufacturing industries have provide a more balanced situation where sections of the old industrial

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14 12

Percent

10 8 6 4 2 0 1987/88 1989/90 1991/92 1993/94 1995/96 1997/98 1999/00 2001/02 2003/04 2005/06

Figure 1.5

Corporate profitability in India, 1987/1988 to 2005/2006

Source: Own calculation of annual average profits on the basis of Reserve Bank of India’s regular surveys of around 2000 non-government, non-financial public limited companies published in Reserve Bank of India Bulletin. The annual surveys normally cover three years, so for every year except the first and the last two there are three observations, from which I have calculated an average profit ratio.

elite (the Birlas, Ambanis, Bajajs, etc.) have regained their position, but now share it with new members coming from the IT sector, pharmaceuticals, biotech, telecommunication and the commercial airline industries. 39 The dramatic rise of information technology companies is one remarkable development among Indian companies after the economic reforms. Another is the increase in inward foreign direct investments, compare the more than tenfold increase in India’s share of global investments noted above. Foreign companies have directed their investments toward many of the new areas that were opened up to international investors, but they also, and more controversially, started buying out their Indian partners in those joint ventures that were mandatory under the old investment rules. In some instances foreign companies even started new subsidiaries, which compete with the ventures jointly owned with Indian partners. Actions such as these by foreign companies in combination with a general increase the level of competition made some Indian companies appeal to the Indian government for some measure of protection—“a level playing field”— against the superior financial power of foreign companies.40 As a response to these protests from different sections of Indian industry

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the government introduced an element of protection in its FDI policy in 1998.41 Despite this and other administrative protective measures the economic liberalization policies have been continued over a broad front. From the information presented in table 1.1 on the changes in structure of the corporate sector in the early part of the reform period there seems to be little reason for the concerns voiced over a possible foreign takeover of the industrial sector.42 The most significant change in the corporate sector during the 1990s was the relative decline of the public sector, largely due to a tremendous increase in the assets of private companies along with a stagnation of government investments. Among private companies the increase has been evenly shared among Indian and foreign companies, with a slight decline in the share of foreign companies and a similar slight increase among Indian companies outside the circle of leading business houses. The increase in foreign direct investments from the late 1990s onward may have increased the relative weight of foreign capital in the Indian economy somewhat, but the presence of foreign companies is still at a very low level.43 From the available information on the behavior of private business enterprises, there seems to be clear signs of a change toward more future-oriented economic activities, which may make Indian industry able to manage even in an open and competitive global economy dominated by a new high-tech production paradigm. This is reflected in the broad sector-wise changes presented above, but it is also confirmed by a recent unique study of the reorganization of a large Indian company, Crompton Greaves Ltd., an electrical engineering company.44 The company started as a British company, became Indian owned Table 1.1

Distribution by ownership of corporate sector assetsi

Percent share Total corporate sector ● Government sector ● Private sector – Indian private sector – Top 50 Indian business houses – Foreign private sector

1991 100.0 46.6 53.4 46.0 26.2 7.3

1994

100.0

100.0 35.3 64.7

86.2 49.1 13.8

57.2 30.5 7.5

1997

100.0

100.0 27.5 72.5

100.0

88.4 47.2 11.6

64.3 33.8 8.3

88.6 46.7 11.4

Note: i The table is based on data on the corporate sector published by the Centre for Monitoring the Indian Economy (CMIE). The data cover around 70% of the total corporate sector. Source: Centre for Monitoring the Indian Economy (www.cmie.com).

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and had lived a quiet life under the protection offered by the old trade regime. The liberalization policies in the 1990s exposed the company to new competitive pressures and in response the company underwent a reorganization of its internal functioning and its relationship with suppliers and customers, much along the lines envisioned in the new industrial production paradigm and with the self-professed ambition of being a “world class producer” (Humphrey et al., 1998, p. 46). Similar examples of successful restructuring can be found among a broad selection of industrial companies. As a result, there is a rapidly increasing number of Indian companies—professing to be “World Class”—that are successfully coping with the challenges of globalization, both in the IT sector, which is central to the emerging new industrial paradigm, but also, such as Crompton Greaves, companies in more traditional industrial sectors, often making good use of new technologies.45 One indication of their sharply rising capabilities is the remarkable growth in foreign investments, including take-over’s, by Indian private companies. The number of Indian companies venturing abroad has virtually exploded. In 2004, the Reserve Bank of India could report 714 joint ventures and 1,043 wholly owned subsidiaries operating abroad, much above earlier figures.46 Led by companies belonging to the large Tata conglomerate (Tata Steel, Tata Motors, Tata Tea, Tata Chemicals and others) many Indian companies are today scouting Europe and the United States in search of potential candidates for commercial takeovers and a number of large deals have already materialized.47 It remains, of course, to be seen whether these deals will result in commercially viable enterprises, but the Indian companies seems quite confident in their ability to successfully manage their new acquisitions.

1.8

India: A Summary Assessment

The general conclusion from this survey of how India has managed the challenges from economic globalization, especially after the 1990s economic liberalization, differs according to the level at which the assessment is undertaken. At the global level, India’s overall position remains fairly marginal despite some advancement during the last few years. It is remarkable, though, that India has been able to maintain a significant element of economic independence due to its diversified pattern of foreign trade. At the national level, India has managed quite well since the crisis and the economic reforms of the early 1990s—but it must be noted that it had respectable growth rates already during the

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1980s, when its exposure to globalization was much weaker. While service activities have increased, manufacturing seems to have lost some steam along with economic liberalization. External economic balances have overall been positive despite a negative trade balance and India has accumulated considerable foreign reserves. When judged by the performance at the sectoral level, it is remarkable that India seems to have been able to enter into those economic activities which can be judged to have the best future potentials for economic growth. India is of course far from being an advanced knowledge-driven economy, but there are significant signs of rapid growth in knowledgeintensive economic activities. These positive changes are clearly seen at the company level. At this analytical level it is also remarkable how India has been able to advance economically without becoming excessively dependent on transnational companies. In this sense, India’s long tradition for economic self-reliance seems to have survived in the new globalized environment, which is truly remarkable, and it may give the country a better platform for taking part in the global economy than many other countries.48 A good indication of this is the remarkable surge in Indian investments abroad. Overall, India seems relatively well placed to take advantage of the changes going on in the global economy.49 This does not mean that India will emerge as a global economic power, nor does it mean that India will become a significantly better place to live in for the millions of poor Indians. There are vast areas where India’s industrial economy lacks the most basic preconditions for sustained economic growth. The main immediate obstacle to industrial growth is the deficient physical infrastructure, which needs to be dramatically improved. Funds to finance improvements have been hard to find in the public budgets, partly because of the intense competition for public funds among different political constituencies where short-term benefits usually rank higher than long-term projects with little immediate impact. This could well be one of the reasons why India continues to seek foreign aid for many of its infrastructure projects. The most important long-term obstacle is probably the lack of consideration for what is often referred to as social or human development. 50 There has been no coherent strategy to tackle the immense problems of poverty, poor health and education facilities, unemployment, and so forth. If measured against the standards of the new economic paradigm, improvements in human development, in particular in the field of education, will be of decisive importance in determining whether the new economic activities will be confined to enclaves or will spread

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to larger parts of the Indian society. While all this is well known to the Indian educated elite, the political conditions for implementing a coherent social and economic reform program seem to be largely absent. The present political scene, marked by the need to keep together very diverse political coalitions each having its own narrow political agenda, certainly does not seem capable of producing a firm majority possessing neither the political will, nor the administrative capabilities to carry through the needed policy reforms.

1.9 The Chinese Experience—A Brief Comparison51 Comparisons between India and China have a long history, and they often seem obvious due to the unique size of the two Asian giants. The very different organization of the two economies does, however, present a number of difficulties for a fair comparison, mostly because of the strongly private capitalist orientation of the Indian economy and the peculiar state-owned and state-directed nature of the Chinese economy. This difference means, for example, that while it makes good sense to speak of a conscious Chinese strategy for managing economic globalization, this is much less true in India with its multitude of private entrepreneurs and very little state effort to coordinate their activities, especially after the introduction of economic liberalization. In the following, I will nevertheless attempt to assess China’s economic progress along the same four analytical levels used to assess India’s progress in order to be able to characterize and systematically compare the two countries.

1.9.1

Global and National Level

At both the global and the national level, China’s economic progress has been truly remarkable, especially since the early 1990s. In 1980 China’s GDP constituted 1.7% of world GDP—the same proportion as India’s. This share declined slightly during the 1980s, reaching 1.6% in 1990. From then on, however, China has advanced rapidly to reach a 2006 share of 5.5% of global GDP. At the same time China’s presence in world markets increased even more rapidly. From a share of 0.9% of global exports of goods and services in 1980, China advanced to 1.6% in 1990, and “took off” to reach a (preliminary) 2005 share of 6.4%, making it the third largest exporter in the world.52 China’s export today exceeds large traditional exporters

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such as Japan, France, the United Kingdom, and the Netherlands. A similar but even more rapid growth pattern is found in global exports of manufactured goods (WTO, 2007). The most spectacular growth, however, has been in China’s share as a recipient of global foreign direct investments (FDI). In 1980, China had a share of global FDI similar to that of India, namely 0.1%. This rose to 1.7% in 1990, while India’s share remained at the same level. After 1990, China’s share of global direct investment advanced very rapidly to reach a share of more than 13% in 1994 before leveling off at around 7% of global FDI.53 All available data thus point to a very impressive advancement for China in the global economy, especially since the early 1990s, and there are no signs as yet of any slowdown in China’s rapid march forward. One caveat in China’s advancement in the global economy comes, however, from its increasing reliance on relatively few export destinations. Today the United States and Japan alone account for close to half of China’s exports, and together with the European Union and Hong Kong they consume 70% of China’s exports. This situation has made Chinese exports highly vulnerable to changes in these markets, including the threat from anti-dumping initiatives. 54 More than half of China’s exports consist of “processed exports,” that is exports based on final-stage processing of imported inputs, and its export growth has thus had very high import contents. 55 Furthermore, a large percentage of China’s imports come from other Asian economies, which shows how closely China is tied into the East and South-East Asian network of trade.56 As a result there is a clear common interest in maintaining high growth rates in the region, but should economic growth for some reason falter, regional competition for markets and for investments may also increase and may lead to political instability. The impressive international performance of China has its basis in and is complemented by equally impressive domestic growth rates. Annual growth rates have, with the exception of a few years, exceeded nine 9% since the early 1980s. Manufacturing activities have driven economic growth, but overall manufacturing’s share of national GDP has remained constant at approximately 35%—a very high level compared to most other countries. 57 One remarkable results of the expansion of the domestic economy is the reduction in poverty that has proceeded at a much faster rate than in India. The rapid growth of the domestic economy has not been without problems, however, and critics have pointed to a number of imbalances and potential problems

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for future growth.58 To most observers, these problems are not yet seen as presenting obstacles to economic progress in the near future although signs of social unrest and environmental degradation are becoming more visible.

1.9.2

Developments at the Sectoral and at the Company Level

A glance at the sector-wise distribution of China’s industries shows that the recent industrial growth has been especially rapid in the more modern and high-tech oriented industries. The best example is the manufacture of “communications equipment, computers and other electronic equipment,” which has grown to become the largest single industrial branch (measures by sales revenue), surpassing traditional industries such as textile and garments and even the large steel industry. Textile and garments combined remains the largest industry in employment terms, however. 59 Overall, China’s industrial sector is still dominated by traditional industries with a strong element of intermediate industries such as chemicals, metals, and petroleumrelated industries but including also transport equipment and electrical machinery. Export of goods normally classified as high-technology items— mostly electronic goods—has grown rapidly during the 1990s, reaching 22.4% of total exports in 2000. At the same time, low-technology manufactured items—primarily textiles and garments—have maintained their high share of close to 50%.60 The export items in relative decline have mainly been primary products and manufactures based on natural resources. From the observations on the nature of industrial growth in China and the composition of its exports, it would seem that China is well on its way in a transition to a Post-Fordist knowledge-intensive industrialization. On the other hand, the continued high shares of low-technology products in both production and export point in the direction of maintenance of a traditional Fordist pattern of industrialization. The puzzle of this “dual-track” development is resolved when we focus on the company level in China’s recent development. This is the area where some of the skeptical comments to the Chinese economic miracle have appeared, especially in comparison with the Indian development. The critics point to the fact that most of the export growth and most of the high-tech activities have been undertaken by foreign transnational companies, whose presence in the Chinese economy has risen dramatically as a result of the inflow of foreign direct investments since the early 1990s. It is estimated that more than 50% of

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the total value of all Chinese exports is accounted for by foreign companies located in China.61 Furthermore, an impressive share of more than 80% of China’s export of high-technology items originates from affiliates of foreign companies.62 Foreign companies also have a large presence in low-technology industries, one example being garments. It has been estimated that in 2000, more than 49% of total sales in garments came from foreign companies with a production base in China.63 Another estimate says that if the export by Chinese companies producing under contract with foreign companies is added to the export undertaken directly by foreign companies, the total share of Chinese export that falls under the control of foreign enterprises comes close to 70%.64 These data strongly indicate that the impressive Chinese economic growth miracle to a very large extent is the result of a highly successful strategy of inviting foreign companies to produce and export to the world market using the cheap but relatively skilled Chinese labor force. China has thus been strongly integrated into the global web of commodity chains managed by large transnational corporations. The strong role of foreign companies in the growth of China’s economy has led some commentators to predict that India’s much more “homegrown” or self-reliant path of economic development is likely to be more sustainable in the future.65 There is little doubt that the long-term aim of the Chinese strategy is to transform its present dependence on foreign transnational companies into a situation where new internationally competitive Chinese-owned companies—private or state-owned—will play a much stronger and possibly dominant role.66 Whether this will eventually be the outcome is still unknown. A detailed examination of some of the largest Chinese companies has questioned their ability to challenge the overwhelming global dominance of large, mostly western, transnational corporations.67 There have also been some official voices expressing disappointment with the absence of the expected economic and technological spill-over from transnational corporations to domestic companies.68 Despite these pessimistic assessments, Chinese companies have in recent years made spectacular advances in international markets led by the large state-owned companies. Many state-owned companies have successfully ventured abroad in search of oil and other natural resources, mostly in African countries.69 These resource-seeking investments may be seen as a logical consequence of the domestic strategy of resource-intensive growth and they have been much larger than similar Indian investment projects. What is more interesting are recent examples of private Chinese companies acquiring prominent

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Western companies. The domestic computer manufacturer, Lenovo, thus bought IBM’s loss-making personal computer division in late 2004, thus entering the top league of global computer manufacturers, and Nanjing Automobile Group bought the defunct British car-maker MG Rover. Other examples of prominent globally active Chinese companies include Huawey in telecom equipment and Haier in white goods.70 The foreign investment activities by Chinese private companies seem to be less diversified than those of Indian companies, and they have been concentrated on a few, but very large acquisitions. The private nature of the Chinese companies involved has also been questioned, with some commentators pointing to the very close links between the companies and the Chinese government or the Chinese military.71 These links suggest on the one hand that the investments may be seen as attempts to fulfill the official Chinese ambition of creating its own large transnational corporations. On the other hand, doubts remain whether the Chinese companies will succeed in turning loss-making entities into profitable ones. In this context, the close links to Chinese officialdom (and to state financial resources) may act as a financial safety net but at the same time it may provide less incentive to ensure commercial profitability and long-term sustainability.

1.10 Conclusion In comparison with India, China’s management of economic globalization has for an immediate observation yielded far more and far better results. China has become a major player in the world economy and on world export markets, and it has experienced much higher growth rates and social improvements. Furthermore, the Chinese economy has made some decisive moves toward new knowledge-intensive, high-tech activities. On the other hand, most of the Chinese growth has rested on an intensified use of Fordist production practices, as in textiles and garments, and assembly operations within electronics. These activities may not yield much value-addition, and a large proportion of the economic growth has been directly or indirectly controlled by foreign companies. Same types of activities are found in India, but here foreign control has been much less and private domestic companies have been much more prominent actors. And in relative terms, it is likely that new high-tech Post-Fordist activities are more prevalent within India and certainly within its booming software industry dominated by domestic companies. Given these differences, the truly exiting question

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regarding the future is not so much the question of “who will win”— India or China—but rather what type of strategy will prove viable in a globalized world economy: India’s more traditional, self-reliant way of “climbing the ladder” or China’s attempt to utilize foreign investments and the insertion into the low ends of global commodity (and value) chains clearly dominated by global transnational corporations in order to obtain high rates of growth as a first phase of a more comprehensive development strategy. China’s ambition is clearly to let this first phase be followed by a second phase that seeks to transform the quantitative gains of the first phase into qualitative gains through the creation of globally competitive Chinese companies in modern, high-technology industries (as illustrated in figure 1.6).72 So far, no other country has succeeded in pursuing this kind of sequential strategy. Both Japan and South Korea saw to it that their domestic companies were heavily protected during their economic ascent and their economies remained for long largely closed to foreign competitors. Singapore may represent an earlier version of the strategy that China is using today, but what was appropriate for a small entrepôt island economy may not be as relevant for a continental size economy such as China’s. On the other hand, it needs to be recognized that the changes in the global economy have made a closed-economy strategies largely irrelevant, and that a determined and resourceful government such as the Chinese may have good

Strategy based on Strategy based on traditional manufacturing knowledge-intensive industries (‘‘Post-Fordism’’) (‘‘Fordism’’)

Strategy based on foreign companies

? Strategy based on domestic companies

Figure 1.6

China India

India’s and China’s different strategies to reach economic prosperity

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chance of succeeding in turning the invasion of foreign companies into an engine for development of local companies. An important strategic weakness of both India and of China is the lack of genuine technological innovation activities and the absence of significant and strong technological spillovers from whatever foreign investments they have received. Both countries have intensified their efforts in research & development, but despite this an actual output of innovations and technological breakthroughs have not materialized yet.73 One possibility is that both countries will be successful by using different strategies to manage globalization and achieve economic progress. The theoretical implication of this outcome is to strengthen the viewpoint that every nation has to find its own development strategy using the experience of others as a source of inspiration rather than as a predetermined blueprint for success. This will in many ways be a welcome development that could move the debate on development strategies away from the sterile opposition between the neo-liberal and the state planning positions. For the global economy, the implications of continued economic progress of India and China are huge and widely debated internationally. One largely ignored aspect concerns the effects on the poorer parts of the world economy. Poor countries may see their prospects for future development evaporate because of India and China filling out whatever space for progress is globally available—as is probably the case within the global textile and garment industry at present. They may, however, also see increased prosperity as a result of growing beneficial links to the growing Asian economies, as witnessed by some African exporters of raw materials and importers of cheap consumer goods, primarily from China. Should China or India—or both—fail, the consequences will probably depend on which one it is. A failure of India to develop will probably affect the global economy the least because of the country’s lower degree of global integration. A collapse of the Chinese economy on the other hand may plunge the world economy into severe turmoil that may only be mitigated by the development of stronger compensating links with other large economies, possibly India. In this sense, the fate of the two large Asian countries may increasingly be intertwined in a new type of future Great Asian Game.

Notes 1. The media hype on this has been extensive, especially within India itself, where the country today is often being portrayed as a rising superpower. Among

26

2. 3.

4. 5. 6. 7. 8.

9.

10. 11.

12. 13. 14.

15.

16.

Jørgen Dige Pedersen the more analytic celebrations of India’s potential for economic greatpower status along with China, Brazil and Russia is the report by Goldman Sachs on the rise of the BRIC countries (Brazil, Russia, India, and China). Goldman Sachs (2003), Dreaming with the BRICs: The Path to 2050 (by Wilson, D., & Purushothaman, R.), Global Economics Paper No. 99, 2003. Dicken, P. (1998), Global Shift. Transforming the World Economy. London: Paul Clapham, p. 4. Gundlach, E., & Nunnenkamp, P. (1998), “Some Consequences of Globalization for Developing Countries,” in J.H. Dunning (ed.), Globalization, Trade and Foreign Direct Investment, Amsterdam: Elsevier, pp. 153–174. Hirst, P. & Thompson, G. (1996), Globalization in Question. London: Polity Press. Oman, C. (1994), Globalization and Regionalization: The Challenges for Developing Countries. Paris: OECD Development Centre. Burbach, R. & Robinson, W.I. (1999), “The Fin De Siecle Debate: Globalization as Epochal Shift.” Science & Society, 63:1, Spring: 10–39. Hoogvelt, A. (1997), Globalisation and the Postcolonial World. The New Political Economy of Development. London: Macmillan, Ch. 6. Dunning, J.H., van Hoesel, R., & Narula, R. (1998), “Third World Multinationals Revisited: New Developments and Theoretical Implications,” in J.H. Dunning (ed.), Globalization, Trade and Foreign Direct Investment. Amsterdam: Elsevier, pp. 255–286. Strange, S. (1996) The Retreat of the State. Cambridge: Cambridge University Press; Strange, S. (1998) Mad Money. Manchester: Manchester University Press. Hoogvelt (1997), p. 131. See Weiss, L. (1997), “Globalization and the Myth of the Powerless State.” New Left Review, 225, September/October: 3–27 compared to Strange 1996. Haggard, S. (1995), Developing Nations and the Politics of Global Integration, Washington DC: Brookings Institute. Oman (1994); Hoogvelt (1997). The story of the 1990–1991 crisis and the policy conditions attached to the loan agreements is narrated in great detail in Swamy, Dalip S. (1994), The Political Economy of Industrialisation. From Self-reliance to Globalisation. New Delhi: Sage. It is noteworthy that almost all conceivable political constellations—Center, Left, and Right—have been in power in New Delhi during the 1990s. One should also note that economic reforms did not all start in 1991. Liberalizing reforms were undertaken in various sectors during the 1980s, and while the timing of the 1991 reform package may have been influenced by the economic crisis and the pressures from the IMF/World Bank, the main ingredients had been prepared in the key economic ministries well before the crisis. See Pedersen, J.D. (2000), “Explaining Economic Liberalization in India: State and Society Perspectives.” World Development, 28:2: 265–282. Figures are taken from World Bank, World Development Indicators (Online). Due to different accounting practices, non-availability of data, and a host

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17.

18. 19.

20. 21.

22.

23.

24.

25. 26.

27. 28. 29.

30.

31.

27

of other data problems, aggregate figures derived from national accounts and from export data must be regarded as broadly indicative of shares and trends. India’s share of world export for selected commodities is listed in Government of India, Economic Survey 2004–2005. New Delhi: 2005, Table 7.5. Together with rice these are the only articles where India commands more than 10% of world markets. Figures are from UNCTAD’s FDI online database (www.unctad.org). Last accessed February 13, 2008. Examples are given in UNCTAD, India’s Outward FDI: A Giant Awakening? UNCTAD/DITE/IIAB/2004/ 1. Geneva: 2004. Reserve Bank of India, Annual Report 2004–05. Mumbai: 2005 provides an overview. See also ch. 2. Trade figures can be found on the WTO Web site (www.wto.org). Last accessed September 19, 2007. Increasing oil imports from international oil markets not allocated to particular supplier countries have caused the sudden apparent decline in OPEC imports. This has distorted import figures since 1998/1999. Calculated from Reserve Bank of India, Handbook of Statistics on Indian Economy 2007 (Mumbai, 2007). The latest revised figure is from Central Statistical Organisation (www.mospi.nic.in). Last accessed February 6, 2008. DeLong, J.B. (2003) “India since Independence. An Analytic Growth Narrative,” in Dani Rodrik (ed.), In Search of Prosperity. Analytic Narratives on Economic Growth. Princeton and Oxford: Princeton University Press, pp. 184–204. Good sources for critical views are the annual “Alternative Economic Surveys” published in New Delhi since 1992/1993 by the Public Interest Research Group, Delhi Science Forum and/or The Alternative Survey Group. Drèze, J. & Sen, A. (2002), India. Development and Participation. Delhi: Oxford University Press. Survey in Amin, A. (1994) “Post-Fordism: Models, Fantasies and Phantoms of Transition,” in Ash Amin (ed.), Post-Fordism. A Reader, Oxford and Cambridge, MA: Blackwell, pp. 1–39; Hoogvelt (1997), Ch. 5. See references in Kaplinsky, R. (1997), “India’s Industrial Development: An Interpretative Survey,” World Development, 25:5: 681–694. Reich, R.B. (1991) The Work of Nations. Preparing ourselves for the 21st century. New York: Albert A. Knopf. Perez, C. (1985) “Microelectronics, Long Waves and World Structural Change: New Perspectives for Developing Countries.” World Development: 441–463; Perez, C. (2001), “Technological Change and Opportunities for Development as a Moving Target.” CEPAL Review, 75: 109–130. To some the new paradigm implies a simultaneous dissolution of the national character of economies, which makes the task even more difficult. Among developed nations, the OECD is working to develop monitoring instruments to map the new “knowledge economy.” Similar questions form the closing remarks in Kaplinsky (1997).

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32. It is important here to emphasize once again that what is at stake is not the particular product produced, but the nature of the production process. It is very likely that for example computers may be produced—and often are— under “Fordist” principles while garments may be produced according to the principles of high-tech flexible specialization. 33. The policy changes were effected through the Computer Policy of 1984, the National Textile Policy of 1985, and the Software Policy of 1986. 34. The section on textile industry is based on UNIDO (1995), India. Towards Globalization, London: Economic Intelligence Unit, pp. 118–131 and on primary data on the industry from the Central Statistical Organisation. 35. See UNIDO (1995), pp. 193–201 and for greater detail Heeks, R. (1996) India’s Software Industry. New Delhi: Sage, and for recent years Department of Information Technology, Annual Report, New Delhi: various years. 36. See Ghemawat, P. & Patibandla, M. (1998), “India’s Exports since the Reforms.” Economic and Political Weekly, 33:20: 1196–1198 for a discussion of the changes within garments and software export. 37. From August 1991 to August 2004 the computer software industry and the textile industry made 3,355 and 813 collaboration agreements, respectively. The amounts of foreign investment involved were limited, however, with textiles representing 1.2% and software 3.7% of the total approved amount of foreign investments. The increase in investments in the software industry came only in the late 1990s. In 1998, for example, investments in both sectors each represented only 1.6% of the accumulated total foreign investments. SIA Newsletter, April 1998 and September 2004. 38. The list was reproduced in The Economic Times (Internet edition) in June 1999. 39. See “The Billionaire Club.” Business Standard, December 2004/January 2005. Out of 178 billionaires, 38 were from the IT industry and 24 from the pharmaceutical industry. Indian businessmen residing abroad are often included in the various lists. The world’s richest Indian is probably Lakshmi Mittal (Arcelor Mittal steel company). 40. In late 1993, a small group of industrialists—nicknamed the “Bombay Club”—issued a statement critical of the opening up to foreign competition, and in March 1996 the secretary-general of the influential Confederation of Indian Industry (CII) issued a statement strongly critical of the way in which multinational companies were allowed to behave vis-à-vis their Indian partners. 41. Ministry of Industry, Press Note 18, New Delhi, 1998, gave Indian companies effective veto powers over any future investment projects by their foreign partners in a similar field of activity. The restrictions were relaxed but not abolished in 2005 (Press Note 1). 42. Ganesh, S. (1997), “Who Is Afraid of Foreign Firms? Current Trends in FDI in India.” Economic and Political Weekly, 32:22: 1265–1274. 43. My own calculations based on the companies included in the regular studies published by Reserve Bank of India show a slight increase in the share of foreign controlled companies in the total sample of private companies after 1998/1999, but the share in 2004–2005 was still lower than in

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44.

45.

46.

47.

48.

49.

50.

51. 52.

53.

29

1990–1991. In a larger sample of manufacturing companies, the share of foreign companies in total sales was below 14% in 2001. See Nagesh Kumar (2005), “Liberalisation, Foreign Direct Investment Flows and Development. Indian Experience in the 1990s.” Economic and Political Weekly, 40:14: 1459–1469. Humphrey, J., Kaplinsky, R., & Saraph, P.V. (1998), Corporate Restructuring. Crompton Greaves and the Challenge of Globalisation. New Delhi: Response Books. See for examples Ghoshal, S., Piramal, G., & Budhiraja, S. (2001), World Class in India. A Casebook of Companies in Transformation, New Delhi: Penguin Books. Government of India, Handbook of Industrial Policy and Statistics 2003– 2005, New Delhi: Ministry of Commerce & Industry, 2005, Table 5.16, pp. 139–141. A few examples: Tata Motors bought the truck division of South Korean Daewoo, Dr. Reddy’s Laboratories recently bought German drug maker Betapharm, Bharat Forge acquired Imatra Kilstra of Sweden, Suzlon Energy has bough a Belgian producer of wind turbine generator gear boxes and, largest of all, Tata Steel acquired the Anglo-Dutch steel producer Corus. The list grows longer for every month passing! In a parallel study I am conducting on Brazil’s experience with economic liberalization, it comes out clearly how much the economic liberalization (and privatization) has increased the role of foreign companies in that economy. This was also the conclusion drawn at an early stage by Bimal Jalan, one of the most experienced economic advisors to the Government of India. Jalan, B. (1996), India’s Economic Policy. Preparing for the Twenty-first Century. New Delhi: Viking. Drèze and Sen have strongly criticized what they call the “monumental neglect of social inequalities and deprivation in public policy.” Drèze and Sen (2002), p. xv. Important issues such as the social sustainability of reforms and the importance of embedding reforms in a broader social configuration in order to strengthen India’s democracy are dealt with in Bhaduri, A, and Nayyar, D. (1996), The Intelligent Person’s Guide to Liberalization. New Delhi: Penguin Books. Recently Amartya Sen has voiced his concern that India could end up as a strange combination of California on the one hand and sub-Saharan Africa on the other (India Today, February 13, 2006, p. 30). China is in this context “Mainland China,” that is Hong Kong, Macao, and Taiwan are not included. All figures are from World Bank, World Development Indicators (online). There are unfortunately major difficulties involved in calculating China’s external trade, not least because of movements of goods to and from Hong Kong. In merchandise trade alone, China accounts for 8% of global trade (WTO, International Trade Statistics 2007, Geneva, 2007). UNCTAD, FDI Online (www.unctad.org). There are major problems in estimating and comparing FDI flows across countries due to lack of standardized procedures for reporting FDI. India’s FDI inflows are probably

30

54.

55. 56. 57. 58. 59. 60. 61.

62. 63. 64. 65. 66. 67. 68.

69.

70.

71. 72. 73.

Jørgen Dige Pedersen slightly underestimated, while China’s may be overestimated due to “roundtripping” (Hong Kong–China) and different reporting practices. UNCTAD, World Investment Report 2005 (New York and Geneva, 2005, pp. 4–5) reports large discrepancies between the reporting by China and by investing economies. Li, Y. (2005), “Why Is China The World’s Number One Anti-dumping Target?” in UNCTAD, China in a Globalizing World. New York and Geneva, pp. 75–103. Ibid. UNCTAD, Trade and Development Report 2002, New York and Geneva: 2002b, pp. 162–164. World Bank, World Development Indicators (Online). OECD, OECD Economic Surveys: China 2005, Paris. These are 2004 data taken from National Bureau of Statistics, China Statistical Yearbook 2005, Beijing. UNCTAD, World Investment Report 2002, New York and Geneva: 2002a, p. 162. See ibid., p. 163, Breslin, S. (2005), “Power and Production: Rethinking China’s Global Economic Role.” Review of International Studies, 31, pp. 735–753 & Flassbeck, H., Dullien, S., & Geiger, M., “China’s Spectacular Growth since the Mid-1990s—Macroeconomic Conditions and Economic Policy Change,” in UNCTAD, China in a Globalizing World. New York and Geneva, pp. 1–44, p. 36. UNCTAD (2002a), p. 162. UNCTAD 2002b, p. 152. Breslin (2005), p. 743. Huang, Y. & Khanna, T. (2003), “Can India Overtake China?” Foreign Policy, 137, July–August: 74–81. Kerr, D. (2007), “Has China Abandoned Self-reliance?” Review of International Political Economy, 14:1: 77–104. Nolan, P. (2002), “China and the Global Business Revolution.” Cambridge Journal of Economics, 26: 119–137. China Daily, “Overseas Investment on the Up,” February 2, 2005 (Extract from The Chinese Academy of Foreign Trade and Economic Cooperation, Report on Transnational Corporations in China 2005). Broadman, H.G., with Plaza, G., Ye, X., & Yoshino, Y. (2006), Africa’s Silk Road. China and India’s New Economic Frontier. Washington: World Bank 2006. The information on these internationally active Chinese companies has been taken from various reports in the international press (Economist, Financial Times, Asia Times Online). See “The Huawey Way” (2006), Newsweek, January 16, pp. 33–36. This is also the argument in Kerr (2007). Altenburg, T., Schmitz, H., & Stamm, A. (2008), “Breakthrough? China’s and India’s Transition from Production to Innovation.” World Development, 36:2: 325–344.

2 The Rise of Indian Multinationals: Explaining Outward Foreign Direct Investment from India Michael W. Hansen

2.1

Introduction

Many years of mediocre performance of Indian industry has recently been replaced by a newfound optimism. Indian firms appear to be reasserting their role in the global economy, and global investors now see India as one of the main investment destinations of the future. That developing countries, like India, are attracting interest among foreign investors is not new. The new thing, however, is that developing countries themselves are becoming sizable foreign investors. In the last few years, India has seen an astounding growth in outward foreign direct investment (OFDI): While inward FDI (IFDI) doubled between 2004 and 2006, OFDI grew four times in the same period.1 World class newcomer Indian firms are moving massively into IT and services in developed countries, and incumbent Indian houses are diversifying into the knowledge industry and/or acquiring the crown jewels of European and US manufacturing industry at intensifying rates. In industries such as pharmaceuticals, software, IT, telecommunications, and transport, Indian MNCs base their investments on advanced technologies2 , high knowledge intensity 3 and on cutting edge strategies and organizational modes.4 Even within the traditionally highly protected Indian manufacturing industry we have seen a range of Indian manufacturing firms becoming global leaders in their industry.5 Thus, it appears that India is in the middle of an OFDI takeoff.

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The Indian OFDI path is indicative of an aspect of globalization that will be crucial to economic development in the twenty-first century. Instead of being at the mercy of external forces of globalization (or at the mercy of national policies and regulations seeking to contain those forces of globalization), firms from developing countries are becoming the new protagonists of globalization, competing on par with MNCs from developed countries and sometimes even eclipsing them. Developing country firms have succeeded in becoming global lead firms in sectors such as building materials, financial services, steel production, hotels and hospitality, contract manufacturing, and so on,6 and firms such as Gazprom, Cemex, Samsung, Hyundai, Infosys, CNPC, Lenovo, Mittal, Tata, Flextronics, and so forth are rapidly becoming household names in global industries. For this reason, it is crucial to understand and analyze the rise of developing country MNCs, its manifestations, its causes, and its implications, and here the Indian case is an appropriate place to start—the country is already now the fourth largest economy in purchasing power parity (PPP) terms,7 it has an economy that is leading in the world within knowledge intensive sectors, and it has a young population that is destined to outnumber that of China within the next three decades.8 This chapter will take the temperature on Indian OFDI. It will start out by describing the major trends in Indian OFDI and finding out who the major investors are. It will, furthermore, review the received theory on OFDI from developing countries in search of theories that may aid us in understanding OFDI from India. Finally the chapter will confront the Indian experience with received theory and draw conclusions as to the drivers of Indian OFDI as well as to the applicability of received theory.

2.2

A Historical Account of Indian OFDI

In recent years, OFDI from developing countries has increased significantly, from a level around $30 billion in 1990–1995 to a level around $90 billion 2000–2005.9 Relative to global FDI, FDI from developing countries has increased from a level of approximately 8% in the 1990s to a level of around 18% today.10 This increase is mainly due to investment from Asian developing countries. While the Asian OFDI was previously driven by Hong Kong, Singapore, Taiwan, and Korea, now India and China are becoming the leading Asian outward investors, accounting for more than one quarter of OFDI from this region

The Rise of Indian Multinationals

33

in 2006, up from 10% two years earlier. In other words, together with China, India is becoming a sizable player in Asian OFDI.11

2.2.1

The Phases of Outward Indian FDI

OFDI from India is not a new phenomenon. In 1920, Mafatlal (textile) invested in a cotton-spinning operation in Uganda. Birla invested in Africa in the 1950s and in Southeast Asia between 1965 and 1981. In the early 1960s, large Indian conglomerates such as Tata and Kirloskar expanded their activities into Africa and Sri Lanka. And Ranbaxy set up its first JV abroad in Nigeria in 1977. These investments were, however, modest and hardly detectable in FDI statistics. In the late seventies and early eighties there was a more profound increase in OFDI, which gave rise to a literature on Indian OFDI.12 However, it was only with economic reforms in 1991 and onward that OFDI from India picked up in earnest; and since 2001 investment has surged. To characterize OFDI from India, Pradhan13 and Sauvant14 distinguish between two major phases: the first phase goes from the early investment boom of the mid 1970s to the adoption of the new industrial policy in 1991, the second phase runs from 1991 to the early 2000s. The phases are associated with major policy as well as structural changes in the Indian economy. We will, however, argue that the contours of a third phase are now discernable in Indian OFDI patterns and policy, going from 2001 and onward. Thus, in the following, we will make a distinction between three phases of Indian OFDI—denoted “the early phase,” where OFDI was small and stagnant and severely restricted by OFDI regulation; “the start up phase,” where OFDI began to grow in tandem with liberalization of policy regimes; and the current “takeoff phase,” where OFDI surged in conjunction with continued and deeper liberalization and opening of the Indian economy.

2.2.2

The Early Phase (1975–1990)

During the early phase of Indian OFDI, the vast majority of investments were made by manufacturing firms. The level of commitment of the investing firms was modest, and typically investments played minor roles in their strategies. Moreover, in all cases, the Indian firms were minority participants in the OFDIs. The vast majority (86%) of investment went to other developing countries, the main destinations being Singapore, Thailand, Sri Lanka and Malaysia, and was made in the form of minority participation.15

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Michael W. Hansen

In the early phase of Indian OFDI, OFDI polices were highly restrictive as OFDI was seen as a diversion from national development priorities. Starting in 1969, Indian guidelines for OFDI stated that OFDI should be export-supportive, and the equity contribution should be in the form of exports of machinery, equipment, and knowhow.16 Moreover, OFDI should be in the form of Indian minority participation to save Indian currency and capital.17 In practice, OFDI was restricted further due to extremely slow and difficult approval procedures. Also more general industrial polices had implications for OFDI: for instance, antitrust legislation may have pushed large Indian conglomerates into OFDI, as there were no more opportunities for growth at home.18 Finally, OFDI was mainly seen as part of South-South economic and political co-operation.

2.2.3

The Start-up Phase (1991–2000)

During the OFDI start up phase, the level of OFDI gradually increased. Larger proportions of investments were made in the service sector, and investments became increasingly oriented toward developed

12000

14000 12000

10000

10000 8000 6000 6000 4000 4000 2000

2000

0

0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Flows, outward

Figure 2.1

Stock, outward

Outward FDI (OFDI) from India 1980–2006

Source: UNCTAD (2007).

Stock

Flows

8000

The Rise of Indian Multinationals

35

countries.19 The backdrop to the growing OFDI was profound liberalizations of the Indian investment regime. The restrictive OFDI policy of the 1970s and 1980s changed with the reforms that were initiated in the wake of the New Industrial Policy in 1991. The government instituted automatic approval procedures for OFDI under thresh-holds that were gradually raised during the period, from $2 million to $100 million. 20 A number of constraints and restrictions on OFDI were furthermore lifted. The curbs on equity participation were removed, and the approval system was made speedier and more transparent.21 During this period, the number of bilateral investment treaties between India and other countries grew from no treaties to more than forty treaties, and India engaged in various regional trade agreements, in which FDI was an important component. Among these regional trade and investment agreements was the Bangladesh-India-Myanmar-Sri Lanka-Thailand Economic Cooperation (BIMSTEC), China-India Free Trade Agreement, South Asia Free Trade Area (SAFTA), the Indian Ocean Rim Association for Regional Cooperation, the Indo-Lanka Free Trade Agreement, and the ASEAN-India FTA.22 While therehad been waves of Indian OFDI in the 1980s, as mentioned, the ODFI of the 1990s was larger and more durable and included more industries and a broader selection of developing countries. Thus, the level of investment increased from on average $5 million a year before 1991 to $132 million after 1991 and the stock of 70 60 50 40 30 20 10

19

80

–1

99 0 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06

0

Figure 2.2 Number of bilateral investment treaties between India and other countries, cumulative Source: UNCTAD (2007).

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Michael W. Hansen

OFDI rose from on average $95 million in 1980–1990 to $720 million in 1991–2000. The total number of approved OFDI projects was 2562 in the 1990s, almost eleven times more than the number of projects approved 1975–1990. 23 In terms of location, a very significant shift took place as well. While 86% of OFDI previously went to developing countries, this share fell to approximately 40% during this period. Among the developed countries it was particularly the United Kingdom and the United States that dominated. 24 During the start-up phase, a very significant movement from manufacturing to services took place, in which manufacturing accounted for 65% of equity and services for 33%; this relation had almost been reversed in the period between 1991 and 2000, so that services now accounted for 59% and manufacturing for 39%. Investors in this phase of Indian OFDI went from the escape and simple market-seeking investments of the early OFDI-phase to increasingly advanced market-seeking strategies, where firms were moving into developed countries to access markets and to access strategic assets in these countries.

2.2.4

The Takeoff Phase (2001–)

As argued, we can see the contours of a third phase of Indian OFDI. From 2001, and certainly from 2003, we have seen a notable surge in Indian OFDI; OFDI has increased more than five times from 2001 to 2006 whereas inflows increased only about two and a half times, and alone between 2005 and 2006 there was a 150% increase. The latest surge in FDI has to a large extent been driven by mergers and acquisitions M&As. Where 37 M&As were made in 2001, by 2006 this number had increased to more than 170; in particular from 2005, M&As gained momentum, increasing from 70 to 150. 25 Many of the recent deals were so-called mega deals, for instance Mittal’s acquisition of Arcelor in 2006. 26 The M&A strategies are particularly popular in the pharmaceutical and the software industries, 27 and typically it is large firms that undertake such deals, although some software M&As have been made by SMEs. 28 In terms of sectors, non-financial services (which include IT) overtook manufacturing in the late 1990s, and although manufacturing in recent years has overtaken services again, services remain important. The service-internationalizers include old houses that have diversified into software and IT (e.g., Tata Consulting Services, Satyam and Wipro

37

5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0 19

8 19 7 8 19 8 8 19 9 9 19 0 9 19 1 9 19 2 9 19 3 9 19 4 9 19 5 9 19 6 9 19 7 9 19 8 9 20 9 0 20 0 0 20 1 0 20 2 0 20 3 0 20 4 0 20 5 06

US$ mill

The Rise of Indian Multinationals

Figure 2.3

Indian M&As abroad

Source: UNCTAD (2007).

Technologies). Others are new start ups within the software industry (e.g., Infosys and PCS). 29 Among the examples of business process outsourcing and back office internationalizers, we can mention that Daksh Services, India’s largest business process outsourcing (BPO) company, has established a facility in the Philippines; that MsourcE in 2003 invested in building a language centre in Tijuana, Mexico; that Datamatics Technologies acquired CorPay Solutions (United States) in 2003; that Hinduja TMT Ltd took over the Philippine call centre c3, in 2003; and that HCL Technologies has increased its investment in Belfast.30 Many of the OFDIs in services are supportive of export. Thus, OFDI by Indian IT and consultant firms is typically a way to expand from their traditional outsourcing base into developed countries to tailor their services to clients and to improve sales efforts.31 In the takeoff phase, natural resource-based investors have also started internationalizing in earnest, for example the chemical and steel industry acquiring upstream activities in Canada and Australia, or energy firms engaging in acquisitions of assets in exploration, refining and retailing.32 Among the better known examples are the acquisition of oil and gas fields in Sudan and Russia by the Oil and Natural Gas Commission Ltd. (ONGC), the US$3 billion acquisition in Iran by Indian Oil Corporation, 33 or the acquisitions of copper mines in Australia by Hindalco. 34 The exceptionally high growth rates of India have revealed its vulnerability to energy shortages and a paramount development priority for the Indian government has become

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Michael W. Hansen

100%

2

3

5

21 80%

46

33

44 62

60%

40%

76 54

62

55

20%

36

0% 1975–1985

1986–1990 Other

Figure 2.4

1991–1995 Services

1996–2001

2002–2006

Manufacturing

Sector composition of Indian OFDI

Source: Reserve Bank of India (2006).

to acquire natural resource assets. The Indian government has, consequently, pushed for its energy firms (which are partly state-owned) to gain licenses and permits for resource exploitation. 35 In the “start-up” OFDI phase, developed countries took over as the dominant destination for FDI. However, in 2001 and 2002, FDI in developing countries surged and lead to developing country FDI become leading again, largely explained with a few spectacular natural resource investments in Russia in 2001 and Sudan in 2002. By 2003, FDI in developed countries was dominant again, mainly due to the large M&As discussed above. Also, FDI in offshore centers such as Mauritius, Virgin Islands and Bermuda has gained in importance during the “takeoff” phase. Whether these are in fact platforms for investments in developed or developing countries is unclear; there is some indication that investments in the off-shore center Mauritius may conceal investments in Africa, as Mauritius is a member of COMESA (the African trade block). Apart from the resource seeking investments in Africa, Indian investment in developing countries has increasingly been directed toward the most advanced developing countries, that is Hong Kong and Singapore. While the latest surge in FDI has investors of market, resource, and efficiency seeking types, it is evident that Indian firms are increasingly

The Rise of Indian Multinationals

39

80 70

Percent of all

60 50 40 30 20 10 0 1996–2000

2000–2001

2001–2002

Developed

Figure 2.5

2002–2003

Developing

2003–2004

2004–2005a

Offshore centers

Country orientation of Indian OFDI

Source: Indian Ministry of Finance.

investing abroad to get access to and acquire firm-specific assets and intangibles, such as technology, skills, and marketing expertise. Sometimes these acquisitions are part of Indian MNCs’ attempt to further expand their strong competitive position into new markets, while they in other cases are attempts to compensate for relatively weak ownership advantages (except for a strong financial standing) by acquiring technologies, brands, and human resources abroad.36 These strategic asset-seeking investments partly take place through acquisitions, such as Wipro’s buy of Nerve Wire Inc. (United States), I-Flex’s acquisition of Supersolutions Corp. (United States) and Reliance Infocomm’s acquisition of Flag Telecom (United Kingdom). But they can also take place through investments in green field R&D facilities in locations with clusters of talent and related firms, for instance Tata Consultancy’s investment in development centers in China and the United States.37 It is not just human and technological assets that Indian firms seek to buy into through OFDI. In their effort to build new brand names or consolidate existing brands, a number of Indian firms have engaged in highly proliferated acquisitions abroad, including Tata Motors’ acquisition of Daewoo (Korea) in 2003, Infosys’ acquisition of Expert Information Services Pty. Ltd (Australia) in 2003, the

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acquisition of RPG Aventis (France) by Ranbaxy Technologies’, Tata Tea’s acquisition of Tetley Tea (UK) in 2000, or Tata Steels’ take over of the Corus group in 2007. The “takeoff” phase’s surge in OFDI took place against the backdrop of continued liberalization. A number of new measures further facilitated OFDI: By 2004, the Indian government allowed companies to make OFDI up to 100% of their net worth, while it was previously 25%. Moreover, the previous $100 million ceiling was lifted. The commitment to OFDI was confirmed at the highest political level in 2004 by the then PM: “Indian corporates will hereafter be freely permitted to make overseas investments up to 100 per cent of their net worth, whether through an overseas joint venture or a wholly owned subsidiary . . . This will enable Indian companies to take advantage of global opportunities and also to acquire technological and other skills for adoption in India.”38 Also PM Manmohan Singh has actively expressed his support for Indian firms to go global. “All our firms, be they in the public sector or the private sector, must become more competitive so that they can face increased competition with success from abroad . . . many Indian firms today do have the managerial leadership to go global and compete at the global level . . . we need to understand how we can replicate such success stories so that more and more India firms go global.”39 In fact, India had little choice but to liberalize its OFDI regime. Restrictions on OFDI face two problems in an open economy: One is that individual firms may have adequate capital even if the government faces foreign currency constraints. In this situation, OFDI restrictions may restrict corporate expansion strategies that otherwise would be viable. The other is that OFDI is increasingly required to build and sustain competitive advantage in an open economy, as domestic producers would otherwise be at a disadvantage with regard to foreign firms. The opening of OFDI regimes has helped Indian firms acquire a portfolio of assets and gain experiences that have enabled them to face the growing competition in the Indian market and become global companies in their own right.40 While India definitely has opened up, there has been very little active promotion of OFDI. India has mainly pursued an “Open Door Policy,” as opposed to the “Selective Targeting Policy” which is known from East and Southeast Asian countries.41 There are few signs that India is adopting anything resembling Chinas “Go Global” policy, where the government, among other things, has set up a $200 billion wealth fund to promote foreign investment (including direct). Instead

The Rise of Indian Multinationals Table 2.1

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Phases in Indian OFDI Early phase

Start-up phase

Takeoff phase

Amount

Low OFDI

Rising OFDI

Surge in OFDI

Location

Neighboring developing countries

Increasingly developed countries

Developed countries, but key resource seeking investments in developing countries

Mode

Joint ventures, minority

Greenfield investments, majority owned joint ventures

M&As, greenfield investments

Industries

Manufacturing

Manufacturing declining, rapid growth in services

All sectors, manufacturing and natural resource rising

Motives

Simple market and natural resource. Escape investments

Market seeking, Efficiency seeking. Beginning strategic asset seeking

All, but strategic asset seeking very important

O-advantages

Scaled down technology and low-cost business models

Increasingly strong O-advantages, in particular in services

World-class advantages in growing number of service and manufacturing firms

OFDI regime

Highly restrictive

Gradual liberalization of OFDI regime

Open door policy, beginning OFDI promotion

Highly integrated investments

India has moved incrementally from highly inward-looking policies with strong restrictions on internationalization, to liberalization of external trade and investment regulation. India has not (yet) actively promoted OFDI through for example support for OFDI, information about investment opportunities, political insurance schemes, or even financial subsidies such as loan financing.42

2.3

Theories of Developing Country OFDI

In the previous section we have documented that profound changes in Indian OFDI have taken place in the last fifteen to twenty years and especially since 2001. In the following, we will try to explain these changes with the point of departure in the extant theory of OFDI from developing countries.

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2.3.1

Traditional FDI Theory

According to traditional FDI theory, FDI is closely related to the ownership-specific/competitive advantages of the investing firms.43 Ownership-specific advantages play two roles: First, they are the reason why firms invest abroad in the first place. Thus, firms must possess some unique advantages (technological, managerial, reputational, etc.) that they can exploit in foreign locations. Second, the possession of ownership specific advantages explains why MNCs are able to overcome the “disadvantages of foreignness” in relation to indigenous firms. These disadvantages are related to problems of obtaining market intelligence, access to authorities, and access to factor markets, as well as to the costs of managing across borders. While some theories of FDI understood FDI as a result of large firms’ attempts to extent their market power into foreign locations,44 other FDI theories focused more on external market failures when explaining FDI. Thus, the “internalization theory” of FDI45 argued that when firms extend their activity to foreign locations, it is not only because they are monopolistic rent seekers as argued by the “Hymer—Caves—Kindleberger tradition,” but also, and especially, because they are efficiency seekers that want to reduce transaction costs of cross border activity. The transaction costs are for instance monitoring costs, bargaining costs and enforcement costs and they derive from the opportunistic nature of market agents and the uncertainty and asset specificities associated with transactions. Especially in markets for intermediary products and intangibles, market failures are widespread and therefore internationalization will be particularly common when transacting such goods. The ideas of the market power and transaction cost schools were sought bridged by John Dunning’s OLI framework.46 The OLI essentially holds that FDI is a result of firms possessing ownership-specific advantages (O) that they want to exploit in foreign locations (L), which they cannot (profitably) do except through internalization (I). The theory of FDI has largely been developed based on experiences of OECD-based firms. Thus, the theory is less suited for analyzing MNCs coming out of locations where O-advantages are weak and where widespread market and institutional failure radically changes the context of FDI. Hence, there are “inevitably gaps” in the traditional FDI literature, when it comes to explaining OFDI from developing countries,47 as OFDI from developing countries remains “a relatively neglected topic” in the literature on FDI.48 Nevertheless,

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we will argue that there are in fact a number of theories and frameworks that can help us understand OFDI from developing countries.

2.3.2

Third World MNCs

The theory on Third World Multinationals (TWMNCs) dates back to the late seventies and early eighties.49 This early literature was inspired by consecutive waves of OFDI from developing countries in Latin America, West and South Asia, and Africa in the 1970s and 1980s. The main propositions of the TWMNC literature can be phrased in terms of the OLI framework: Concerning ownership specific advantages (O), TWMNCs will tend to posses advantages that are less advanced, typically related to products in the mature phases of the product cycle,50 and mainly associated with low cost production, natural resources extraction, and an ability to cater to low margin markets. Concerning location advantages (L), TWMNCs will, as a consequence of their specific O-advantages, tend to focus their activities in countries at the same or lower stages of economic development51 and/or in countries with a low psychic and geographical distance.52 Concerning internalization factors (I), TWMNCs will tend to opt for joint ventures to access local market knowledge, technology and capital, thus, compensating for their inherent resource limitations.53 Especially Lall’s theory of “localized technological change” has been widely applied. Studying Indian MNCs, Lall54 found that these MNCs were located in labor-intensive, low-technology sectors with low levels of differentiation. Rather than exploiting frontier technologies, the O-advantages of these firms were related to their ability to change and adapt imported technology to the specific cultural, market and institutional environments of developing countries and to adapt their business models to developing country conditions. 55 Thus, the success of TWMNCs rested in their ability to de-scale technologies and products56 and distribute and market relatively unbranded and undifferentiated products in developing countries based on their low overheads.57 Due to their inferior O-advantages, TWMNCs would rarely compete directly with western MNCs, 58 but would in stead invest in other developing countries.59 This OFDI would frequently be a defensive move made partly because tariff barriers prevented exports, partly because local entrepreneurs in export countries tried to copy the product. To the extent that investments in more advanced countries took place, it would be to support exports, for example of artisan products.60

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As the O-advantages of TWMNCs were weak, their internationalization would tend to be gradual and sequential.61 Through gradual internationalization, investors gain experience that provides a platform for further expansion and greater commitment. Thus, investments would mainly take place in locations with low geographical and psychic distance, neighboring developing countries that is,62 and joint ventures would be common as a way to gain access to external resources such as knowledge about local markets and/or capital.

2.3.3

Latecomer Firms

Where the traditional OFDI literature viewed OFDI from developing countries as an “outlayer” with “marginal” significance for global economic developments,63 a growing literature has recently challenged this view. Spurred by the surge in OFDI from developing countries in the 1990s, and 2000s and echoing Gerschenkron’s64 notion of “latecomer” advantage of “backwardness” this literature is interested in explaining why growing numbers of developing country firms are successful in competing with western firms in their own markets. Are there, this literature asks, some particular advantages of being “latecomer” that explain the rise of developing country MNCs? The literature on latecomer firms dates back to the late 1980s, when the success of especially Asian original equipment manufacturer (OEM)s to upgrade technology and move into more advanced activities generated growing interest.65 Apparently, a handful of developing countries had moved through an advanced transformation of their industrial structures, which, inter alia, had lead to the emergence of powerful MNCs.66 This literature diverted from the aforementioned TWMNC theory by stressing the ability of developing country firms to compete on par with developed country firms, but “at the same time, its logic reflects the unique aspects of Third World outward investment”67 that had been analyzed by the TWMNC literature. The basic idea of the latecomer literature is that developing country MNCs, qua being located in developing countries, are provided with some particular advantages with regard to western firms. These firms, being latecomers, are not as inhibited by institutions, procedures, traditions, and conventional ways of doing business as are developed country firms. They are, it is argued, more willing to take on new ideas and innovations and less constrained by managerial and strategic orthodoxies.68 They possess a number of advantages emanating from the developing country context, including flexibility, low

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overhead, cost effectiveness, and business models, which fit emerging market contexts.69 A particular strength is these firms’ ability to draw on linkages with other firm and non-firm actors in their internationalization process. Thus, these firms have an advantage in “the use of networks and relationships, organizational structures, the leveraging of cultural ties or institutional affinity and other heterogeneous sources of potential advantage.” 70 In a widely debated article, Matthews71 tried to explain how it can be that “some firms challenge established positions in the global economy, and displace incumbents, some of them highly advanced and fiercely competitive—especially when the challengers start small, lack key resources and are distant from major markets?”72 To Matthews, Asian challenger firms are the true protagonists of globalization, not being “burdened with existing commitments and attitudes born of domestic self-sufficiency and regard the world market as their home.”73 Matthews finds that these firms share three characteristics: (1) their ability to internationalize very rapidly (“accelerated internationalization”); (2) their ability to undertake organizational innovation, for example using network strategies in their internationalization; and (3) their ability to innovate strategically, for example by exploiting fully the opportunities offered by globalization. Thus, in Matthews’ view, internationalization is far from gradual and sequential as predicted by the gradualist school, and rather resembles “born global” paths.74 Moreover, internationalization takes place on the background of unconventional O-advantages and without a strong prior resource base, rather than on the background of exploitation of existing superior O-advantages, as argued by the traditional FDI theory. In fact, according to Matthews, one of the defining characteristics of challenger firms is their ability to complement their existing O-advantages with those of other firms through OFDI.75 For this reason Matthews argue that conventional FDI theory in general, and the OLI in particular, is not very helpful in explaining Asian latecomer firms. As an alternative to the OLI, he proposes the Linkage, Leverage and Learn model (LLL) model for latecomer/newcomer firm advantages. The latecomer firm performs well by focusing, not only on its own, existing advantages, but more on how to acquire advantages externally through linkages (Linkages). Moreover, this firm has a strong ability to leverage resources in networks rather than gaining advantage from internalization (Leverage). Finally, such firms have a strong ability to learn and imitate and build advantage from experiences in linkage and leveraging processes (Learn).

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2.3.4

Converged Firms

Finally, it should be mentioned that not all observers accept the premise that we need a special line of theorizing for developing country OFDI. Thus, it can be argued that it essentially is the same logics and the same dynamics that characterizes developing country and developed country MNCs. At least, the differences are being reduced with globalization: Globalization levels policy and market barriers between countries, allowing developing country MNCs to embark on OFDI on par with their western counterparts. Even if MNCs in developing countries initially may have disadvantages in terms of technology, management and market access, they can relatively easily acquire assets that can mitigate these disadvantages. For instance, markets for capital, technology, and market intelligence have dramatically improved in recent decades, thereby making their acquisition of such assets relatively easy for newcomer/latecomer firms from developing countries.76

2.3.5

A Dynamic Perspective: The Investment Development Path

The above-mentioned theories focus on developing countries as one. In doing that, they fail to provide an explicit account of how the specific home country context influences O-advantages. Obviously, it can be expected that O-advantages of MNCs in least developed countries are very different from MNCs in Newly Industrialized Countries. Moreover, the O-advantages of MNCs in a given country can be expected to change over time, as the country transforms its economy. To inject dynamism into the discussion of OFDI from developing countries, the Investment Development Path (IDP) may be particularly useful. The IDP77 seeks to explain the link between the net-OFDI flows (outward less IFDI) and the level of development of a given country. The hypothesis is that FDI patterns change fundamentally as a country develops. Thus, countries are divided into five stages: At stage one, we have least developed countries. Here, very little FDI takes place, and if it takes place it is mainly inward investment to exploit received comparative advantages, typically natural resources. At stage two, the host country has developed certain advantages that make it desirable for MNCs to move in and exploit these advantages. The advantages will typically be “undifferentiated,” for example natural resources or cheap but unskilled labor. Moreover, beginning economic development at this stage creates a domestic market that foreign investors take advantage of. As the O-advantages

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of local industry are still weak, there is little basis for OFDI, and if it takes place, it will be backward in the IDP or in countries at similar stages of the IDP. Stage three countries have created more sophisticated and differentiated advantages (“created assets”) through industrial policy, education, infrastructure and infrastructure development. These advantages are increasingly exploited by efficiencyseeking foreign investors. Moreover, rapidly growing markets make market-seeking foreign investors flock in especially the larger of these countries. OFDI is taking off at this stage, partly aimed at countries backward or at similar stages in the IDP, but increasingly also aimed at acquiring assets in more advanced countries (strategic asset seeking investments) that can improve local firms’ advantages further. At stage four, a strong domestic industry has evolved. This industry embarks massively on OFDI, partly into the most advanced countries, at stage five, partly to exploit their advantages in less advanced countries. Thus, Stage four countries will be net outward investors. At Stage five—the most advanced countries—we see a convergence of inward and outward flows.

2.3.6

Synthesis

As seen from the above, we have a number of competing theories of OFDI from developing countries. In terms of O-advantages, these theories can be placed on a continuum depending on the degree of convergence between O-advantages of developing country MNCs and developed country MNCs. At one extreme, we have the MNCs with inferior O-advantages, as described by the TWMNC literature. At the other extreme, we have the position holding that MNCs in developing countries are not fundamentally different from those of advanced markets. In between, we have the latecomer firms—firms that are distinctly developing country MNCs but have advantages that enable them to compete head on with developed country MNCs. Rather than viewing these theories as competing, they can be seen as complementary. This is essentially the argument made by the IDP. This theory holds that MNCs have different types of O-advantages at different stages of the IDP and that this explains the level and profile of OFDI. Thus, from the perspective of the IDP, the original TWMNC literature focused on firms from Stage one and two countries, where OFDI was negligible and mainly directed backward in the IDP. The late comer firm literature in contrast, is mainly concerned with Stage three countries. In such countries, domestic firms have growing O-advantages and have started investing in similar or even more

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Michael W. Hansen High Converged firms

Latecomer firms

Strength of O-advantages

Third World MNCs

Low I

II

III

IV

V

Stage in IDP Figure 2.6

Positioning theories in the investment development path

advanced countries to exploit these advantages. Growing investment forward in the IDP at this stage is a reflection of these firms’ attempts to augment their advantages through asset seeking investments, for example acquisition of brands, distribution networks, or R&D facilities. As countries mature even more in Stage four and five, we see a movement toward convergence of the O-advantages of domestic firms with those of developed country firms. Firms at these stages are increasingly competing on par with firms in advanced countries, and are balancing resource, market, efficiency and asset-seeking investments in a similar way.

2.4

Puzzles of the Indian OFDI Path

When we contrast the Indian OFDI path with the predictions of received OFDI theories, at least three (interrelated) “anomalies” become evident: The first concerns the level of OFDI relative to IFDI. The second concerns the destination of OFDI. The third concerns the motives of Indian investors for going abroad.

2.4.1

The Early Rise in Indian Outward Investment

The early phase of Indian OFDI was largely consistent with the predictions of the IDP. Between 1975 and 1991, India was a Stage two country, having started to develop a sizable home market and offering

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un-differentiated cost advantages. OFDI was limited, and to the extent that it took place it was in Stage one or two countries and based on technologies adapted to developing country conditions. After liberalization in 1991, India has increasingly developed more differentiated advantages, for example in IT, software, pharmaceuticals, engineering, and manufacturing. According to the “normal” IDP sequence of investments, India would first experience a rapid increase in IFDI, partly by efficiency-seeking investors exploiting the increasingly differentiated Indian advantages, partly by market-seekers exploiting market potentials. Only then, we would see gradually growing OFDI, as internationally competitive local industries evolved. But in the case of India, IFDI and OFDI “takeoff” has been more or less simultaneous. In fact, while there has been a slow growth in Indian IFDI in recent years, outward investment has soared. From 2001 to 2006, Indian OFDI grew more than five times, while inward investment in the same period only grew two and a half times. And while India ranked fifty six on UNCTAD’s OFDI performance index in 2006, it ranked 113 on the IFDI performance index.78 It is even predicted that Indian OFDI will continue to grow and, at fifteen billion in 2007, eclipse IFDI.79

2.4.2

The Strong Developed Country Orientation

The early Indian OFDI was made in developing countries as predicted by theory, for example in Sri Lanka, Malaysia or Nepal. When embarking on OFDI, Indian firms took advantage of their particular business models, adapted to developing country market and factor conditions. Soon after liberalization in 1991, Indian MNCs grew out of their immediate regional context and, rapidly, developed countries became the main OFDI destination. Moreover, among those investments taking place in developing countries, the Indian OFDI converged on advanced developing countries such as Hong Kong or Singapore. The quick orientation toward advanced markets is puzzling given the fact that we would expect particularly high entry barriers in such markets for firms coming from a development context.

2.4.3

The Importance of Strategic Asset Seeking Investments

Traditionally, Indian firms invested abroad due to various pull factors (market and natural resource seeking) and push factors (e.g., to escape restrictive domestic regulations such as labor laws, licensing

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Michael W. Hansen

requirements and antitrust regulation and circumvent the limited market demand in India).80 These motivations were in accordance with the predictions of the TWMNC theory. However, Indian MNCs have, much earlier than expected, moved into more complex types of investments. Thus, current Indian OFDI is to a large extent aimed at accessing strategic assets in foreign locations, mainly developed countries, through M&As and green field investments. The strategic asset seeking investors are partly firms seeking complementary assets abroad as growing exposure to western MNCs erode their O-advantages at home, partly firms that want to circumvent entry barriers in marketing and distribution in developed countries by acquiring brands, distribution, and marketing systems.

2.5 Explaining the Particular Indian OFDI Path The Indian OFDI has deviated substantially from the “normal” OFDI path of developing countries by moving massively into OFDI, even before IFDI takeoff, by moving into advanced countries rather than developing countries, and by going for strategic assets rather than resources and markets. So how do we account for these deviations from the expected path? Here, we will focus on four possible explanations for the particular Indian OFDI path: The first has to do with the industry structure of the Indian economy; the second has to do with the nature of inward investment in India. The third has to do with firm structure in India. The fourth has to do with the institutional context in which OFDI in India takes place. The offered explanations are of course tentative and would need to be explored further through more formal testing.

2.5.1

The Unique Composition of Indian Industry

According to theory, we would expect OFDI from developing countries to be first in manufacturing and only later in service industries. This is partly because service industries are correlated with advanced economies, partly because service industries typically are late internationalizers.81 However, in the case of India we find that non-financial services became the dominant outward investor at a very early stage in the IDP, exceeding manufacturing in the second half of the 1990s. This is obviously related to the particular Indian industry structure with services playing a relatively large role. For instance, services accounts for 52% of output in India but 30% of output in China. Conversely, manufacturing accounts for 39% in China but 16% in

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India.82 Moreover, and related to the above, whereas India, as opposed to China, never succeeded in developing a sizable manufacturing export industry and attracting large scale investments within efficiencyseeking manufacturing industries (apart from textiles and a few other industries), Indian service exports have been relatively important,83 although, as we shall see, these were not accompanied by large inflows of FDI. The strong service orientation of the Indian economy may explain why India has a relatively strong standing in services OFDI. But more importantly, it may explain the early rise in OFDI. The IT and software industry may start its internationalization and, thus, OFDI earlier and at a more accelerated speed than manufacturing. The quick sequence into OFDI is partly due to the fact that this industry is a “born global” industry in terms of both markets and factor inputs, partly because capital plays a smaller role than in most other global industries.84 Thus, the usual inertness in relation to internationalization and OFDI are relatively absent in the IT and software industry.

2.5.2 The Inward Investment Path of India Traditionally, IFDI has been seen as a primary avenue through which developing country firms could access global value chains and upgrade their technological and human resource capabilities. Through the creation of linkages between MNCs and local firms, IFDI would help domestic industry become international and eventually embark on OFDI.85 However, in the case of India there was never a surge in IFDI which could help build internationally competitive industries. When India, nevertheless, succeeded in building strong advantages in certain industries, it is of course partly due to indigenous accumulation of skills and capital in certain sectors. But it could also be due to the fact that there actually were very strong linkages between Indian firms and foreign MNCs, however, these linkages were in the form of outsourcing collaborations rather than with foreign investors located in India. Though outsourcing collaborations, Indian IT, engineering, and consultancy firms have build O-advantages that relatively fast became platforms for internationalization. As argued by UNCTAD, “the success of Indian firms as service providers in the outsourcing of IT services, BPO and call centers by developed-country companies has exposed them to knowledge and methods for conducting international business, and induced outward FDI through demonstration and spillover effects.”86

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2.5.3 The Particular Indian Firm Structure A characteristic of the Indian industry structure is the prominent position of large “houses” or conglomerates. The dominance of such organizations challenges conventional western management thinking, which would argue that firms should focus on their core competencies and shed non-core activities.87 Several authors88 argue that such organizations, given the institutional context of emerging markets, may indeed be efficient as they, more effectively than focused companies, can overcome market and institutional failures.89 In continuation of this, it has been argued that there is a link between the prevalence of conglomerates and OFDI.90 And large houses such as Tata, Birla Kirloskar, Mahindra, T.V. Sundaram Group, Mafatlal, Mahindra, Bajaj, Singhania, Walchand, Mittal, and others do play a pivotal role in Indian OFDI, for example in relation to the huge M&As in recent years. In other words, the old industrial structure of India displays a remarkable resilience also when it comes to OFDI. But what may the advantages of such houses be in relation to OFDI? First, it could be hypothesized that large houses function as effective internal capital markets that can be used to subsidize OFDI.91 Second, large conglomerates offer opportunities to move people between different divisions, for example managers with international experience or key technical personnel. Third, as the fixed costs of access to government officials needed to support OFDI may be very high, conglomerates may have an edge in relation to SMEs. Finally, as the Indian economy has opened up, the need to internationalize to acquire assets abroad may have been particularly pressing for conglomerates as these companies, having grown out of decades of ISI policies, were ridden with un-competitive technologies, products, organizations, and practices.92 Although conglomerates have been at the forefront in terms of moving abroad, it is still an open question whether they have the necessary management and organization capabilities to make their foreign acquisitions sustainable in the long run!

2.5.4

The Indian Policies and Regulations for OFDI

The institutional strategy literature has argued that the particular institutional fabric of developing countries has huge implications for firm strategy.93 In line with this, it has been argued that the institutional view can be employed to explain OFDI behavior of developing country firms.94 Indirectly, institutions of a given country

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may affect OFDI patterns by shaping the development of firm specific O-advantages and/or firm structures that may be conducive or inhibiting of OFDI. But more directly, institutions may impact OFDI through those set up specifically to regulate OFDI. On the one hand, the state can restrict OFDI through currency and capital transfer rules, ownership requirements, sector reservations, and, in general, making approval procedures slow and burdensome, and so forth. On the other hand, the state may offer foreign investors privileged access to information, foreign currency, capital, expertise, and so forth. Such support may help the MNC from developing countries off-set some of their inherent disadvantages in relation to western MNCs.95 Several authors trace the OFDI pattern of India back to Indian policies and regulations.96 Thus, the changes in Indian OFDI have taken place largely in conjunction with profound changes in Indian OFDI regulation.97 Originally, the government of India viewed deployment of human, physical, and financial assets abroad as a problem, as a drainage of domestic resources. Consequently, stringent OFDI regulation severely restricted OFDI from India, resulting in very low OFDI. During the 1990s, the attitude toward OFDI changed. Growing surpluses in foreign reserves made the Indian government relax restrictions on OFDI. More broadly, OFDI was increasingly seen by the government and elite as a means for India to assert its position in the global economy98 and enhance the competitiveness of the Indian industry. Thus, the 1990s’ growth in OFDI can to a large extent be understood as a result of the gradual liberalization of the OFDI regime. The most recent OFDI takeoff, may partly be explained by the fact that India, by 2003, opened its OFDI regime more or less completely, thus, releasing a pent up “demand” for OFDI. Moreover, it can be argued that the de facto barriers (formal and informal) to OFDI from India today are much smaller than the de facto barriers to inward investment. This may help explain the un-usual sequence in outward and inward flows in India. In that sense, the IDP of India resembles that of Japan, where de facto, if not de jure, inward restrictions remain strong, while restrictions on outward investment are removed, setting the protected domestic industry free to internationalize. Indian policies and regulations may also in a broader sense have affected OFDI. Thus, Indian industrialization strategy may have helped Indian firms build O-advantages that have formed basis for their internationalization. As already mentioned, conglomerates may

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have enjoyed government patronage and support. Due to their privileged home market position, they may have been able to earn rents that could finance OFDI. Moreover, dedicated investment in education and skill formation and the promotion of research and technology by the Indian government, in combination with a lax patent system that allowed Indian firms to engage in reverse engineering, all facilitated the development of strong Indian positions in knowledgeintensive industries like engineering, software, and pharmaceuticals that provided the basis for a quick transition into OFDI.99 Finally, the relatively well functioning Indian financial markets, and, in particular, the existence of a vibrant stock market, has lead to huge increases in the valuation of Indian firms, which have enabled these firms to raise large amounts of equity capital and to borrow money at home and abroad. This capital has, inter alia, been used for a “spending spree” abroad. The high profit rates of foreign subsidiaries of Indian MNCs may further have facilitated OFDI; in recent years we see how re-invested earnings are becoming the main component in financing FDI.100

2.6 Conclusion The rise of MNCs from developing countries such as China, India, Mexico, Korea, Singapore, Malaysia, and Taiwan is a highly fascinating phenomenon, indicating that profound shifts in the globalization process are underway. This chapter examined this phenomenon by looking into the Indian experience. We noted that the Indian OFDI path challenges a number of the orthodoxies of the received literature on OFDI from developing countries: ●

●

●

●

Where OFDI from developing countries traditionally has followed large inflows of FDI, this was not the case in India; Where OFDI from developing countries traditionally has taken place in other developing countries, Indian OFDI is converging on advanced economies; Where OFDI from developing countries traditionally has been in manufacturing and resource extraction, Indian OFDI is driven by services; Where O-advantages of developing country MNCs traditionally have been in mature technologies and industries, many Indian MNCs have their advantages in technologically cutting-edge industries such as IT and pharmaceuticals;

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Where developing country MNCs traditionally have been simple market- and resource-seeking, learning and asset acquisition seem to be central motivating factors behind current Indian outward investment.

These observations force us to revisit received theory of OFDI from developing countries. Evidently, India has succeeded in not only speeding up but also short-circuiting the IDP sequence. One explanation could be that Indian firms have been able to build strong O-advantages, partly by linking up to, and learn from foreign firms through arms-length collaborations. The O-advantages build through outsourcing are now one of the cornerstones of Indian OFDI. Thus, the experience of India suggests that IFDI need not be a precursor for OFDI. Consequently, the IDP needs to pay much closer attention to the role of non-equity linkages in forming O-advantages of local industry and moving a country forward in the IDP. Another explanation is related to government policy, which has strongly influenced the OFDI sequence, first, by holding up the forward movement of the IDP by severely restricting IFDI and OFDI, and, later, by liberalizing investment regimes, thereby providing the conditions for OFDI takeoff. One implication of the observed strong government imprint on OFDI is that we need to pay very close attention to government policies, when explaining the IDP sequence of a given country. Apart from the pivotal role played by direct OFDI regulation, the Indian case also illustrates how broader institutions can shape OFDI patterns. For instance, while large conglomerates in other institutional contexts may be dinosaurs, slowing down and resisting internationalization, they may in the particular context of OFDI from India actually have been an advantage. This is due to the fact that large conglomerates have the opportunity to generate internal resources in support of OFDI and because they can access government support for their internationalization process more easily. A final explanation on the particular Indian OFDI path may be related to the strong position of services in the Indian economy. It seems that the Indian advantage in knowledge-intensive service activities has enabled a relatively fast sequence toward OFDI in advanced countries and activities. Indeed, the Indian experience suggests that an economy basing its wealth on knowledge-intensive services rather than manufacturing or natural resources may be relatively well positioned to exploit the opportunities provided by globalization.

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Notes 1. UNCTAD (2007), World Investment Report: FDI and Natural Resources. Geneva: UNCTAD. 2. Huang, Y., & Khanna, T. (2003), “Can India Overtake China?” Foreign Policy, 137, July–August: 74–78. 3. Pradhan, J.P. (2005), “Outward Foreign Direct Investment from India: Recent Trends and Patterns,” GIDR Working Paper No. 153, February. 4. E.g., among Business Weeks 2006 Information Technology Top 100, there were eighteen from four developing countries and transition economies, including a number from India. The Indian firms were described as having smart management, low cost structures, and visions to join the ranks of the global MNCs. Moreover, in 2005, the Forbes 200 (ranking of the world’s best SMEs) had four Chinese but thirteen Indian firms on the list. A survey of the most innovative companies in 2006 found two Indian companies on the list, namely Bharty Tele Ventures (telecom) and Infosys (software) (Boston Consulting Group Business Week Online [2006], The World’s most innovative companies, April 24, 2006 http://www.businessweek.com/magazine/ content/06_17/b3981401.htm [accessed October 20, 2008]). 5. E.g., Ranbaxy Laboratories, Reliance Industries, Hindalco Metals (part of the Aditya Birla Group), Welspun, Jubilant Organosys, Tata Motors, Bajaj Auto, Moser Baer, Bharat Forge, and so on. (India Brand Equity Foundation [2007], http://www.ibef.org/artdisplay.aspx?cat_id=391&art_id=6878 [accessed October 20, 2008]). 6. Mathews, J.A. (2006), “Dragon Multinationals: New Players in 21st century Globalization.” Asia Pacific Journal of Management, 23: 5–27. 7. Winters, A., & Yusuf, S. (2007), “Introduction: Dancing with Giants,” in A. Winters & S. Yusuf (eds.), Dancing with Giants. China, India and the Global World. Washington, DC: World Bank and Institute of Policy Studies, pp. 1–34. 8. Ibid. 9. UNCTAD (2006), World Investment Report: Developing Country FDI. Geneva: UNCTAD. 10. UNCTAD (2007). It should be noted that OFDI numbers from developing countries are likely to be underreported. Some countries do not identify FDI outflows at all, others only recently started measuring/reporting OFDI. Moreover, flows are often undervalued as official statistics do not always include financing and reinvested components of OFDI. Finally, statistics are often based on reporting from large corporations and thus do not include SME OFDI (D. Aykut & A. Goldstein (2006); “Developing Country Multinationals: South-South Investment Comes of Age,” Paper provided by OECD Development Centre in its series OECD Development Centre Working Papers 257: p. 87). 11. In spite of the rapid growth in Indian OFDI, it should be noted that Indian FDI remains modest in a global perspective: (1) As a share of global FDI, India is still a small player. India was only number 20 in the list of emerging

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12.

13. 14. 15. 16. 17. 18.

19. 20. 21.

22. 23. 24. 25. 26.

27. 28.

29.

30.

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market investors in terms of stock in 2005 (UNCTAD, 2006) and in 2006 it had only moved to number 15 (UNCTAD, 2007); (2) According to UNCTAD’s transnationality index, only few Indian MNCs are highly internationalized (UNCTAD, 2007); (3) Only one Indian company (ONGC) was on UNCTAD’s list of the 100 largest developing country TNCs in 2006 (UNCTAD, 2006: p. 130); (4) Compared to the other BRIC countries China and Russia, India is placed low on UNCTAD’s outward performance index (UNCTAD, 2007). Agrawal, R.G. (1981), “Third World Joint Ventures: Indian Experience,” in R. Kumar & M.G. McLeod (eds.), Multinationals from Developing Countries. Lexington, MA: Lexington Books; Lall, S. (1983), The New Multinationals: The Spread of Third World Enterprises. New York: John Wiley & Sons; Kumar, K., & McLeod, M.G. (1981), Multinationals from Developing Countries. Lexington, MA: Lexington Books. Pradhan, J.P. (2003), Building Indian Multinationals: Can India “Pick up the Winners?” (New Delhi: Jawaharlal Nehru University); Pradhan (2005). Sauvant, K.P. (2005), “New Sources of FDI: The BRICs.” The Journal of World Investment and Trade, 6:5: 639–711. Lall (1983); Kumar & McLeod (1981). Pradhan (2003). Agrawal (1981). Wells, L.T. (1981), “Foreign Investors from the Third World,” in R. Kumar & M.G. McLeod (eds.), Multinationals from developing countries. Lexington, MA: Lexington Books. Pradhan (2005). Sauvant (2005). UNCTAD (2004a), India’s Outward FDI: A Giant Awakening? UNCTAD, October 20, http://www.unctad.org/sections/dite_iiab/docs/diteiiab20041_ en.pdf. (accessed October 20, 2008). Ibid. Pradhan (2005). UNCTAD (2004a). Assocham (2007), “Study on FDI Outflow Role of Manufacturing in the Mergers Acquisitions,” Associated Chambers of Commerce and Industry. Of course it can be debated whether Mittal is Indian. The firm was founded in Indonesia in 1976 by an Indian entrepreneur. The current owner, Lakshmi Mittal, today controls 88% of the company. He is an Indian citizen living in London and the company is listed in Amsterdam and New York. UNCTAD (2005), World Investment Report, Transnational Corporations and the Internationalization of R&D. Geneva: UNCTAD. E.g., Aftek Infosys Ltd., Datamatics Technosoft Ltd., KLG Systel Ltd., Leading Edge Infotech Ltd., Moschip Semiconductor Technology Ltd., and so on. Khanna, T., Palepu, K., & Sinha, J. (2005), “Emerging Giants; Building World Class Companies in Developing Countries. Strategies that Fit Emerging Markets,” Harvard Business Review, June: 60–69. UNCTAD (2004a).

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31. Examples of such firms are Tata Consultancy, Infosys Technologies, Wipro, Birlasoft, Daksh eServices, and Datamatics Technologies (Sauvant, 2005: p. 668). 32. UNCTAD (2006). 33. Sauvant (2005). 34. UNCTAD (2004a). 35. Aykut & Goldstein (2006). 36. Pradhan (2003). 37. Sauvant (2005). 38. Quoted from UNCTAD (2004a). 39. Quoted from Sauvant (2005). 40. Ibid. 41. Altenburg, T. (2000), “Linkages and Spill overs between TNCs and SMEs in Developing Countries,” in UNCTAD, TNC-SME Linkages for Development (Geneva: UNCTAD). 42. Sauvant (2005). 43. Hymer, S. (1960/1976), The International Operations of National Firms: A Study of Direct Foreign Investment. (Cambridge, MA: MIT Press); Dunning, J.H. (1981a), “Explaining Outward Direct Investment of Developing Countries: In Support of the Eclectic Theory of International Production,” in R. Kumar, & M.G. McLeod (eds.), Multinationals from developing countries (Lexington, Massachusetts: Lexington Books); Dunning, J.H. (1988), “The Eclectic Paradigm of International Production: A Restatement and Some Possible Extensions.” Journal of International Business Studies, 19:1: 1–31. 44. Hymer (1960/1976); Kindleberger, C.P. (1969), American Business Abroad. New Haven, CT: Yale University Press; Caves, R.E. (1996), Multinational Enterprise and Economic Analysis, 2nd edition. Cambridge: Cambridge University Press. 45. Buckley, P.J., & Casson, M. (1976), The Future of the Multinational Enterprise. London: Holmes & Meier; Hennart, J. (1991), “The Transaction Cost Theory of the Multinational Enterprise,” in Pitelis, C. & Sudgen, R. (eds.). The nature of the Transnational Firm. London: Routledge. 46. Dunning (1981a; 1988). 47. Buckley, P.J., Wang, C., & Clegg, J. (2007), “The Impact of Foreign Ownership, Local Ownership and Industry Characteristics on Spill over Benefits from Foreign Direct Investment in China.” International Business Review, 16:2, April: 142–158. 48. Bonaglia, F., Goldstein, A., & Mathews, J. (2006), Accelerated Internationalisation by Emerging Multinationals: The Case of the White Goods Sector. (Paris: OECD Development Centre). 49. Lecraw, D. (1981), “Internationalization of Firms from LDCs: Evidence from the ASEAN region,” in R. Kumar, & M.G. McLeod (eds.), Multinationals from developing countries. (Lexington, MA: Lexington Books); Lecraw, D. (1977), “Direct Investment by Firms from Less Developed Countries.” Oxford Economics Papers, 29:3: 442–457; Dunning (1981a); Lall (1983); Wells, L.T. (1983), Third World Multinationals: The Rise of Foreign Investment from

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50. 51.

52.

53. 54. 55. 56. 57. 58.

59. 60. 61.

62. 63.

64. 65.

66. 67. 68. 69. 70.

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Developing Countries. Cambridge, MA: MIT Press. For a review of this early literature see Goldstein, A. (2003), Emerging Multinationals in the Global Economy: Data Trends, Policy Issues, and Research Questions, mimeo, Paris: OECD Development Centre, 2005 or Beausang, F. (2003), Third World Multinationals: Engine of Competitiveness or New form of Dependency? (Hampshire, UK: Palgrave Macmillan). Vernon, R. (1966), “International Trade and International Investment in the Product Cycle.” Quarterly Journal of Economics, 80: 2, May. Dunning, J.H., & Narula, R. (1996), “The Investment Development Path Revisited: Some Emerging Issues,” in J.H. Dunning & R. Narula (eds.), Foreign Direct Investment and Governments: Catalysts for Economic Restructuring. London: Routledge, pp. 1–38. Johanson, J., & Vahlne, J. (1977), “The Internationalization Process of the Firm—A Model of Knowledge Development and Increasing Foreign Market Commitments.” Journal of International Business Studies, 8:1: 23–32. Lecraw (1981). Lall (1983). Kumar & McLeod (1981); Lall (1983). Wells (1983). Lall (1983); Lecraw, D. (1981). Wells (1981); Lecraw (1981); Nambudiri, C.N.S., Iyanda, O., & Akinnusi, D.M. (1981), “Third World-Country Firms in Nigeria,” in R. Kumar & M.G. McLeod (eds), Multinationals from developing countries. (Lexington, MA: Lexington Books). Wells (1981). Ibid. Here the TWMNC literature often refers to the so-called Uppsala theory of internationalization. This theory focuses on experiential learning in internationalization processes (Johanson & Vahlne, 1977). The Uppsala theory was originally developed to understand internationalization of SMEs from Nordic countries in the 1970s, but it has been widely used to analyze OFDI patterns from developing countries (see e.g., Beausang, 2003). Beausang (2003). Vernon-Wortzel, H., & Wortzel, L.H. (1988), “Globalizing Strategies for Multinationals from Developing Countries.” Columbia Journal of World Business, 23 (Spring): 27–35. Gerschenkron, A. (1962), Economic Backwardness in Historical Perspective. Cambridge, MA: Belknap Press. Vernon-Wortzel & Wortzel (1988); Cantwell, J.A., & Tolentino, P.E. (1990), “Technological Accumulation and Third World Multinationals,” University of Reading Discussion Paper in International Investment and Business Studies No. 139, May. Cantwell & Tolentino (1990). Beausang (2003). UNCTAD (2006). Buckley, Wang, & Clegg (2007). UNCTAD (2006).

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71. Mathews, J.A. (2006), “Dragon Multinationals: New Players in 21st century Globalization.” Asia Pacific Journal of Management, 23, pp. 5–27. 72. Ibid. 73. Ibid. 74. Madsen, T.K. & Servais, K. (1997), “The internationalization of born globals: An evolutionary process?” International Business Review, 6(6), pp. 561–583. 75. S. Mathews (2006). Similar arguments have been advanced by other authors. For instance, it has been suggested that OFDI from developing countries can be understood as an attempt to acquire lacking O-advantages through internationalization (Moon, H. and T. Roehl [2001], Unconventional Foreign Direct Investment and the Imbalance Theory, International Business Review, Volume 10, Number 2, 2001, pp. 197–215). In a similar way, Hwang (Hwang, K. (2003), Why do Korean firms invest in the EU: Evidence from FDI in the peripheral regions, EI working papers, 2003–05, December, 2003) has argued that Asian firms a good at undertaking “reverse FDI,” that is FDI made to buy/acquire skills. 76. Teece, D. (2002), “Firm Capabilities, and Economic Development: Implications for NIEs,” in Kim, L. & Nelson, R. (eds.), Technology, learning and Innovation. Cambridge: Cambridge University Press. 77. Dunning, J.H. (1981b), “Explaining the International Direct Investment Position of Countries: Towards a Dynamic or Developmental Approach.” Weltwirtschaftliches Archiv, 117:1: 30–64; Dunning & Narula (1996); Dunning, J.H., & Narula, R. (2004), “Industrial Development, Globalization and Multinational Enterprises: New Realities for Developing Countries,” in J.H. Dunning and R. Narula (eds.), Multinational and Industrial Competitiveness. Cheltenham, UK: Edward Elgar, pp. 38–77. 78. UNCTAD (2007). 79. Assocham (2007). The unusual Indian path has not been missed in the Indian debate, not even at the highest political level. In a speech in the United States, the Indian Minister of Finance said that “I am aware of the so-called Investment Development Path (IDP) theory. According to that theory, in the initial stages of development, a country receives FDI flows. Once a country reaches a certain level of development, outward investment takes place. I do not know if India’s current level of development and Indian companies’ outward orientation fit in with that theory. Till 2005–06, Indian firms’ outward investment was very modest. In that year, the outward investment was US $ 2.9 billion. In the next year, 2006–07, it shot up to US $ 11.0 billion. FDI flows into India also shot up to a new high of nearly US $ 20.0 billion in 2006–07. The two stages of accelerated FDI inflows and accelerated FDI outflows appear to have converged in India, marking a break with the conventional IDP theory” (Address by Mr. P. Chidambaram, Finance Minister at the Wharton School, University of Pennsylvania on September 26, 2007). 80. UNCTAD (2004a). 81. UNCTAD (2004b), World Investment Report: FDI in Services. Geneva: UNCTAD. 82. Winters & Yusuf (2007).

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83. While China exports seven times as much as India, the service export of the two countries is not that different ($62 billion versus $51 billion) (Winters & Yusuf, 2007). 84. Khanna, T., & Palepu, K. (2004), “Globalization and Convergence in Corporate Governance: Evidence from Infosys and the Indian Software Industry.” Journal of International Business Studies, 35: 484–507. 85. Altenburg (2000); Scott-Kennel, J., & Enderwick, P. (2005), “FDI and interfirm linkages: exploring the black box of the IDP.” Transnational Corporations, 14:1: 105–130. 86. UNCTAD (2004a), India’s Outward FDI: A Giant Awakening. 87. Hamel, G., & Prahalad, C.K. (1990), “The Core Competence of the Corporation.” Harvard Business Review, 68:3, May–June: 79–91. 88. Khanna, T., & Palepu, K. (1997), “Why Focused Strategies May be Wrong for Emerging Markets,” Harvard Business Review, July/August: 41–51; Peng, M.W. (2002), “Towards an Institution-Based View of Business Strategy,” Asia Pacific Journal of Management, 19; Nielsen, C. (2005), “The Global Chess Game. Or Is It Go? Market Entry Strategies for Emerging Markets,” Thunderbird International Business Review, 47:4: 397–427. 89. The market failures are for instance: (1) Brands are difficult to build due to lack of credible information. Conglomerates can overcome these problems by applying brands across product categories; (2) Raising capital is difficult. In capital markets, credible information is difficult to obtain due to the lack of a critical press and failure of a judicial system that can hold mis-informers liable. Thus, investment will be below optimal. Conglomerates can internalize market intelligence and ensure cross-subsidization; (3) Lack of trained personnel: In labor markets, there is lack of vocational and business training and it is difficult to fire people when restructuring takes place. Being a conglomerate allows a company to establish its own schools and training facilities and to find employment to people that have become redundant due to restructuring; (4) High cost of political influence: The high costs of interacting with regulators and politicians, may give large conglomerates an advantage (Khanna & Palepu, 2007). 90. Morck, R.K. (2005), A History of Corporate Governance around the World (Chicago: NBER and University of Chicago Press); Aykut & Goldstein (2006). 91. Buckley, Wang, & Clegg (2007). 92. UNCTAD (2006). 93. Khanna & Palepu (1997); Peng (2002); Hoskisson, R.E., Eden, L., Lau, C.M., & Wright, M. (2000), “Strategy in Emerging Economies.” Academy of Management Journal, 43:3: 249–267. 94. Buckley Wang, & Clegg (2007). 95. Aggarwal, R., & Agmon, T. (1990), “The International Success of Developing Country Firms: Role of Government.” Management International Review 30:2: 163–180. 96. Sauvant (2005); Pradhan (2005); Dige Pedersen, J. (2007), “Den Anden bølge af Indiske Udlandsinvesteringer.” Den ny verden, 40:1. 97. UNCTAD (2006).

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98. It thus appears that the Indian elites have arrived at the conclusion that to assert its moral and political standing in the world, India needs to become economically strong through globalization. Outward investment could be seen as a key ingredient in India’s globalization strategy (Alamgir, J. (2005), The Power of Narrative in Managing Globalization in India, Boston: University of Massachusetts University, Department of Political Science Working Paper Series). 99. Pradhan (2003). 100. Sauvant (2005).

3 Global Value Chains, Market Organization, and Structural Transformation of Bangalore’s Software Cluster in the 1990s and Beyond Rasmus Lema

3.1 Introduction A key insight of the institutional approaches to industrial dynamics is that specific models of economic organization may combine the institutional arrangements of markets, hierarchies, and networks in different ways, resulting in inter-firm relations that are complementary to different types of “business systems” or “varieties of capitalism.” This chapter sets out to examine and discuss the particular local and global models of industrial organization that underpinned India’s software industry during the “takeoff phase” in the 1990s. As one of the most celebrated cases of rapid integration into the world economy this case holds important insights for the ongoing debate on local institutional dynamics in the age of deepening globalization. Is the increasing transnational coordination of economic activities overriding local organizational structures and institutional arrangement combinations? If so, what are the implications for the process of industrial upgrading in new growth regions? This chapter delves into the debate on global-local interaction, by using the concepts of “global value chains” and “local market organization” to assess the case of the software cluster in Bangalore in southern India during its establishment on the world economic map in the period between 1991 and 2001. The central questions addressed are the following: (1) How was the character of local market organization

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in Bangalore related to the industry’s export success? (2) What was the role of global value chains in shaping local market organization? (3) How have global value chains and the local variety of market organization impacted upon Bangalore’s industrial development trajectory? The chapter explores these questions by focusing on Indian-owned firms based in Bangalore, their interrelations as well as relations to firms external to the cluster. The chapter proceeds as follows. Section 3.2 briefly presents the conceptual underpinnings of this chapter while section 3.3 draws up the backdrop for the discussion of Bangalore’s growth and transformation. The two subsequent sections are more directly concerned with the question posed above. Section 3.4 discusses Bangalore insertion into global value chains, while section 3.5 discusses the character of the local mode of market organization. The concluding section 3.6 reviews the insights on the dynamics of the industry and the implications for industrial upgrading during the 1990s. The key argument made in this chapter is that the insertion into global value chains and the heavy reliance on global linkages was profound in shaping the local organizational structure as well the “horizon of opportunities” in Bangalore. Despite strong national institutional legacies a distinct globally integrated organizational setup emerged in the software sector. On the one hand this setup underpinned and facilitated rapid economic growth but on the other hand it gave rise to certain impediments for structural transformation. However, section 3.7 looks beyond the 1990s and discusses the further development of the cluster in the new millennium. It suggests that since the turn of the century Bangalore firms have slowly initiated a new phase of development.

3.2 Global Value Chains and Local Market Organization A central feature of current global capitalism is the increasing transnational organization of production through “global value chains” that connect users and producers across countries and continents.1 Whereas global value chains are related to the vertical sequence of global-scale production, “market organization” relates to linkages between firms at the local or national level.2 Market organization, a key component of a nations or regions business system, refers to inter-firm relations within bounded localities, often (but not necessarily) between firms that are horizontally related with regard to the

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value chain. In this chapter I explore market organization at the level of the cluster.3 Linkages between firms in both internal and external markets may take a variety of forms. A simple but useful distinction can be made between thin and thick linkages. Thin linkages are confined to the formalized and short-term exchange of goods and services as well as information on prices and quantities. Firms are “arms-length” related and exhibit a large degree of mutual autonomy. Thick linkages, on the other hand, involve authority, trust or community relationships. They are more durable, based on reciprocity and may be embedded in personal relations between actors. Thick linkages are generally argued to provide the mean for interactive learning and collective knowledge generation.4 McKendrick, Doner & Haggard have argued that IT industries tend to be organized into two different types of clusters, “technology clusters” and “operational clusters”. 5 Lead firms that focus on product development and ongoing innovations dominate the first type of cluster, relying to a large extent on tacit knowledge and face-to-face interaction. The second type of cluster, often based in low-cost locations, is focused on bases processes of generic manufacturing, assembly and logistics. Hence, while interrelated, these clusters are focused on different lines of activity for which firms and supporting institutions specialize. According to Sturgeon the global value chains that link lead firms and operational suppliers are increasingly taking the form of thin and flexible, yet information intensive, linkages among firms. This constitutes a successful “new American model of industrial organization”. Building on a strength-of-weak-ties argument, Sturgeon argues that flexible relationships between firms in these networks spur greater adaptability to changing market conditions than do various forms of thick relational networks. Hence, there are signs that such thin relational networks may become the dominant form of global value chains; they may be replacing more relational production network forms that, in turn, will become isolated. Furthermore Sturgeon contends that global lead firms seek to leverage thick linkages locally, in geographical areas of cutting-edge technology characterized by a large degree of tacit knowledge (e.g., the ideal-typical Silicon Valley), while to an increasing degree outsource all aspects of production that can be codified to suppliers that can leverage lower costs and economies of scale in base processes. Although Sturgeons work has been centered on U.S.-based lead firms and their strategies, he argues that the

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supply platforms inserted into such “modularized” value chains tend to be “relatively open systems that can fulfill a specialized role within larger, global-scale production networks”. According to Sturgeon the supply bases in such operational clusters may experience fast upgrading in the sphere of operational provision of base processes and services but they are effectively de-linked from the innovation activities of lead firms that generate high rents.6

3.3 Bangalore’s Growth and Transformation Bangalore was the first Indian city to have a software technology park in 1991 and this marked the beginning of the software industry’s takeoff phase and Bangalore’s firm establishment on the world economic map. The “end” of this decade long “takeoff phase,” which is the focus of this paper, was marked by the slump in the U.S. technology sector shortly after the turn the millennium. The reasons and background factors for India and Bangalore’s export success in the software industry are reasonably understood and widely documented. Hence they shall not be discussed here in any detail.7 Software exports from Karnataka state (in which Bangalore is the capital city) rose from two million in 1991 to two billion in 2001. The number of registered companies exporting from the state (including MNCs) rose from thirteen to more than one thousand.8 This quickly made Bangalore the largest exporter of software in India. Throughout the decade first-mover companies grew in size and benefitted from economies of scale and reputational effects while smaller start-ups cumulatively joined the industry and faired with differentiated results. This created a top-heavy industrial structure. But to what extent did massive entrepreneurial dynamism and rapid export-growth of the software industry translate into industrial upgrading toward increasingly high value added activities? Much of the discussion of this question has tended to assume that upgrading and industrial transformation would entail a gradual transition from outsourcing services to own-brand software products for the global market.9 However, revenues generated from products were limited to 4% at the turn of the millennium, a figure which was decreasing during the 1990s.10 Hence the remainder of this paper concentrated on the offshore services segment and the different types of activities within it. The development process for software services aimed at customized solutions, the main space in which Indian firms operate, is often

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described as consisting of six steps.11 The first step of requirement analysis takes place in consultation with the specific end-user. The second step is the design, architecture and integration of products/ projects that is built up of objects or modules, whereas the third step is concerned with the design of these specific modules. The fourth and fifth step, where actual software code is written and tested respectively, is referred to as “programming.” The last step consists of the maintenance of existing software systems. The next section discusses how these steps in the software development process are distributed in the global value chain.

3.4 Bangalore in Global Value Chains The global value chains that Bangalore feed into reflect the transnational dispersion of the software development process. In most outsourcing relationship, the OECD based customer and lead-firm undertake requirement analysis and provide high-level design specifications which involves close interaction with the end-user. For firms or business units catering for end-users in the market for IT consulting services, these are the critical and strategically important lines of activity. Success in these areas requires deep domain and customer related knowledge as well as relationship assets. Indian firms, on the other hand, concentrated on the remaining functions in the production chain including programming and low-level design. Programming is a labor-intensive process with low barriers to entry, stemming from relatively small fixed costs. Onsite teams at the lead firm premises provided a key communicative interface between buyer and vendor. Nevertheless, this model entailed a clear division of labor between the end-user facing lead-firms and the service-oriented Indian suppliers. Thus during the 1990s, the Indian software industry became firmly rooted in the emerging offshore model and was dominated by routine-based tasks in the field of standard application development and maintenance.12 This niche was complementary to the changing nature of external lead firms that were increasingly following “core competence” strategies throughout the 1990s.13 The emergence of the offshore model can be seen as a co-evolving process along with the vertical disintegration of their customers. The onsite business (body-shopping), which dominated the (slower) growth model before the 1990s, was complementary to the vertically integrated “old American firm.” And although a large share of onsite work was still conducted in the

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period under review, the move toward increased outsourcing among customer firms was paramount in spurring offshore model of service delivery in India. However, as will be argued, there were no preexisting practices for offshore software development before this period and the successful transition to the offshore model was dependent on significant entrepreneurial dynamism, experimentation and adaptation related to the development of this model within Indian companies. A manager in one of Bangalore’s leading firms, Infosys, explained the logic behind typical outsourcing arrangements between local firms and their foreign customers as “win-win alliances” based on a clear division of labor. He used the case of the Infosys-Microsoft relationship to illustrate the case of a symbiotic relationship. Microsoft was clearly one of those; they did not have a services portfolio, we did not have a product portfolio. We say we will not get into products and that’s a very strong statement from us, and from them they have made a commitment that services will be given to partners.

Thus these outsourcing relationships involved a dedication to downstream activities in the Indian firms. Customers confirmed the importance of the suppliers’ dedication to remain “pure-players” in the downstream segments. While there were (and still are) variations this was a rule of thumb and was clearly articulated discussions foundational discussions. A Microsoft employee, for instance, expressed this when he was commenting on a particular relationship with a Bangalore supplier. We felt we could enter into this business relationship with them and not worry that they’ll be competing with Microsoft in the sales channel down the road which would cause customer confusion. In essence, we felt the relationship would be very symbiotic. . . . They [the Indian firm] clearly articulated what they are going to do but were also very specific as to what they are NOT going to do. Being clear as to what you are and are NOT going to do, helped us to establish trust and confidence in what their long term plans were.

Thus as a reflection of buyers’ interests, the niche and business model of most Indian software firms was based on providing complementary services with regard to their foreign customers with defined horizons of action. Kshema Technologies, a startup of the mid 1990s defined its role as that of a “virtual extension” to its foreign customers. This

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business model in precise way captures the essence of the nature of outsourcing relations between local firms and their customers: The Virtual Extension is a customer centric business model that involves the creation of a software unit which operates like the customer’s own software services unit and offers a virtual ownership of a part of Kshema to the customer. The virtual extension . . . has unlimited scalability.14

Thus an important element of customer centricity was the development of software units that operate like the customer’s own software services units. These are known as dedicated ODCs, offshore development centers. Firms earmark an isolated part of the company’s premises and a team of employees to the customer as to protect information of the customer firm.15 The business model of most Bangalore firms was similar to the “virtual extension” but came under different names. As a revenue model the virtual extension was highly effective. As an example, Infosys maintained an on average 30% plus profit margin throughout the latter half of 1990s. This gave companies little incentive to change their business model. As explained by the Infosys representative quoted earlier, We are here to make money. We are not here to impress somebody by moving up some value chain defined by someone. We are here to make money for our shareholders. And we do it the way we think is best. We will move up the value chain, and by that I mean we will make more money. It doesn’t mean that we will do X kind of work or Y kind of work.

Making money was equal to offering cheap software-process services with little risk and high scalability for lead firms. Therefore local firms focus on process tasks applicable across a wide range of business domains. Software service providers, if successful, cater for a very large number, sometimes hundreds, of customers, as opposed to a small number in some relational networks. Large software firms worked with several hundred customers simultaneously. This large number of customer firms in a broad range of business domains was enabled by the focus on somewhat generic bases processes in the software development cycle which could be deployed across customer domains. With regard to the nature of inter-firm linkages in the development process, the type of information flowing between the Bangalore

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based firms and their customers extend well beyond price and requirements as in some thinly relational linkages. Rather, large amounts of production related information flows back and forth. Multiple site visits confirmed that ODC staff had online access to the customers’ information repositories and were able to retrieve “real-time” design specifications, appraisals and other production related information. The linkages between local firms and their customers, however, are not appropriately described as “thick.” All projects are delivered with detailed codified documentation, enabling others to fix and develop the software further. Because of the limited degree of tacit knowledge embedded in most relationships “switching costs” were reduced. Furthermore, in order to reduce risks connected with the “sharing” of information the customer firms often conditions the relationship in very detailed written contracts. In this ways, the relationship between buyer and supplier was characterized by mutual autonomy as in the modular global value chains described by Sturgeon. How did such modular global value chains relate to local inter-firm connections? This is the questions for the next section.

3.5

Local Market Organization in Bangalore

A number of studies of “local clusters in global chains” have identified strongly hierarchical forms of local market organization, where outsourcing orders from distant customers are received by a few leading firms within the cluster that, in turn, coordinate a network of local subcontractors. This has meant that leading firms in such clusters have upgraded and evolved into “comprehensive solution providers.” On the one hand they maintain linkages with customer-firms and on the other hand subcontract less-skilled work to SMEs in the cluster.16 As discussed in section 3.3, there was a top-heavy structure in Bangalore too, with huge differences between the leading (large and successful) and following (small and striving) firms of the cluster. Certainly these differences reflect differences in linkages to customers, varying with the number of linkages and their “throughput capacity.” However, they do not reflect their position in a clusterinternal division of labor. Limited differentiation in the customercentric virtual extension business models was a critical feature of the local form of market organization in Bangalore. This had important implications for the type of competition among firms. Informants used expressions such as “cut-throat” when asked about the relations of competition with regard to cooperation among firms in Bangalore.

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Neighboring firms bid for the same projects and therefore perceive competition as a zero-sum game.17 Competition for customers was reinforced by competition for skilled personnel. As the software industry was growing rapidly, and as tasks often demanded skills that went well beyond “programming” as such, the market for experienced software professionals was highly competitive with one of the highest attrition rates in the world at around 25% toward the end of the millennium.18 The relatively narrow source of competitive advantage left little scope for deep specialization. This, in turn, meant that the possibilities for building alliances based on complementary competencies were limited. For reasons and because of contractual clauses the firms in Bangalore tended to be vertically integrated undertaking all tasks inhouse. This also meant that successful firms in the cluster were also large firms in terms of people employed. However, some firms have tried to work their way around problems of decreased flexibility and risk of excess capacity by making use of staff-supplementation firms. Labor from such companies was brought on to the premises of the contract-winning firm to do simple programming work when supplyside bottlenecks occurred. Hence, some firms have utilized this form of “in-sourcing” when the companies are under-staffed for shorter periods of time in relation to specific projects since this would circumvent constraints imposed by the customer with regard to the guarantee of no direct third party involvement (such as subcontracting). Some companies employed staff through staffing companies such as Manpower or smaller local companies on a permanent basis. The contractual arrangement between the buyer and supplier of services excluded the options of third party involvement. Even in some cases where co-located companies work on the same problem for the same costumer, all communication (if any) would normally go through the customer. Since Bangalore’s firms undertake tasks that were virtual extensions of their customers’ processes, these customers are effectively demanding non-disclosure and “professional” forms of corporate governance. Indian firms were effective in setting up systems and processes to tackle sensitive issues. A particular case in point is the very high level of attrition which remained high throughout the 1990s. The introduction of graded security-levels, employee stock option schemes (ESOPs) and confidentiality agreements were among the elements in the focused efforts to confine attrition to lower-level staff and mitigate the negative impact of a high attrition rate. Recent interviews with customers based in the OECD suggest that they were

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assured that suppliers were capable of handling the problem effectively. A head of global sourcing in a large multinational company stated retrospectively that: “We were expecting high attrition [in the supplier firm], but we also knew that our partners in India had the teams and the processes for handling that”. The statements given by the suppliers in India was that high attrition levels posed real challenges, but from an operational perspective rather than a knowledge perspective (apart from the occasional senior-level exit). High levels of documentation ensured that ongoing work was continually codified. Informants suggested that the ability to codify work at the level of the programmer was high and that business and technical issues were easily separated even at the level of system architects and project leads. This facilitated the “interchangeability” of the bulk of resources in a given project, although replacement of staff in a project is time consuming and depends on the availability of other people with matching skills. At the industry level attrition was probably hampering the industry from growing even faster and the systems mentioned above incurred high transaction costs on firms. On the other hand these principles increased customer confidence and became essential standard elements of long distance outsourcing relationships. In this way Indian firms were actively engaged in adaptation to changing external needs and requirements of commanding customers. Arguably this responsiveness with regard to organizational change and business model adaptation was among the key but largely overlooked factors behind the success of the industry. Not surprisingly interviews with customers confirmed the importance ascribed to adaptation. One informant in large U.S. software house emphasized the ability of suppliers to be “responsive to customer issues” as the key determinant in supplier selection overall, and this was also the reason given for choosing a particular Bangalore firm for more demanding work which was critical to the buyer. Similarly a manager in the IT wing of a large European multinational commented on the relationship with its Bangalore supplier stating that “they have shown very high responsiveness to our needs” when they were requested to do this. These needs related much to the building of new skills and capabilities but also to issue of organization and modes of interaction as well as the clear and trustworthy articulation of longer term intentions. The general picture emerging from customer-side interviews is one of overall satisfaction with the adaptation and responsiveness exhibited by the Indian entrepreneurs. Importantly these customer

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interviews were biased toward successful relationship with high-level of customer satisfaction.19 However, this only underlines and connection between responsiveness/adaptation and performance and suggests that software firms in Bangalore are under constant pressure to strengthen their adaptive capabilities and customer centric business models in order to compete with the market leaders. Overall, customers’ interests appear to have had a decisive influence on intra-firm dynamics and the local mode of market organization. Global value chains and the relative “power” exercised by lead firms are important in explaining why traditional subcontracting and other forms of inter-firm linkages were among the things they “were NOT going to do”. One local business leader commented on his participation in the local industry from it early inception, and the limited importance of his social ties to local industry leaders such as Narayana Murthy, the creator of Infosys. Just because I know Narayana Murthy, that doesn’t mean I will get a sub-contract from Infosys. . . . It would be highly unlikely. Normally people in India, in other industrial segments, if you know somebody and you have always been friends you become a subcontractor for him. Not in the software industry.

To sum up, the Bangalore was characterized by a low degree of market organization.20 The compartmentalized and parceled structure of firms was, in effect, an open pool of cheap and secure software production offerings. This is to say that the “nature” of the global value chains that Bangalore feed into produced a special kind of cluster that was very different from the ideal-typical description of traditional technology clusters. In the case of Bangalore’s software cluster the two spheres of global value chains and the local form of business organization form an inseparable complex with important consequences for the industrial dynamics in the cluster. The next section outlines some of the implications of these dynamics with regard to the industrial upgrading of Bangalore-based firms.

3.6 Concluding Discussion: Implications for Industrial Transformation So far this chapter has examined Bangalore firms’ insertion into global value chains, the character of local market organization and the relationship between the two. This concluding section summarizes the

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arguments made so far and then goes on to discuss the implication for industrial transformation and upgrading in the cluster. The chapter has argued that in the case of Bangalore, “forces of globalization” were a decisive shaper of organizational outcomes. However, this was not a passive or automatic process. Local entrepreneurs were effective in adapting to changing external needs and requirements, thereby securing successful interaction and learning with and from external actors. By securing competitiveness in global markets this model has buttressed one of the most outstanding cases of local economic development in recent history. Growth and competitiveness in Bangalore during the 1990s required the establishment of a highly open mode of market organization that ensured the client firms’ flexible, secure and cheap access to software development resources. The success has been dependent on entrepreneurial dynamism and Bangalore-based firms’ ability to develop “suitable” business models and process capabilities to support their efforts. As result the agglomeration of software firms in Bangalore differs fundamentally from known models of industrial organization. It differs from the typical “technology cluster,” characterized by dense networks, as has been found in Silicon Valley. Software firms in Bangalore have succeeded individually, not as parts a thickly interlinked collective of firms. As an “operational cluster,” based on the success of customer-centric business models, there is little scope for building local linkages and forming a cluster-internal division of labor. Rather, the supply base residing in Bangalore is weakly interlinked. In this way the mode of market organization in Bangalore was the outcome of successful adjustment to the needs and practices of customer firms based in the United States and elsewhere. In this process a system has developed that not only was quite different from the ideal typical technology cluster, but also from that of many other sectors and spheres of the Indian economy. As observed by the Economist, “quality standards, management styles, and ideas of corporate governance owe more to western, especially United States, models than to traditions of Indian firms”. 21 Bangalore’s software industry may be characterized as a high-growth industrial cluster underpinned by a market-driven model and operating as an extension of an AngloSaxon model of capitalism. Hence the case of Bangalore also differs from the ideal-type descriptions of the “Asian model” of network capitalism in countries such as Japan, Korea, or Taiwan and therefore this case challenges the frequently contended view that U.S. capitalism is generally based on

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combinations of atomistic markets, formal private hierarchies and relatively loose networks while the combination of networks and community relationships predominate Asian models. Needles to say, Asia is not homogenous. Although scholars have identified a distinct type of business system which is heavily shaped by the institutional legacy of the inward-looking (pre-reform) period22 this seems not to apply to the software which was a global from its inception and had greater external than internal linkages. As emphasized by the global value chain literature the metaphor of network capitalism and atomistic markets are applicable in the context of internal markets as well as external markets. The important point emerging from this chapter is that despite strong national institutional legacies islands of distinctiveness may emerge where external linkages are the defining feature of sectors.23 Understanding the dynamics and evolution, in this case, necessitates a scrutiny of its global linkages. In the other words the dynamics of inter-organizational change and structural transformation in “global supply platforms” are not easily captured with locally centered focusing devises.24 In the case of Bangalore’s software industry it is evident that this global supply platform model was highly effective in securing fast growth during the 1990s. But what where the implications of a growth-agenda defined by Bangalore’s participation in global value chains with regard to structural transformation and further transition toward a “next stage” growth-model based on increasing knowledge and learning? Central features of both global value chains and the local form of market organization have strained such a progression. The innovative capabilities of local firms were strained by the “centralizing” tendencies of lead firms’ core competences and the importance of tacit knowledge. The core innovative activities of OECD-based software lead firms tended to be “non-globalised” and “bound” to their home locations. 25 In other words the organizational models rarely provided proximity to end-users and access to knowledge and resources embedded in end-customer facing functions. As a result of the “modular approach” to software development, learning possibilities were limited since exposure of Indian firms to knowledge creating processes was fractional.26 In this way—as it was normally codified knowledge that flowed through the links—the global value chains that Bangalore feed into exhibited inherent barriers to entering certain innovationbased tasks. Bangalore was constrained but the logic governing operational clusters/supply platforms.

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3.7 Beyond the 1990s The previous sections were concerned with the ten year period between 1991 and 2001. As has been argued this period witnessed an impressive accumulation of software development capabilities. However, the acquisition of innovation capabilities which could allow firms to progress beyond the offshore-model, to “the next stage,” was limited. This section turns to the subsequent five year period between 2001 and 2006. Did firms in Bangalore progress to a new growth stage based on innovation capabilities? On the one hand it is clear that offshore model-type growth, as described in the preceding sections, has extended firmly into the new millennium. Industry statistics suggest that application development and maintenance, activities typical of traditional outsourcing orders, continues to dominate.27 On the other hand there is evidence of newfound knowledge-creating capabilities which gives rise to (cautious) optimism. One indicator of this progression is the increasing diversification of IT software business lines. IT consulting, remote infrastructure management, offshore product development services, independent testing services, and proprietary technology or product development are all examples fast growing business lines in which established and new companies have been able to redefine their role in the division of labor in this sector. Doctoral research by this author has concentrated on firms leading these business lines and has sought to examine the extent and circumstances driving the progression. This research suggests that a strengthening base of innovation-active companies now stand out. 28 In the virtual extension model customers would get “more of the same thing, but faster cheaper and better” by outsourcing certain tasks. Today select Indian firms have become actively involved in defining requirements and specifications. Research on the buyer-side shows that customers are beginning to change their internal processes and practices due to their relationships with Indian IT firms. In this sense the value proposition has begun to change from operational efficiency (based on improved productivity and quality) to dynamic advantages (based on business transformation and innovation). Outsourced tasks are based not only on use of existing knowledge; they also involve the creation of new knowledge. While previously the Indian firms were functioning as virtual extensions of the customer’s teams their activities were largely confined to coding tasks. Today Bangalore firms are sometimes becoming

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“comprehensive solution providers” in certain areas. Due to their sheer size Wipro and Infosys are important in this regard. To take a few examples Wipro have become a “one-stop” solutions provider in remote infrastructure management, handling all elements of customers infrastructure elements such as networks, databases or storage. Infosys increasingly engage in consultancy works such as business process modeling (BPM) for their customers. This extends to the “framing” phase of change and high-end value chain steps, including requirement analysis. Smaller companies are providing outsourced product development services, for instance, in which they design new products end-to-end, based on short visioning documents from customers. How can one explain the noted increase in capabilities? The detailed analysis of knowledge linkages in the capability building process suggest that, while the local market-organizational setup is slowly strengthening, local linkages were only marginally important in the development of new capabilities. On the other hand, global value chains combined with intra-firm entrepreneurial dynamism and strategic intent—like in previous phases of progression—were factors of crucial importance. The evidence suggests that local firms have found ways to work their around the constraints associated with the offshore model which has allowed them to engage in processes of interactive learning with foreign value chain actors. In particular innovative companies have succeeded in developing much deeper and often trust-based relationships with customers. Also, as highlighted by Hansen in this book, many firms have become global companies which have allowed them to establish a firm presence in customer locations where critical and often tacit knowledge is produced. This has involved a radical transformation of the role of onsite staff from the days of the body shopping model. Onsite staff is increasingly coinvolved in roadmap development and high-level design activities. Such developments have been facilitated by the increased spending power of Indian companies allowing them to “purchase” stronger relationship capabilities through people with cultural backgrounds and network assets in customer locations. A key insight from research on the buyer-side is that there has been a radical shift in the nature of activities which some customers are now willing to outsource. These customers are rapidly adopting “open business models” in which companies look outside their boundaries for ideas and innovative work. 29 This adoption of open business models on the buyer-side may have a major influence on the future direction of the Indian software industry.

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Notes This chapter builds on two rounds of fieldwork in Bangalore totaling nine months and more than 150 interviews. Fieldwork in 2002, conducted jointly with Bjarke Hesbjerg, concentrated on the 1991–2001 period. Fieldwork and interviews in 2006 (in Bangalore and “customer locations” in the OECD) concentrated on the subsequent 2001–2006 period. An earlier draft version of this paper appeared in Fleming, D., & Nordhaug, K. (2006), Global Challenges—Local Responses. An Institutional Perspective on Economic Transformation in Asia. Roskilde: Roskilde University. I thank collaborators at the Indian Institute of Management Bangalore and colleagues at the “GlobAsia” group at Roskilde University for support and comments. Rajesh Kumar and Murali Patibandla, provided very helpful comments and suggestions. 1. The term global value chain refers the full range of activities required to bring a product or service from its conception to its end use. A focal point in global value chains analysis is the type of inter-organizational relationship connecting buyers and suppliers. See Gereffi, G., Humphrey, J., & Sturgeon, T. (2005), “The Governance of Global Value Chains.” Review of International Political Economy, 12:1: 78–104; Schmitz, H. (2004), Local Enterprises in the Global Economy: Issues of Governance and Upgrading. Cheltenham, UK: Edward Elgar. 2. “Market organization, or inter-firm relations, can be broadly compared across economies in terms of the extent to which transactions are primarily organized around long-term relationships between particular exchange partners as distinct from being ad hoc and at arm’s length . . . markets exhibiting low levels of organization function like markets in which standardized commodities are traded between anonymous buyers and sellers” Whitley, R. (1992), “Societies, Firms and Markets: The Social Structuring of Business Systems,” in Richard Whitley (ed.), European Business Systems: Firms and Markets in Their National Contexts. London: Sage, pp. 6–45. See also Whitley, R. (1996), “Business Systems and Global Commodity Chains: Competing or Complementary Forms of Economic Organisation.” Competition and Change, 1: 411–425, Whitley, R. (2001), “Developing Capitalisms: The Comparative Analysis of Emerging Business Systems in the South,” in G. Jakobsen, & J.E. Torp (eds.), Understanding Business Systems in Developing Countries. New Delhi: Sage. 3. Defined by Porter as “geographic concentrations of interconnected companies and institutions in a particular field”. Porter, M. (1998), “Clusters and the New Economics of Competition,” Harvard Business Review, November–December. 4. In both the value chain and business organization literature more sophisticated typologies of interfirm relations have been developed. For the present chapter, the simple dichotomy discussed here will suffice. Thick linkages such relationships are often emphasized in the “new economic sociology” that adopts the Polanyan notion of embeddedness. See Granovetter, M. (1985), “Economic Action and Social Structure: The Problem of Embeddedness.”

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6.

7.

8.

9.

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American Journal of Sociology, 91: 482–510. On the importance of such relationships for interactive learning see for instance Lundvall, B., Johnson, B., Andersen, E.S., Dalum, B. (2002), “National Systems of Production, Innovation and Competence Building,” Research Policy 31:2: 213–231. McKendrick, D., Doner, R.F., & Haggard, S. (2000), “A Theory of Industry Evolution, Location, and Competitive Advantage,” in McKendrick, D., Doner, R.F., & Haggard, S. (eds.), From Silicon Valley to Singapore: Location and Competitive Advantage in the Hard Disk Drive Industry. Stanford: Stanford University Press. The de-linking thesis is most clearly articulated in Sturgeon, T. (1997), Does Manufacturing Still Matter? The Organizational Delinking of Production from Innovation. Berkeley Roundtable on the International Economy (BRIE). This argument rests on the (problematic) premise that only certain value chains steps such as design contain innovation activities. This line of thinking is also innate in later publications. See Sturgeon, T.J. (2002), “Modular Production Networks: A New American Model of Industrial Organization.” Industrial and Corporate Change, 11:3: 451–496. For the “open systems in global networks” argument see Sturgeon, T.J. (2003), “What Really Goes on in Silicon Valley? Spatial Clustering and Dispersal in Modular Production Networks.” Journal of Economic Geography, 3: 199–225. In systems theory “open systems” are nested within larger system and the linkages between levels can have important ramifications for the dynamics of change. “Closed systems,” on the other hand, exhibit inter-locking relationships between its components. Operational clusters (supply platforms in the global economy) may resemble open system that constitute pools of resources and infrastructure which global firms can dip into as and when required. See also Amin, A., & Thrift, N. (1992), “Neo-Marshallian Nodes in Global Networks.” International Journal of Urban and Regional Research 16:4: 571–587. Good overview articles are provided by Athreye, S. (2005), “The Indian Software Industry,” in A. Arora, & A. Gambardella (eds.) From Underdogs to Tigers: The Rise and Growth of the Software Industry in Brazil, China, India, Ireland, and Israel. Oxford; New York: Oxford University Press, 2005. and Desai, A.V. (2005), “India,” in Simon Commander (ed.), The Software Industry in Emerging Markets. Cheltenham, UK; Northhampton, MA: Edward Elgar. One of the best sources on the economic history of Bangalore is Heitzman, J. (2004), Network City: Planning the Information Society in Bangalore. New Delhi; New York: Oxford University Press. Lema, R., & Hesbjerg, B. (2003), The Virtual Extension: A Search for Collective Efficiency in the Software Cluster in Bangalore (Roskilde: Roskilde University), Table 4.21, p. 92. A stylized three-stage model for industrial development of software exporters in developing countries was put forth by UNCTAD among others. In stage one the industry delivers export of labor, mainly through the supply of onsite programming services that are performed at the customers’ premises. This stage may be referred to as the “body-shopping model” In stage two the industry moves to the export of such services through primarily offshore

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11.

12.

13.

14.

Rasmus Lema work, conducted in the developing country and then transferred to the customers. This stage may be referred to as the “offshore model.” In stage three the industry moves to the export of products through the development of software products. UNCTAD (2002), Changing Dynamics of Global Computer Software and Service Industry: Implications for Developing Countries. (Geneva: UNCTAD.). When the software export industry emerged in India in the early 1980s it was based solely on the onsite service business model. In the early 1990s the share of onsite work as a proportion of total revenues had decreased to 77% of Indian software exports. During 2001 the offshore proportion exceeded the 50% milestone which signifies the progression to stage two in UNCTADs model. Thus the first two stages seem to correspond with the Indian experience. However, as is also recognized by UNCTAD, the progression from stage two to stage three (as defined here) is neither clear nor straightforward. As will be discussed in the last section of this chapter some Bangalore software firms are currently progressing to “the next stage,” but increasing own brand product development (of so-called packaged software) has a relatively insignificant role to play in this process. NASSCOM (2001), The IT Software and Services Industry in India: Strategic Review 2001. New Delhi: National Association of Software and Services Companies. Needless to say this is a very simplified model of the software development process. In reality there are various feedback loops and iterations which are sometimes captured in similar so-called waterfall models of the software development process. Also, recent trends in the software development, such as the introduction of “agile” development methods with a modular architecture and constant testing, do depart from the description given here. Nevertheless, as it represents a fundamental essence of software development it is a useful heuristic tool for the type of value chain analysis embarked upon in this paper. It is widely agreed that comparative advantage arose from factor costs differentials in low-skilled activities such as coding, testing and sometimes low-level design, which were shifted from the traditional software producing countries (primarily the United States but also Japan and European countries) to Bangalore-based software suppliers. For details see chapter four in Lema & Hesbjerg (2003). Thus innovation activities in local firms have tended to be focused on the enhancement of base processes. Typical R&D efforts were focused on processes such as technologies to create repeatability across projects in the form of software components that are reusable or project management frameworks. Hence, while Indian software firms have been active in building capabilities, these have been concentrated in process and downstream service capabilities. See Athreye, S.S. (2005), “The Indian Software Industry and Its Evolving Service Capability.” Industrial and Corporate Change 14:3: 393–418. Kshema Technologies marketing material quoted in Lema & Hesbjerg (2003, p. 165). Kshema Technologies was recently acquired by MphasiS/EDS.

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15. One interviewee likened this organizational principle with intelligence agencies where one unit does not know what the other is doing for security reasons. 16. See for example Bair, J., & Gereffi, G. (2001), “Local Clusters in Global Chains: The Causes and Consequences of Export Dynamism in Torreon’s Blue Jeans Industry.” World Development 29:11: 1885–1903. 17. Arora and colleagues argue that local firms engaged in a competitive bidding race, pushing the price down and the rents toward the customer. Arora, A., Gambardella, A., & Torrisi, S. (2004), “In the Footsteps of Silicon Valley? Indian and Irish Software in the International Division of Labour,” in Timothy Breshnahan, & Alfonso Gambardella (eds.), Building High-Tech Clusters. Cambridge: Cambridge University Press. Despite such pressures, however, profit margins in the industry are relatively high. Moreover this bidding race was mitigated by steadily rising wages for skilled labor. 18. Mayer-Ahuja, N., & Feuerstein, P. (2007), “IT-Labour Goes Offshore: Regulating and Managing Attrition in Bangalore,” in SOFI Working Paper 2007–2 (Göttingen: SOFI). 19. Even in these cases numerous challenges—and sometimes shortcomings— were highlighted. This included, for instance, the “effectiveness of communication” and the difficulty of establishing a “shared understanding” of pressing problems. But on the positive side the same firms were praised for the willingness and ability to tackle these problems upfront. 20. The character of market organization is discussed at length in Lema & Hesbjerg (2003). 21. The Economist (2001), “A Survey of India’s Economy: The Plot Thickens,” The Economist, June 2. 22. Holmström, M. (2001), “Business Systems in India,” in G. Jakobsen, & J.E. Torp (eds.), Understanding Business Systems in Developing Countrie. New Delhi: Sage. 23. However, dependence on global value chains has not lead to convergence as such. Although Bangalore was linked with and dependent on firms in technology clusters in the west, the differences in the tasks performed in different “nodes” of the value chains lead to very different local organizational outcomes. To this extent, the case of Bangalore turns the notion of thin arms-length relations in U.S. capitalism and more thick forms of linkages in Asia (and elsewhere) upside down. 24. This seems to questions many assumptions in local institutional approaches such as the business and innovation systems literature. Lema, R. (2006), “Production and Innovation in Supply Platforms: Insights from the Innovation Systems and Value Chain Approaches.” Journal of Electronic Science and Technology of China 4:4: 339–344. 25. Wibe, M.D., & Narula, R. (2002), “Interactive Learning and NonGlobalisation: Knowledge Creation by Norwegian Software Firms.” International Journal of Entrepreneurship and Innovation Management 2:2/3: 224–248. 26. D’Costa, A.P. (2004), “Export Growth and Path-Dependence: The Locking-in of Innovations in the Software Industry,” in A.P. D’Costa, &

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E. Sridharan (eds.), India in the Global Software Industry: Innovation, Firm Strategies and Development. Houndmills, Basingstoke, Hampshire; New York: Palgrave Macmillan. 27. In Karnataka such “Enterprise Application” development constituted 57% of exports in 2006. 28. An analysis of thirty-six innovation events in twelve such dynamic companies shows that firms have reached advanced levels of innovation capabilities, some which extends to “new-to-the-world” innovations. Lema, R. (2007), “Outsourcing and Innovation in Indian Software Industry,” in Paper presented at the Second International Workshop on The Changing Knowledge Divide in the Global Economy, 2–5 May 2007 (Institute of Development Studies, Brighton, UK). 29. Chesbrough, H.W. (2006). Open business Models: how to thrive in the new innovation landscape. Boston: Harvard Business School Press.

4 Institutional Change and Industrial Development: The Experience of the Indian Automobile Industry Aya Okada

4.1

Introduction

India’s recent growth record is very impressive, making it one of the world’s fastest-growing emerging economies. Its economic reforms over the past two decades have resulted in dynamic restructuring, growing pressure to compete globally, and an increased inflow of foreign capital. The automobile industry is one of the industries that have gone through the most rapid transformations in recent years. Indeed, the industry has recently achieved remarkable growth, with its annual production volume soaring to over eleven million vehicles (including two and three wheelers) as of 2007. India is now the fourth largest car-producing country in Asia—after Japan, China, and Korea—and is rapidly emerging as a global hub for small car production. What has made it possible for India to transform its manufacturing sector to become globally competitive, despite decades of sluggish performance? Drawing on the experience of the Indian automobile industry, which has emerged as one of India’s key manufacturing industries, this chapter examines the institutional forces that have contributed to India’s industrial development. It also analyzes the recent processes of industrial upgrading involving local auto component firms. In particular, this study focuses on the role of institutional arrangements involving the state, assemblers, and their suppliers that have facilitated the transformation of the industry and thus industrial development.

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The evolution and development of the Indian automobile industry is of particular interest for several reasons. First, the industry has been strategically important for every country that now produces cars.1 In particular, for emerging economies such as India, it has been a key industry in determining the course of post-war industrialization. Second, the automobile industry in India is almost as old as in Japan, one of the key auto producing countries, and even predates India’s independence in 1947. Despite this early start, for several decades the Indian industry grew more slowly than those in other countries. Third, the automobile industry did start growing remarkably in the mid-1980s, due partly to active government intervention. Of particular importance was the establishment in the mid-1980s of Maruti Udyog Ltd. (recently renamed Maruti-Suzuki India Ltd., hereafter Maruti), as a joint venture firm between the Indian government and Suzuki, which has since led the growth of the Indian automobile industry. Fourth, India has witnessed remarkable transformations in its automobile industry since the early 1990s, when it introduced the New Economic Policy; virtually all global car producers entered the Indian market by the end of the decade. Fifth, as the domestic market grows due to the recent rapid expansion of the middle class and its improved global competitiveness, the Indian automobile industry is expected to play a prominent role in the global automobile market in coming years. Finally, Asia has emerged as the center of global car production, and the regional economic integration has intensified within Asia, with more and more countries entering free trade agreements (FTA) and economic partnership agreements (EPA). Very dynamic global and regional patterns in the division of labor and of cross-sourcing have recently begun to emerge in Asia, involving not only global players from Japan and Korea, but also from India, China and ASEAN countries. The case of the Indian automobile industry presented in this chapter suggests a more nuanced interpretation of the forces that have brought about industrial transformations, rather than the widely accepted claim that attributes these transformations to a triumph of liberalization and other neoliberal policy packages introduced through economic reforms since 1991. Rather, this study shows that the institutional change that has been brought into the industry, particularly inside the firm as well as within interfirm linkages, played a crucial role in bringing about industrial transformations. This study draws on historical data and on evidence I collected through several rounds of extensive fieldwork in India between 1997

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and 2005. Most of the analysis draws on the data I collected through interviews with two leading auto manufacturers, Maruti and Tata Engineering and Locomotive Co. Ltd. (recently renamed Tata Motors Ltd., hereafter Tata). I also interviewed people at over fifty component suppliers to these firms. This chapter is organized as follows. Section 4.2 conceptually discusses the relationship between institutional change and industrial development in the context of developing countries. Section 4.3 describes the historical evolution of the Indian automobile industry and the industry’s structural transformation during the processes of economic reform over the past two decades. Section 4.4 analyzes the changing nature of supplier relations and the institutional change that has brought about industrial transformations. Section 4.5 discusses how the institutional change in the Indian automobile industry has led to its development and changed its position in the global market. Section 4.6 concludes with a summary of the findings.

4.2

Institutional Change and Industrial Development

Over the past six decades, developing countries have been pursuing industrialization as a way to achieve economic growth. However, as globalization has proceeded in the past couple of decades, it has pushed these countries to liberalize, deregulate, and transform their economies, significantly changing the ways they promote industrial development. In this section, I draw on the relevant literature to consider how institutional change might help promote industrial development in developing countries. Various bodies of the literature in economic organizations, organizational sociology, and economic history have focused on the role of institutions in economic development. Challenging the mainstream neoclassical approach, these scholars stress the role of firms2 in reducing transaction costs,3 and the role of interfirm networks.4 Also criticizing the premises of dominant neoclassical economics, Douglass North5 theorized about the nature of economic transformations by incorporating institutional analysis, and suggested that industrial and economic development occur incrementally, influenced by technological and institutional changes, with individual entrepreneurs responding to the incentives embodied in the surrounding institutional framework as agents of change. According to North, organizations

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such as firms change their organizational structures incrementally, while engaging in organizational learning by acquiring new knowledge and skills.6 Although these influential works may be highly relevant and provide insights into the current processes of industrial transformations in developing countries, we still need evidence from the developing world to assess the validity of their claims, as these works are largely based on the historical accounts of the Western nations.7 The literature on economic development also points to the importance of organizations of firms, and vertical interfirm relations, as a way to promote industrial and economic development. For example, George Stigler referred to Adam Smith’s famous theorem that “division of labor is limited by the extent of the market” as he pointed out that as an industry grows, the increased degree of division of labor and specialization makes it more profitable for firms to promote vertical “disintegration.”8 This affects the extent and amount of knowledge to be kept and diffused within and between organizations. On the other hand, the market failure approach regards the establishment of interfirm linkages as a way to overcome market failures—as a firm’s compromise between buying inputs and raw materials from the “perfect market” and establishing its own vertical integration by completely internalizing the production activities of related firms which would be a manifestation of “complete” market failure.9 Transaction cost economists also discuss vertical integration versus disintegration, by focusing on the cost of conducting transactions, especially of reaching contractual agreements on information transfer as a determinant of firms’ “make or buy” decisions.10 From an institutionalist perspective, Michael Piore and Charles Sabel saw the U.S. economy of the 1970s as being at crossroads, requiring a technological and institutional breakthrough they called “the second industrial divide”: that is, they called for industrial transformations to shift away from relying on the dominant model of mass production, toward more flexible production systems involving flexible use of skills and creation of industrial networks that facilitate interfirm cooperation, as in Emilia-Romagna, Italy.11 Influenced by this flexible specialization literature, a growing body of literature suggests that the organization of work is an important element shaping the patterns of industrial transformations. This includes management practices, such as flatter hierarchies between managers and workers, a high proportion of engineers at the plant level, and emphasis on manager training and education.12 Other scholars

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emphasize the importance of introducing decentralized production processes, characterized by teamwork, task rotation, and worker participation in continuous improvement as the best way to induce intrafirm knowledge transfer and attitudinal changes in the workplace.13 On the other hand, the successful experience of rapid regional development in Emilia-Romagna and Silicon Valley, which are both characterized by the existence of dense horizontal networks and interfirm cooperation among highly innovative firms, has triggered much interest among scholars and policymakers in both developed and developing countries: how might industrial agglomeration and clustering affect regional, and national, economic development?14 Building on the concept of “global commodity chain” developed by Gary Gereffi and his colleagues,15 which encompasses not only supplier relations but commodity chains in the service sector, the recent literature on global value chains focuses on networks among firms involved in a wide range of economic activities from design to production, to marketing, retail, and after-sales service.16 This perspective focuses on the role that core or “lead firms,” often multinationals, play in governing the chain by setting and enforcing parameters on suppliers in developing countries and thereby upgrading their organizational capabilities. Scholars from various disciplines have studied the changing nature of supplier relations in manufacturing, and those in the automobile industry in particular.17 But much of the literature has focused more on the nature of contractual relations between final product assemblers and component suppliers18 and less on the question of how changes in contractual relations affect the patterns of firm-level learning and industrial upgrading. The kinds of knowledge, skills, and learning that workers, and firms, acquire will reflect the incentives embedded in the institutional constraints.19 Thus, we need to understand what incentives are created and embedded inside and outside the firm. Based on the discussion above, I now turn to the experience of the Indian automobile industry to analyze how institutional change inside and between firms has influenced the patterns of industrial development.

4.3 Economic Reforms and Structural Transformation of the Automotive Industry The Indian automobile industry has grown remarkably over the past two decades, becoming one of the nation’s key manufacturing sectors.

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This section briefly describes the industry’s recent and dynamic transformations. India has undergone economic reforms since the mid-1980s and more drastically since the government introduced its liberalization policy, along with a new industrial policy, in 1991. This was a drastic departure from India’s earlier strategy of import substitution industrialization. That strategy, which had continued since the late 1950s, involved an inward-looking trade regime, autarky, and highly protected and regulated domestic markets, along with restrictions on foreign direct investment (FDI). In the 1990s, the Indian automobile industry experienced considerable restructuring, remarkable growth in both vehicle and component sectors, and increased competitiveness. In fact, the auto component sector grew even faster than the vehicle sector.

4.3.1 Growth Spurt in the 1980s Since the mid-1950s, India lagged behind other auto-producing countries in the development of the automobile industry. Until the mid1980s, the closed and regulatory nature of the Indian economy gave it little exposure to foreign technology or international competition. 20 India’s early industrial policy regime thus long discouraged innovation, cost reduction, and the acquisition of technological capabilities, causing considerable inefficiencies, sluggish export performance, and slow growth. 21 Along with the absence of competition within the domestic market, and the licensing that controlled the purchase of foreign technologies, these policies left the automobile industry with large technological gaps compared to the world’s leading car producers. They also discouraged the industry from attaining economies of scale and improving its performance in terms of both costs and quality. In these institutional environments, the number of passenger cars in production remained almost unchanged throughout the 1970s, at 33,000 per year on average.22 In fact, the share of the automobile industry in the total value added of the manufacturing sector declined from 10.2% in 1965 to 6.3% in 1985. 23 Moreover, India has long adopted the industrial policy of reserving more than 800 industrial products to be produced exclusively by small-scale industry (SSI) firms. 24 Also, for the past three decades, the government promoted small firms through various policy measures, including preferential treatments in land acquisition, water, electricity and telephone connection, and concessionary excise duties. 25

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These policies have had a large impact on the development of the automotive component industry in at least two ways. First, they prevented large auto manufacturers from intensifying their vertical integration by acquiring small suppliers and expanding into their activities. Second, the reservation policy encouraged the growth of supporting industries. Thus, unlike the experience in Southeast Asian countries, this kind of government support and protection ensured that small- and medium-scale firms that were capable of producing technologically simple components existed long before liberalization policy was introduced. Despite the government’s generous support for the SSI sector since the 1970s, however, many of the vertical interfirm linkages created between Indian firms had largely been inefficient and internationally uncompetitive until the mid-1980s.26 Even in more recent years, resource constraints kept small firms from developing their own skills. Since the 1980s, however, the Indian automobile industry has witnessed remarkable growth, along with a rapid growth in the inflow of foreign direct investment (FDI), and has experienced dramatic transformations in its industrial structures, production processes, and market environments. In the mid-1980s, the government adopted macroeconomic adjustment policies, along with some liberalization of the industrial and trade regimes. These policies aimed at relaxing import restrictions to support the import of foreign technology, particularly in high-tech industries. But these reforms had only modest effects. 27 With these policy changes, considerable de-licensing occurred in the automobile industry, permitting four Japanese auto makers to enter the commercial vehicle sector, all in joint ventures. In addition, the government permitted existing vehicle manufacturers to diversity their products, which allowed, for example, Tata to enter the passenger car segment. However, all four Japanese makers in the commercial vehicle sector withdrew by the early 1990s, due to difficulties in operating in the Indian market, such as demand fluctuations, frequent labor disputes, working with the Indian management, and achieving the quality standards they required. Then, in 1982, Maruti entered the Indian market. This joint venture between the Indian government and Suzuki dramatically changed the course of the industry’s development. 28 Suzuki’s 26% equity participation in Maruti was the largest single FDI in India and the first major investment by a Japanese company. 29 With generous support from the government, Suzuki managed to remain successful all along,

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with Maruti being its largest overseas operation. Maruti remained a state enterprise until 1992, when the government’s share of equity was reduced from 60% to 49.9%. With these changes, even before the 1991 introduction of the liberalization policy, the passenger car segment grew remarkably, at 19% annually in the 1980s, and the component industry grew at 13% annually during the same period. 30 Table 4.1 shows the trends in production by segment. As the table shows, considerable growth occurred in the first half of the 1980s in both passenger car and twowheeler segments. As figure 4.1 indicates, much of the growth in the passenger car segment has been due to Maruti’s growth. In 1983, Maruti started producing a small passenger car modeled after Suzuki’s 800 cc cars, in its plant in Gurgaon. This was the first modern assembly plant in India, and a close copy of Suzuki’s Kosai plant in Japan, in terms of plant layout, equipment, the organization of production and the operating principle. But the Maruti plant was far less automated than the Suzuki plant because of large technological gaps between the two countries and much lower labor costs in India. Indeed, Maruti’s cars were 21% cheaper than the lowest-priced existing passenger car produced by domestic manufacturers, but they offered much higher quality, more safety features, and greater fuel efficiency.31 Since then, Maruti has dominated the small car segment, which was virtually untapped before its entry. With capital costs written off Table 4.1 Trends in production by type of vehicle (in number)

1960 1970 1980 1985 1990 1995 2000 2003/2004* 2006/2007**

Passenger vehicles***

Jeeps

Commercial vehicles

Two wheelers

Three wheelers

19,097 35,205 30,538 102,456 176,821 329,879 514,185 900,752 1,544,850

5,501 9,334 15,068 26,876 41,944 66,652 127,614 N.A. N.A.

27,518 40,972 68,311 101,228 145,628 237,247 155,789 260,345 520,000

16,878 113,047 417,602 1,125,606 1,875,522 2,551,166 3,942,657 5,365,013 8,444,168

496 4,229 26,519 49,267 95,528 155,801 220,421 268,702 556,124

Total

69,490 202,787 558,038 1,405,433 2,335,443 3,340,745 4,960,666 6,794,812 11,065,142

Notes: *** Passenger vehicles include passenger cars, utility vehicles, and multi-purpose vehicles (MPVs). N.A. means that data are not available. After 2001, the Society for Indian Automobile Manufacturers (SIAM) stopped including this category in its statistics. Sources: SIAM (2002), * SIAM’s internal document (2005), ** SIAM Web site (http://siamindia. com, accessed date November 5, 2007).

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450000

No. of Vehicles

400000 350000 300000 250000 200000 150000 100000 50000 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00

0

Year Hindustan PAL-Peugeot Figure 4.1

Premier Maruti

Daimler Chrysler Tata Motors

Hyundai GM

Passenger car production by manufacturers

and over 90% localization, Maruti’s production costs were extremely low. Priced at Rs. 210,000 (approx. US$6,000), Maruti’s small car was still “probably the cheapest car available in the world” until the late 1990s.32 With sales of its cars soaring by 16% per year, Maruti sold more units in its first five years of operation than all other domestic manufacturers combined had sold in the previous forty years.33 In 1986, its production exceeded 50,000 cars—within three years after its start. With regard to export performance, Tata was traditionally a major exporter, beginning to export trucks to more than eighty developing countries as early as in 1961.34 Exports accounted for over 15% of its output in the early 1980s, even though the volume was still small; it exported a total of only 28,214 vehicles in the twenty years between 1961/62 and 1981/82.35 Although exports were much less profitable than domestic sales, Tata promoted exports as a deliberate strategy to prove its capabilities in the international market. 36 Meanwhile, in 1986, Maruti started exporting 10% of the cars it produced each year, as a response to the public criticism that the firm was not contributing to local technological development. Until the early 1990s, however, Maruti (like its collaborator Suzuki) was reluctant to export its products, fearing that they would not meet

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the quality standards required for export in the global market. But in 1986, the government began pushing Maruti to export, in order to promote innovation; in its near-monopoly position, the firm had little incentive to innovate without exports. This export push forced Maruti to respond to the feedback from overseas dealers and customers, producing more cost-efficient and better-quality cars. In the late 1980s, the government carefully protected and supported Maruti, using licensing and policy measures to prevent other foreign firms from entering the Indian market and other domestic firms from entering the small-car segment.37 Moreover, in 1983, the government reduced customs and excise duties for small cars under 1,000 cc, a category for which virtually only Maruti’s small cars could qualify.38 In the years that followed, only Maruti was granted foreign exchange clearance by the government for two models of its middle-sized cars.39 Moreover, the government required Maruti to achieve a high level of localization, which forced the firm to develop local suppliers. This led it to develop an automotive cluster next to its main plant in Gurgaon and within the National Capital Region (NCR).40 Thus, by setting up and developing Maruti, the state played a key role in initiating the industry’s transformation, and in promoting the industry’s growth.

4.3.2 Globalization and Transformation of the Indian Auto Industry in the 1990s Following the 1991 new economic policy, the industrial licensing that had controlled the industry for decades was abolished in 1992. Then, the component industry was de-licensed in 1992, and the vehicle manufacturers in 1993.41 These changes allowed firms to enter the market, expand their operations, diversify their products, upgrade their technologies, and increase their production, without going through the lengthy process of obtaining licenses. Moreover, the 1991 liberalization policy dramatically reversed India’s anti-FDI position. The policy entailed that: (1) in 35 highpriority industries, including automobiles, up to 51% of equity holding by foreign investors is automatically approved if certain norms are satisfied; (2) FDI proposals no longer have to include technology transfer agreements; (3) trading companies primarily involved in export activities are allowed up to 40% foreign equity; (4) existing firms can raise foreign equity up to 51% for proposed expansion in priority industries; and (5) the 1973 Foreign Exchange Regulation

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Act (FERA) of 1974 was amended and its restrictions on foreign firms were lifted.42 Gradually, the 51% limit on foreign equity was raised to 75%, except in a few industries.43 In addition, a new policy package targeting the SSI sector, including tiny units, permitted equity participation in SSI firms, including that by foreign collaborations, up to 24%, to encourage modernization and technological upgrading in the sector.44 One of the most dramatic changes resulting from economic reforms was the increased inflow of FDI, as many of the world’s top car producers and component manufacturers entered the Indian market, where they saw a huge growth potential. Indeed, in response to Maruti’s growing dominance in the rapidly expanding domestic market, domestic producers such as Premier Auto (PAL) and Hindustan Motors (HML) had to upgrade their models, with foreign technical collaboration from Fiat and Peugeot and from Isuzu respectively. Daimler started producing luxury cars in 1995, with a new joint venture with Tata. By 1998, other global players such as GM, Toyota, Ford, Hyundai and Daewoo had all entered the Indian market to take advantage of its growth potential and the access to a low-cost manufacturing base; this gradually made the domestic market more competitive. At least thirteen global players had entered by 2000 with an installed capacity of 1.3 million cars, but this created serious problems of over-capacity, except for Maruti. By the late 1990s, Maruti achieved remarkable growth in production, with fifty-three cars produced per employee per year, compared with five for HML.45 This made the firm’s productivity the highest in the Indian automobile industry, and even comparable to those of world-leading car manufacturers such as Toyota, which produced fifty-one vehicles per employee in 1991.46 Also, many global component producers started operations in India to supply these new joint-venture car manufacturers; these producers included Delphi, Lucas-TVS (a joint venture between the TVS group and Lucas in the United Kingdom), MICO (a joint venture with Bosch in Germany), and Denso India (a joint venture between Maruti and Denso).47 The largest number of foreign joint ventures came from Japan, due not only to Maruti’s dominance but also to the large presence of Japanese joint ventures in the two-wheeler segment. The entry of these global suppliers raised technology and quality standards, and posed enormous challenges to local component producers, particularly in terms of improving their quality standards, as the local producers were exposed to the unprecedented global

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competition emerging within the domestic market. One strategy they opted for was to form partnerships with foreign component manufacturers, mainly with suppliers of their customers in their home countries, to improve production and technological capabilities. Some had multiple partnerships with foreign component manufacturers from different countries, to meet different specifications and standards required by each of their key customers. Thus, the Indian automobile industry experienced rapid transformations in the 1990s. Not only did India see a considerable increase in the demand for consumer goods, but middle-income purchasing power also expanded in the domestic markets. These changes led to a change in India’s industrial structure in favor of consumer goods. Meanwhile, income inequality widened and household savings fell. During the 1990s, then, the increase in middle-class demand, coupled with the openness to imports and to international patterns of taste, forced Indian manufacturers for the first time to “ ‘win over’ consumers rather than to produce poor-quality standardized products for a supply-constrained market.”48 Looking specifically at cars, the domestic market expanded markedly (see table 4.1), as more middle-class consumers could afford to purchase cars (estimated as 100 to 200 million) and the variety in consumer tastes increased. Indeed, by the mid-1990s, Maruti’s small cars gradually changed the way people used cars in India, from chauffeurdriven to owner-driven, as the emergent middle class, including women, started enjoying driving. This made owners more conscious about the specifications, quality, fuel efficiency, and brands of their cars, which could indicate their socioeconomic status. With the rapid growth of both domestic sales and exports, the industry nearly tripled its overall production of passenger vehicles, from 176,821 in 1990 to 514,185 in 2000 (see table 4.1). With Maruti’s dominance in the small-car segment, however, other foreign manufacturers that entered the Indian market in the 1990s had to turn to the higher end of the middle-sized passenger car market; they could hardly compete with the price of Maruti’s small car, given their lower levels of localization and the higher costs of imported components.49 Thus, despite the intensified competition within the domestic market, Maruti continued to grow remarkably, with its share in the passenger car market rising to 80% in 1996/97, even after the entry of other global players. Thus, Maruti diversified its product range, introducing new middlesized passenger cars in the early 1990s. Meanwhile, Tata, which had

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traditionally accounted for over 70% of the heavy and light commercial vehicle markets, 50 also diversified its product range and entered the passenger car market, introducing three models of multi-utility vehicles in the early 1990s, and a small passenger car, “Indica,” in 1997, entering the market segment that Maruti had almost monopolized up to then. Tata performed successfully in terms of both remarkable growth and its entry, without FDI involvement, into the domestic passenger car market, where competition became fiercely intensified; this performance stands out compared with other domestic producers, and even in the developing world as a whole. Many recent studies report the growing dominance of FDI in the automobile industry in the emerging markets such as Mexico, Brazil, and China, where local producers, both assemblers and suppliers, increasingly lost their independence in the 1990s (the exception is perhaps Hyundai in Korea).51 During the 1990s, however, exports grew less quickly than did production and sales in the domestic market; the number of passenger cars exported only nearly doubled from 25,660 in 1991/1992 to 53,165 in 2001/2002. Maruti and Tata remained the main exporters, accounting for 95% and 86% of passenger car and commercial vehicle exports respectively in 1998/99.52 In fact, in the first half of the 1990s, the growth in exports of components was much faster at an average of 13.4% per year, than exports of passenger vehicles, with its average of 5.9%. Until the late 1990s, however, component exports focused mainly on the lower-grade “after market” for repair parts abroad; the very limited technological capabilities of Indian component manufacturers kept them from producing high-technology, high-quality original equipment manufacturers (OEM) parts for foreign car makers. In the 1990s, however, the automotive component industry grew by 21% per year, as it benefited from the entry of many new foreign makers that had to use local suppliers. The government’s imposition of local content forced these firms to procure materials and parts locally. And, despite the 1991 liberalization policy, imported components still bore disproportionately high customs and excise duties; using imported components, new entrants could never produce cars as cheaply as Maruti.53 Until 1991, the government’s Phased Manufacturing Program (PMP) forced foreign firms to accelerate their localization. Though the PMP was lifted in 1992, the government still implicitly demanded 50% local content in approving foreign collaboration proposals, and 70% after five years, in order to protect and develop the domestic component manufacturers. To promote FDI, the government deliberately

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formed no specific policy for the automobile industry with respect to local content. Instead, it signed a confidential “Memorandum of Understanding” (MoU) with each new entrant on a case-by-case basis. Firms were allowed to import complete knockdown (CKD) kits with a 45% import duty in return for their commitment to localization. Once firms achieve certain levels of local content, they can import CKDs at the prevailing duty rate of 20% to 40%.54 In 1997, responding to pressure from the automobile industry for a clear and transparent policy, the government formed a new policy requiring that a new foreign entrant have a minimum foreign equity of US$50 million in the first three years of operation and achieve local content of 50% in the first three years, and 70% by the fifth year. 55 These policies, along with intensified competition within the domestic market, have meant that some foreign auto makers, such as Daewoo and Peugeot, found it too hard to survive, and ended their operations within a few years. Interestingly, PAL, one of the long-standing domestic car producers, also had a technical collaboration with Fiat, producing the Fiat Uno until it ceased operations in 1999 after many years of troubled labor relations. As seen above, economic reforms since the mid-1980s, and more intensely since the 1990s, have led to the transformations of the automobile industry. Clearly, Maruti and Tata, the industry’s two leading firms, played a key role in these transformations: they promoted growth and improved export performance, and meanwhile gained competitiveness as the Indian automobile industry became more integrated with the global auto industry. 56 Although the Indian state liberalized and deregulated its trade and industrial regimes, it still maintained its role in industrial governance, and therefore in promoting the industry, through various policy measures such as imposing local content on new foreign entrants, promoting exports, and controlling import tariffs. Thus, the nature of the state involvement changed considerably—from direct provision of subsidies and ownership, to more nuanced management of the institutional environment in which the firms in the industry operate.

4.4 Changing Supplier Relations and Upgrading Local Suppliers57 In the 1990s, the automotive component industry also experienced dynamic restructuring. By the mid-1990s, the auto industry consisted

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of more than thirty assemblers of different vehicle types, including seventeen passenger and/or commercial vehicle producers, and the automotive component industry. The latter consisted of over 400 firms in the organized sector, accounting for 75% of the total automotive component production in value terms, and approximately 5,000 smallscale firms in the unorganized sector, accounting for the other 25%. 58 However, the component industry was still fairly small by international standards;59 in 2003 its total annual production of US$6.7 billion was equivalent to only 24% of the annual sales of a single fairly large global supplier, Delphi.60 This meant that the industry faced serious problems in attaining economies of scale.

4.4.1

Creating a Local Supplier Base

Mostly because of the policy regime of the import substitution industrialization and self-reliance dating to the 1950s, domestic auto producers such as HML, PAL, and Tata traditionally achieved high levels of local content, attaining nearly 100% until the mid-1990s. Maruti also achieved high local content: 96% for its 800 cc small cars and mini vans, and over 80% for other models.61 Several factors explain Maruti’s unusually high local content. First, the government’s PMP mandated foreign firms to promote localization; Suzuki’s MoU with its joint-venture partner, the Indian government, included its commitment to achieve 50% local content within the first three years, and 70% by the fifth year. Second, given the appreciation of the yen in the early 1980s, along with the high customs duty imposed on CKD imports, Maruti could not compete with other domestic producers.62 Thus, not only local content requirements but also cost considerations led Maruti to develop local suppliers. Third, initially, Maruti focused on the domestic market and not on exports, allowing it to compromise on the quality of the components produced by local suppliers; this would not have been acceptable if it were exporting its products. Fourth, Suzuki was a small assembler in Japan, ranked only sixth among the nine Japanese car manufacturers. Thus it has had a relatively weak supplier base at home, compared with larger assemblers such as Toyota and Nissan. It does have a “kyoryokukai” (supplier associations formed by a car manufacturer for its “keiretsu” supplier firms), but only for its small-scale suppliers located near its plants.63 When Maruti started operating in India, few of Suzuki’s dedicated suppliers could afford to follow Suzuki to India to supply parts for

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Maruti. Finally, as discussed earlier, many local small-scale firms that could serve as ancillaries already existed, although their technological level was not compatible. Faced with having to choose between the poor quality of locallyproduced components on the one hand and the need to increase local content on the other, Maruti adopted several strategies. First, it arranged a joint venture between local suppliers and Suzuki’s suppliers in Japan. Maruti itself holds equity in about a dozen such joint-venture suppliers of key components, many located on Maruti’s premises, giving it greater control over the management of their operation and performance standards. Moreover, it has made enormous efforts to develop the capabilities of its suppliers, as I discuss below. Further, while Maruti gets key components from a small number of large-scale suppliers in southern states such as Tamil Nadu, since the 1980s its growth has also encouraged many smallscale entrepreneurs to start business in nearby locations; about one third of Maruti’s 404 suppliers were established after Maruti started its operations in 1983.64 These new small firms became more easily attuned to Maruti’s quality standards and style of business than the old ones. By creating very close interfirm linkages, the firm effectively developed its suppliers’ production, managerial, and engineering capabilities.65 New entrants did not initially start with a high degree of localization. For instance, Daimler relied on about 95% CKD imports, while Daewoo relied on 83% imported components.66 Even after the PMP was lifted in 1992, these assemblers had to continue their localization efforts, by searching out desirable local suppliers, setting up their own subsidiaries, or bringing in their own suppliers from home. The government’s local content requirement on new entrants, coupled with high customs duty (50% for CKDs and components, in addition to a countervailing duty of 60% in the mid-1990s), effectively forced newly entering assemblers to achieve a high level of localization; in turn, this forced them to use domestic suppliers, including many small firms, and upgrade their production capabilities. Meanwhile, new entrants such as GM, Ford, Toyota, and Honda encouraged their group firms or their established suppliers to create manufacturing facilities in India, often by forming joint ventures with Indian suppliers. In fact, some newcomers such as GM and Toyota invested in component supplier bases near their plants. The increasing presence of these global suppliers in India posed serious challenges to local vehicle assemblers, as they had to develop and consolidate their

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supplier bases which had largely relied on a large number of smallscale local suppliers. The increased competition with new suppliers arriving in India with foreign assemblers has also forced local component manufacturers to improve the quality of their products, and their own capability in technology, quality, and productivity. To strengthen their own supplier base, local assemblers, such as Tata, HML, and Mahindra & Mahindra, all set up joint ventures with global suppliers. Similarly, in 1997, Maruti also set up a new supplier park close to its plant in Gurgaon as a joint venture between Maruti and the Haryana State Industrial Development Corporation (HSIDC), to house Maruti’s sixty-five first-tier suppliers which produce essential components for Maruti cars, and to ensure an unhindered supply of these components. The growth of the industry has also led the industrial structure to divide into tiers: the car assembler deals with only the first tier of suppliers which in turn obtain supplies from lower tiers of suppliers. This increased the number of firms involved in the supply chains. Car assemblers such as Maruti and Tata started consolidating and streamlining their first-tier suppliers to make the production processes leaner. The large-scale first-tier suppliers were increasingly required to semi-assemble modules such as steering systems and rear axle systems that were put directly on the final assembly line at the car assemblers. Such consolidation moves among car manufacturers have also drastically changed the nature of supplier relations. Manufacturers have imposed higher performance standards on their suppliers with tighter control over their operations; on the other hand, suppliers are pressured to either improve their performance, or lose business. This has resulted in a dramatic shift in the power relations in the supply chain, giving the assemblers much more leverage. Until relatively recently, few first-tier suppliers could produce high quality products, so goodquality first-tier suppliers had enjoyed some leverage with customers, who had to rely on them to promote localization. These changing dynamics between car manufacturers and suppliers helped promote supplier upgrading, as discussed in the next subsections.

4.4.2

Changing Supplier Relations

During the inward-looking trade and industrial regime that lasted into the mid-1980s, a small production volume and absence of competition

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provided vehicle assemblers with few incentives to strengthen the capabilities of their suppliers. Thus, Indian supplier relations were generally “arm’s length” in nature, as they had also been in the United States until the 1980s;67 assemblers formed short-term contractual relationships with a large number of suppliers largely driven by prices. However, Maruti took a dramatically different approach to its suppliers: it developed longer-term close relationships with them based on reciprocal interactions, with a greater emphasis on quality and on-time delivery, adopting some elements of the Japanese model of supplier relations. The entry of several new joint-venture car manufacturers in the 1990s, which increased the number of product varieties, led local component manufacturers to diversify their customers. This also induced these suppliers to adopt more flexible production techniques to ease the changeover of tools and lines and allow low-cost tooling.68 In fact, car manufacturers in India generally encourage their suppliers to take on multiple customers due to a relatively small volume of production, thus allowing them to seek economies of scale. Car assemblers have also needed multiple sources, because factors such as poor infrastructure (roads, electricity, and telecommunications) have made it costly to rely on a single source of supply for each component. Despite such moves, a considerable number of suppliers remain loyal to one customer. For instance, of Maruti’s 404 suppliers, fifty-eight depended on the firm for more than 90% (in many cases 100%) of their sales until the late 1990s.69 Given India’s vast size, the location of assembly plants generally influences the location of suppliers. Geographical dispersion of auto manufacturers to different parts of the country historically led to the evolution of industrial clusters in various locations such as Pune, Faridabad, and Chennai, where many small-scale component suppliers have been agglomerated,70 most of them supplying only customers in the region. Thus, while every car assembler has suppliers from all over the country, each has a supplier base in its respective region. For example, 60% of the 5,800 manufacturing firms in industrial clusters in Pune in the state of Maharashtra constitute a supplier base for the three local auto manufacturers (Tata, Bajaj Tempo, and Bajaj Auto) located in the city, enjoying the country’s largest agglomeration of auto suppliers.71 Similarly, the majority of Maruti’s first-tier suppliers are agglomerated in Gurgaon and its neighboring cities in Haryana. More than 100 of these firms were small-scale. Most second-tier suppliers are also located in the same city as their customers, the first-tier suppliers.

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The entry of joint-venture car manufacturers increased competition within the Indian market, and further intensified this agglomeration of component firms. This is largely because the increased awareness about the importance of on-line delivery through the adoption of some elements of just-in-time (JIT) inventory systems, motivated first-tier suppliers to establish new plants close to each customer. For example, several of Maruti’s first-tier suppliers located in Haryana established new plants in Maharashtra to cater to Tata, and vice versa. With the introduction of the JIT concept, which aims to reduce assemblers’ inventory costs, some first-tier suppliers with more than two customers set up new plants close to their main customers in three or four different regions to cater to each of them. While the presence of these suppliers in proximity helps reduce assemblers’ inventory costs, it also places some constraints on the suppliers, as they have to manage and finance simultaneous expansions in widely dispersed locations.72 But even Maruti and its suppliers have not fully adopted the JIT inventory system, let alone local manufacturers. The poor state of India’s infrastructure, including electricity and roads, has made it very difficult for the Indian automobile industry, including Maruti, to operate under the JIT principle. Some local suppliers even have different FDI partners for different plants catering to different car manufacturers. For example, Motherson Sumi, a wiring harness supplier, started in the early 1980s as a joint venture firm with one of Suzuki’s main suppliers in Japan; the matchmaker was a Japanese general trading firm, whose main client is Suzuki. In the early 1990s, Motherson Sumi set up a new plant in Pune to cater exclusively to Tata’s Pune plant. When Daimler came to India to start a joint venture with Tata, Motherson started a new joint venture with Daimler’s German supplier. Interestingly, little technical collaboration or information exchange goes on between Motherson’s Japanese FDI-involved plant and its German FDIinvolved plant, as the specifications for products differ according to the customer.73

4.4.3 Supplier Upgrading As the supplier relations changed, various institutional mechanisms were introduced within the supply chain that have induced suppliers to upgrade. In particular, Maruti has made great efforts to develop and upgrade its suppliers’ capabilities in several ways. The development of suppliers has been particularly important for Maruti, given

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its high reliance on outsourcing which accounts for 80% of the value of a car, even higher than the 70% level of outsourcing in Japan.74 First, Maruti participates in the equity of its key suppliers, many of them located beside its main plant in Gurgaon, to strengthen its influence and control over them, and thus to ensure their quality and efficient operation. Second, along with Suzuki, it has actively sought a match-making arrangement between over forty Maruti suppliers and Suzuki’s suppliers in Japan, thus facilitating knowledge transfer and improving quality standards at Indian suppliers. Third, Maruti started sending its engineers to its key suppliers in joint ventures with Maruti for extended periods of time. This was a new practice in India, as prior to the entry of Maruti in India, where “arm’s length” supplier relationships had prevailed. Fourth, Maruti assigned its seven vendor development departments in its two materials divisions to be responsible for a fixed group of suppliers according to their product line, and they frequently interact with their assigned suppliers to provide them with technical assistance, evaluate their products and performance, and jointly solve their problems. For example, one supplier explained, “Our rejection rate was very high. Maruti taught us how to curtail the rejection, by improving housekeeping and changing the layout of both office and factory spaces.”75 Another firm noted that Maruti found its die-casting workshop very stuffy and suggested ways to improve the layout and ventilation. Moreover, most suppliers received their drawings from Maruti, indicating that they were generally not very involved in their own product design development. Maruti’s engineers responded by working more closely with these suppliers. As most suppliers are located in proximity to Maruti, the costs of such frequent monitoring are kept relatively low. In addition, Maruti provides its suppliers with gauges and calibrators for setting and enforcing Maruti’s quality standards on their products. With these measures, as in the case of Japanese automobile assemblers,76 Maruti has developed institutionalized mechanisms to improve product quality and increase productivity within the supply chain. Fifth, a group of Japanese engineers sent from Suzuki visits all the Maruti suppliers periodically. They have made extremely detailed suggestions on specific areas for improvement. Finally, Maruti also provides its suppliers with financial support in the form of payment within fifteen days after delivery, which particularly helps the small firms to gain financial stability, as they often lack working capital and

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access to credit.77 Clearly, Maruti has forged close long-term linkages with its suppliers based on performance-based reciprocity, following some elements of “lean production”78 with great emphasis on “interfirm collaborative problem-solving.”79 By the late 1990s, faced with the changing market conditions, Tata too changed its supplier relations. Until 1997, Tata’s supplier management had largely been confined only to inspection and instruction regarding the use of gauges, other than earlier joint prototype development of certain components before their commercial production. In 1997, however, Tata drastically changed its supplier relations from “arm’s length” to longer-term, closer ones, as part of its strategic move to enter the passenger car market in the face of ever-intensifying competition.80 Tata has responded to the rapid transformations in the industry, by redefining not only the division of labor but also the quality of the relationship with its suppliers, with a considerable shift in focus from the inspection of products to the control of processes. This in turn induced a great deal of learning on the part of suppliers; one Tata supplier noted that in its new relationship with Tata the firm had to work on redesigning and reengineering, including die designs to conform to Tata’s new quality standards. The firm’s manager commented, “What was accepted two years ago is no longer acceptable today.”81 Like Maruti, Tata also provides detailed drawings to most of its suppliers. But Tata’s Engineering Research Center, an R&D facility, started “simultaneous engineering” jointly with its suppliers by the mid-1990s, especially its prototype and design development, in the areas where Tata’s own technological base was not strong. Both Maruti and Tata distribute manuals on quality improvement, specification, on-time delivery, and cleanliness; thus they diffuse knowledge, norms, and values, and standardize expected procedures and performance among suppliers. Formalization of training for suppliers has helped make new knowledge more explicit, less tacit, and thus facilitated its diffusion and transfer in the supply chain. Moreover, in addition to requiring suppliers to obtain ISO certificates, both Maruti and Tata instituted their own systems of selfcertification, a common practice among Japanese auto assemblers: only certified suppliers can remain in business, and their products can be placed directly on the assembly line without on-site inspection at the assembler. Further, both firms developed a system of vendor rating and auditing, which determine the assemblers’ decisions on longterm contractual relations, and thus constantly reminds suppliers of

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the need to improve their performance. In fact, these quality improvement efforts resulted in a significant reduction in rejection rates (e.g., down to 99.55 ppm in the case of Tata), thus improving productivity at the assembly firms. On the other hand, these changes in interfirm supplier relations have brought about intra-firm organizational restructuring, at local and foreign-affiliated car manufacturers, and many small-scale suppliers. Intensified competition has led firms to adopt techniques, such as total quality management (TQM), “kaizen” (or continuous improvement), and QC circles, to improve both the efficiency of production and the quality of products. Not only did Maruti adopt some Japanese work organization practices itself, it also served as a model for diffusing such practices through the industry and in particular among suppliers, thus promoting industry-wide learning. Two linked factors most clearly induced organizational change at these firms and thereby upgraded the suppliers: their interest in improving quality, and pressure from their customers. Many firms explained the reasons for their increased quality consciousness. Intensified competition in the 1990s forced them to reduce costs and improve productivity, and led them to introduce formal in-firm training, even in small firms. As one supplier put it, “If we want to survive, we have to do training.”82 The rapid transformations within vehicle manufacturers have clearly been translated into suppliers’ strategies for institutional change. Another supplier noted, “As our customers’ awareness has improved, they now want us to upgrade our operation. We now require better machines, better procedures, new layout, new testing equipment, more housekeeping, and improved quality.”83 Thus the demand, pressures, and guidance from customers have played an important role in changing the attitudes of suppliers toward skills development and upgrading. Behind all these factors, one strong driving force for the introduction of training programs among supplier firms in the 1990s was their interest in obtaining ISO9000/ISO9002 certificates, required by both Maruti and Tata: many increased their budgets for training activities in the mid-1990s to meet this goal. In fact, many firms noted that they spent a large portion of their training costs on paying local management consultants that they hired specially to introduce Statistical Process Control (SPC), TQM, and ISO. Though many expressed concern about whether it was worth spending so much on training, they do it, because it is what “everyone is doing.” Thus, new ideas, techniques, and practices have been rapidly diffused throughout the

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industry, even among small firms. Suppliers’ decisions to invest in training were not necessarily based on their immediate profit-maximizing interests. Rather, they were motivated by the industry-wide dissemination of new norms and values infused through the increased standardized training programs conducted by their customers and independent consultants.84 As the process of ISO certification entails a detailed sequence of standardized organizational reforms involving virtually every aspect of their production activities, the requirement of obtaining ISO certification has effectively forced suppliers to adopt these procedures as an institutional form. Suppliers’ adherence to the principles of ISO has in turn become institutionalized as a norm—which has been rapidly diffused throughout the industry in response to a rapidly changing institutional environment. Because the ISO certificates also serve as a status symbol of good quality and as a ticket to credibility from customers, this process of institutionalization was also legitimized among suppliers fairly quickly. This process of diffusion has also helped suppliers change their perception of production management from ex-post “inspection” to ex-ante “prevention” with greater focus on quality improvement embedded in the production processes. While neither Maruti nor Tata have directly required their suppliers to undergo organizational reforms in the areas of work organization and training, they have certainly had a strong indirect influence. Even though many suppliers have multiple customers, only Maruti and Tata, among many vehicle assemblers, imposed strict quality standards on them in the 1990s. Many firms admitted that Maruti and Tata had implicitly threatened to terminate business unless they improved their standards.85 Rewards also motivate suppliers to improve their performance; Maruti gives annual performance awards to the best performing suppliers each year at an annual convention, inviting all its suppliers. The criteria for award selection include (1) delivery schedule; (2) quality; (3) prices; (4) loyalty; (5) maintenance; and (6) rejection rates. While some suppliers also recognize that ISO certification boosts the firms’ international recognition and global market access in the long run, their main motive is still to satisfy their customers’ demands. Clearly, the customers’ increased demand for quality improvement has induced suppliers to accelerate their upgrading. Moreover, the increased need to improve the quality of products and the efficiency of operation made professional managerial skills more important even among small firms, as indicated by an increased

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demand for educated and qualified managerial workers, particularly in production control, quality assurance, inspection, maintenance and line management. Thus, a growing number of employers, particularly among young well-educated entrepreneurs, started gaining managerial skills through outside industrial associations, particularly the Confederation of Indian Industry (CII) and the Automotive Component Manufacturers’ Association (ACMA). In addition, other region-specific horizontal networks among entrepreneurs and managers, such as the Maratha Chamber of Commerce in Pune and the Faridabad Small-Scale Industry Association (FSSIA) started organizing regional seminars and training programs for members. Through training activities these industrial associations have played a crucial role in disseminating new management techniques, knowledge, and values among Indian entrepreneurs and managers. Moreover, some suppliers participated in management training courses in Japan organized by Japanese training institutions such as the Association of Overseas Technical Scholarship (AOTS). Participants paid half of their air tickets, and AOTS and their hosts such as Maruti bore the rest of the costs, including board and lodging. During these courses, they learned Japanese production systems, particularly such areas as production control, inventory systems, and other management techniques; then, to observe the Japanese shop-floor practices, they were assigned to Japanese firms that produce products similar to theirs. This experience has helped them change their perception about how to run their business. For example, a young owner of a component supplier in Pune participated in a training course organized by AOTS in Tokyo. On his return, he changed the production process and the layout of his factory, while installing a new floor with a new color-coding scheme, and referring to what he had observed in Japan.86 These changes have significantly improved the efficiency of the operation and reduced the wastage and rework, thus improving productivity. Some suppliers, particularly small ones, noted that the management’s exposure to Japanese production practices was eye-opening, leading them to introduce various forms of organizational innovation. Intermediary training organizations such as AOTS played an important role in disseminating knowledge, ideas, and management techniques that value quality. This industry-wide diffusion of new knowledge, skills, norms, and values has helped change firms’ perceptions about what changes are required to improve their business, thus creating an institutional

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environment that is conducive to institutional change at both firm and industry levels. Interestingly, organizational change appears to occur faster among firms whose owners (and their sons) are exposed to production processes in Japan, either in their foreign partnerships or through AOTS training. As illustrated above, with these quality enhancement mechanisms in place, the supply chains of Maruti and Tata are no longer just contractual relationships but actually involve the diffusion of norms, standards, and values, as well as the transfer of technical knowledge and skills. Organizational learning at suppliers induced through such institutionalized enforcement mechanisms differs considerably from the “opportunistic behaviors” of firms that the transaction cost theorists predicted.87 The nature of interfirm linkages that Maruti and Tata have developed with their suppliers also differs from the embeddedness argument88 that the patterns of firms’ behaviors are embedded in the prevailing structures of social relations between firms. Indeed, neither the embeddedness argument nor the cultural argument89 can successfully explain the close supplier relations that Maruti has created and the dramatic changes that have occurred in Tata’s supplier relations, both fairly unconventional within the prevailing social relations. Rather, various forms of institutional arrangements, particularly for quality improvement, built into the supply chains have led the firms to develop reciprocal relationships with their suppliers: Trust was acquired as the suppliers adhered to a set of strict standards and requirements, rather than embedded in existing networks of social relations.

4.5 Recent Developments and New Challenges As discussed above, the structural transformations that the Indian automobile industry has experienced since the mid-1980s have led it to grow remarkably in recent years, and to become more competitive, more internationally visible, and more deeply integrated into the global market. Indeed, as globalization proceeds, India’s relative position within the global economic landscape has changed even more dramatically, especially since the turn of the century. The industry has continued to grow rapidly, with its annual sales value reaching US$20 billion (of which the passenger cars segment accounts for 43%),90 while the production of passenger vehicles has tripled between 2000 and 2006/07 to reach 1.5 million (see table 4.1). Within the passenger

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car segment, the demand for middle-sized cars has increased rapidly, along with the average income of the Indian. But the small car segment still remains dominant, accounting for 74% of the passenger vehicle market.91 And now India produces more two-wheelers than any other nation but China. Recently, the Indian market became even more competitive, and the trend continues. Though many new global players have entered this competitive domestic car market, Maruti remained a leading firm with 51% market share for its passenger vehicles as of 2003/04, followed by Hyundai (18.6%) and Tata (15.5%). Hyundai, which entered India in 1997, raised its market share quickly, and plans to use its India operation as a platform for exporting small cars to the global market. While a total of eleven manufacturers, including nine foreign car makers, are currently producing passenger cars in India, other firms still have a very small presence; in 2003/04, none had a market share of over 5% (ACMA, 2005).92 In the commercial vehicle segment, Tata remains dominant, accounting for about 70% of market share in the same year, followed by Ashok Layland and Mahindra & Mahindra. Also, in recent years, the rapid growth of two newly-emerging segments—utility vehicles (UV) and multi-purpose vehicles (MPV)—has further diversified the Indian market. In these segments, Mahindra & Mahindra, a traditional producer of jeeps, has been the leader for the past few decades. It had 33% of market share in 2003/04, followed by Maruti (31%) and Tata (16%).93 The government has further liberalized the trade and industrial regimes related to the auto industry. In 2001, it removed the quantitative restrictions (QRs). Moreover, it finally allowed 100% subsidiaries of foreign firms to enter the industry, and abolished the MoU for entrants into the passenger car and MUV segments. This meant that FDI firms saw an end to the localization requirement (previously 50% in the first three years and 70% in five years for new entrants in the car and MUV segments); to export obligations (previously new entrants had to neutralize foreign exchange outflow on imports through exports from the third year of production), and to investment criteria (previously a minimum of US$50 million in equity was required for foreign firms). The government relaxed these requirements on new entrants, because the industry became robust enough to sustain its growth even without these policy measures. Moreover, in 2002, the government announced a new auto policy, which indicates a clear shift in its strategies for the industry, toward building its global competitiveness. The policy aims to: (1) achieve

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a high level of value addition in the country; (2) promote a globally competitive automotive industry and emerge as a global source for auto components; (3) establish an international hub for manufacturing small cars and a key world center for manufacturing tractors and two-wheelers; (4) ensure a balanced transition to open trade at a minimal risk to the Indian economy; (5) facilitate indigenous design, research and development; (6) steer India’s software industry into automotive technology; (7) help develop cars using alternative energy sources; and (8) develop domestic safety standards and environmental standards on par with international standards.94 In addition, the government further reduced the excise duty on small cars from 32% to 24%, and encouraged their export. Indeed, the export of all vehicle types has increased steadily in the past several years (table 4.2). In particular, nearly 200,000 passenger vehicles were exported in 2006/07. While two-wheelers are mainly exported to other developing countries such as Bangladesh, Sri Lanka, Philippines, and Nepal, passenger cars mainly go to European markets, such as Britain, Italy, the Netherlands, and Germany.95 Maruti and Tata still remain the primary exporters of passenger vehicles, along with Hyundai. Maruti currently exports small cars to about 100 countries, but 70% of the volume goes to Europe. This means that the industry has gradually acquired a quality standard that is acceptable even to mature markets like Western Europe. Table 4.2

Trends in export performance by category (in number of vehicles)

Category

2001/2002 2002/2003 2003/2004

2004/2005 2005/2006 2006/2007

Passenger cars Utility vehicles MPVs

49,273 3,077 815

70,263 1,177 565

125,320 3,049 922

160,670 4,505 1,277

169,990 4,489 1,093

192,745 4,403 1,330

Total passenger vehicles

53,165

72,005

129,291

166,402

175,572

198,478

4,824 7,046

5,638 6,617

8,188 9,244

13,474 16,466

14,078 26,466

18,838 26,522

11,870

12,255

17,432

29,940

40,600

49,766

143,896

MCVs & HCVs LCVs Total commercial vehicles Three-wheelers

15,462

43,366

68,144

66,795

76,881

Two-wheelers

104,183

179,682

265,052

366,407

513,169

619,138

Total

184,680

307,308

479,919

629,544

806,222

1,011,278

Source: SIAM Web site (http://siamindia.com) accessed on November 5, 2007.

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In 2007, as part of the government’s permission for 100% subsidiaries of foreign firms to enter India, Maruti’s joint-venture partner, the government, finally disinvested from Maruti to allow it to become Suzuki’s wholly owned subsidiary. Meanwhile, other global players like Skoda (a subsidiary of Volkswagen), Volvo, and Renault-Nissan are finally joining the global race to tap this huge and still rapidly growing market. In addition, existing global players operating in India, such as Honda and Toyota, are trying to expand their manufacturing facilities to further increase their production capacity and diversify their product range. Likewise, Fiat has announced a joint venture with Tata, to produce cars, engines and transmissions in India for the domestic and global markets. On the other hand, Tata, the leading domestic firm, has recently announced plans to introduce its long-awaited “people’s car,” with the revolutionary price of US$2,500, to reach potential customers who currently cannot afford a car. The automotive component industry has grown rapidly in recent years as well, with an annual turnover reaching around US$5.5 billion, and annual exports growing to US$1.2 billion in 2003/04. Some large firms are increasingly exporting their products to the OEM markets in Europe, Japan, and North America. Indeed, OEM production accounts for 68% of all output. This is a marked difference from the earlier trends where auto component exports largely tapped the after markets overseas, in particular in other developing countries as mentioned in section 4.3. Clearly, the industry has succeeded in upgrading rapidly and in building competitiveness, which can be largely attributed to the industry-wide learning that occurred in the past two decades, as discussed in section 4.4. Meanwhile, some Indian auto manufacturers themselves are becoming global players, as they start to set up manufacturing facilities in other countries to take further advantage of globalization. For example, Tata has started operations in South Korea, South Africa, Singapore, and Malaysia, and Mahindra & Mahindra set up facilities in Brazil, Russia, South Africa, and Pakistan. Likewise, Bajaj Auto now has facilities in Indonesia and Pakistan, while component manufacturers such as Bharat Forge have facilities in Germany and China and Sona Steering in Thailand and France.96 The Indian economy’s greater integration into the global market, however, poses new challenges to the Indian automobile industry. First, India’s participation in trade agreements such as FTAs and RTAs with Singapore (signed in 2004), Thailand (signed in 2003),

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ASEAN (signed in 2003), and MERCOSUR (signed in 2003) are generating both opportunities and risks to the Indian vehicle industry as well as to its auto component industry. India is now in the process of negotiating to form FTAs with many other countries, including South Africa, Japan, China, Korea, and Russia. These trade agreements will have a tremendous impact on the sourcing patterns and global division of labor among global auto players and component manufacturers. These agreements are expected to allow global firms to consolidate material and component sourcing, arrange the crosssourcing of components, and gain better market access, meanwhile making imports cheaper. At the same time, they cause much concern to domestic component manufacturers, who expect an increased inflow of cheaper and higher-quality automotive components from ASEAN countries, particularly from Thailand; that development may well hamper the growth of domestic producers. Second, India’s contribution to the global trade in manufacturing is still very small, accounting for only US$40 billion, whereas China’s accounted for close to US$290 billion in 2002. In particular, the value of India’s exports in automotive products remains only one fifth of that of China, and less than 1% of that from Japan.97 This means that India still contributes only a tiny amount to the global automotive products trade, even compared with other Asian emerging economies like Thailand and China. Third, both the vehicle and automotive component sectors must further promote technological upgrading, as their technological capabilities, especially design capabilities, are still limited. In this light, in 2004, the government started enforcing 150% tax deductions for R&D investment, to develop higher technological capabilities.98 Finally, India needs to set environmental standards that are equal to international standards, if it really intends to develop the industry as an export hub of small cars for the global market. Indeed, it started moving in this direction; in 2000, it enforced Euro II equivalent emission standards norms (Bharat Standards II, or BS II) for passenger and commercial vehicles in eleven metropolitan cities, and in 2005 tighter standards (Bharat Standards III, BSIII) for passenger and commercial vehicles in eleven metropolitan cities and BS II across the country.99 These changing institutional environments are expected to force the automobile industry, including the auto component sector, to further engage in learning and skills upgrading, so as to become more globally competitive, which would in turn promote industrial development.

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4.6

Conclusion

This chapter has examined how institutional change that has occurred at the firm and industry levels has contributed to industrial development, by focusing on the experience of the Indian automobile industry. Since the liberalization policy was introduced in India in the mid1980s, and implemented more intensely in 1991, the Indian automobile industry has experienced remarkable growth and dynamic transformations with a growing inflow of foreign capital, resulting in intensified competition within the domestic market. These changes in turn led the component industry to grow remarkably in both production and exports, and restructure itself dynamically with the emergence of a pyramidal structure and increasing alliances with global component suppliers. This study found that two leading firms, Maruti and Tata, have significantly contributed to the growth of the industry, and improved export performance, even before the large inflow of FDI started in the 1990s. In particular, Maruti, with its remarkable growth in production, sales, and productivity, literally became the driving force of the growth spurt in the passenger car segment in the 1980s. It continued to lead the industry in the 1990s, and remains a dominant player in the passenger car segment even today, despite the entry of many global players since the late 1990s. On the other hand, unlike many local vehicle manufacturers in developing countries that have typically weakened their relative market positions in the face of growing dominance by foreign firms, Tata strengthened its market position by diversifying its product range, produced India’s first genuinely indigenous passenger cars in the 1990s, and even emerged as a global player itself in the past few years. Clearly, Maruti and Tata have continued to lead the industry’s development for all these years, while acting as agents of change to introduce various organizational innovations, learning and institutional change. The localization policy imposed by the government forced the leading assemblers to rely on domestic component suppliers; its increased quality concerns effectively forced them to develop and upgrade their suppliers. Moreover, Maruti played an important role not only in developing backward linkages through its own supplier development efforts, but also in helping change the dominant model of supplier relations in the country, from traditional short-term “arm’s length” relationships to more long-term, close ones, involving reciprocal interactions

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with suppliers. Tata also changed its supplier relations to long-term close ones in the late-1990s, while introducing various measures to strengthen its supplier base. Indeed, various institutional mechanisms created by Maruti and Tata through their supply chains, which entailed their pressures and guidance, both explicit and implicit, motivated suppliers to upgrade their facilities, modes of operation, and their workers’ skills. All these have led to unusually high momentum in the Indian automobile industry for intra-firm as well as interfirm learning, resulting in industry-wide learning. The case of the Indian automobile industry presented in this chapter has shown that in the process of globalization, firms—both foreignaffiliated and local, and both assemblers and suppliers—have experienced restructuring, organizational innovation, and technological upgrading, and considerably increased their investment in skills development for their employees. This study reveals that even as the Indian economy has become more globalized under the liberalization of the trade and industrial regime, paradoxically, an interacting set of local institutional factors still critically shapes the patterns of firm-level organizational change, industry-wide learning, and thus the course of industrial development. In particular, interfirm linkages are critical in promoting skills development among small suppliers, thus spreading learning across different segments of the economy. In this study I found that the Indian government and its well-sequenced industrial policies since the mid-1980s have played an important role in creating the institutional conditions that lead to industrial transformations and learning, and thereby promoting industrial development.

Notes 1. Kochan, T.A., Lansbury, R.D., & MacDuffie, J.P. (1997), After Lean Production: Evolving Employment Practices in the World Auto Industry. Ithaca and London: ILR Press, p. 5. 2. For the pioneering work on the role of the firm, see Coase, R.H. (1937), “The Nature of the Firm.” Economica, 4: 386–405. 3. Williamson, O.E. (1975), Markets and Hierarchies: Analysis and Antitrust Implications. New York: Free Press. 4. Powell, W.W. (1990), “Neither Market nor Hierarchy: Network Forms of Organization,” in B.M. Stew & L.L. Cummings (eds.), Research in Organizational Behavior: An Annual Series of Analytical Essays and Critical Review, vol. 12. London: Jay Press, pp. 295–336. 5. North, D.C. (1990), Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press, p. 73.

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6. North, D.C. (1990), Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press, p. 73. 7. One important recent attempt in this regard is Patibandla, M. (2006), Evolution of Markets and Institutions: A Study of an Emerging Economy. New York: Routledge. 8. Stigler, G.J. (1951), “The Division of Labor is Limited by the Extent of the Market.” Journal of Political Economy, 59: 3: 185–193. 9. Lall, S. (1985a), “A Study of Multinationals and Local Firm Linkages in India,” in S. Lall (ed.), Multinationals, Technology and Exports: Selected Papers. New York: St. Martin’s Press, pp. 263–292. 10. See Williamson (1975). 11. Piore, M.J., & Sabel, C.F. (1984), The Second Industrial Divide: Possibilities for Prosperity. New York: Basic Books. 12. See Amsden, A.H. (1989), Asia’s Next Giant: South Korea and Late Industrialization. New York: Oxford University Press. 13. See Stata, R. (1989), “Organizational Learning: The Key to Management Innovation.” Sloan Management Review, 63, Spring: 63–74, and Sabel, C.F. (1994), “Learning by Monitoring: The Institutions of Economic Development,” in N. Smelser, & R. Swedberg (eds.), The Handbook of Economic Sociology. Princeton: Russel Sage and Princeton University Press, pp. 65–123. 14. See, e.g., Saxenian, A.L. (1994), Regional Advantage: Culture and Competition in Silicon Valley and Route 128. Boston, MA: Harvard University Press; Pyke, F., Becattini, G., & Sengenberger, W. (1990), Industrial Districts and Inter-firm Co-operation in Italy. Geneva: International Institute for Labour Studies/International Labour Office; and Breschi, S., & Malerba, F. (2001). “The Geography of Innovation and Economic Clustering: Some Introductory Notes.” Industrial and Corporate Change, 10:4: 817–833. 15. Gereffi, G. (1994), “The Organization of Buyer-Driven Global Commodity Chains: How U.S. Retailers Shape Overseas Production Networks,” in G. Gereffi and M. Korzeniewics (eds.), Commodity Chains and Global Capitalism. Westport, CT: Praeger, pp. 95–122. 16. See, e.g., Gereffi, G., Humphrey J, Kaplinsky R., and Sturgeon T. (2001), “Introduction: Globalization, Value Chains, and Development.” IDS Bulletin, 32:3: 1–8; and Humphrey, J., & Schmitz, H. (2002), “Governance in Global Value Chains.” IDS Bulletin, 32:3: 19–29. 17. E.g., Womack, J., Jones, D., & Roos, D. (1990), The Machine that Changed the World. New York: Free Press; Nishiguchi, T. (1994), Strategic Industrial Sourcing: The Japanese Advantage. New York: Oxford University Press; Fujimoto, T., & Takeishi, A. (1994), Jidousha Sangyo 21 Seiki heno Scenario: Seishou gata System kara Balance gata System heno Tenkan [Towards the “Lean-on-Balance” System] (Tokyo: Seisansei Shuppan); Helper, S., & Sako, M. (1995), “Supplier Relations in Japan and the United States: Are They Converging.” Sloan Management Review, 36:3: 77–84. 18. Granovettor, M. (1985), “Economic Action and Social Structure: The Problem of Embeddedness.” American Journal of Sociology, 91:3: 481–510; Helper & Sako (1995). 19. North (1990, p. 74).

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20. In fact, the Ambassador, the only passenger car model made by HMC, a major domestic auto manufacturer, did not go through any major model change since the 1950s, because the government controlled it through licensing. 21. Lall, S. (1987), Learning to Industrialize: The Acquisition of Technological Capability in India. Basingstoke and London: Macmillan; Rodrik, D. (1995), “Trade and Industrial Policy Reform,” in J. Behrman and T.N. Srinivasan (eds.), The Handbook of Development Economics, vol. 3. Amsterdam: Elsevier Science, pp. 2925–2982; and Agrawal, P., Gokarn, S.V., Mishra, V., Parikh, K.S., & Sen, K. (1995), “India: Crisis and Responses,” in P. Agrawal, S.V. Gokarn, V. Mishra, K.S. Parikh, and K. Sen (eds.), Economic Restructuring in East Asia and India: Perspectives on Policy Reform. Delhi: Macmillan India, 159–203. 22. I calculated these from Automotive Component Manufacturers Association of India (ACMA) (1995a), Automotive Industry of India: Facts and Figures 1994–95. Delhi: ACMA. 23. Takahashi, M. (1995), “Indo no Jidousha Sangyo: Shintenshitsutsuaru Motorization [The Indian Automobile Industry: Emerging Motorization].” World Trends, 2. 24. Small-scale industry (SSI) refers to firms with an initial capital of Rs.6 million (approximately US$150,000), regardless of the size of employment. In the case of a firm that exports at least 30% of its annual production by the end of the third year, the ceiling of investment goes up to Rs.7.5 million. In addition, an ancillary unit, with an initial capital of Rs.7.5 million, also receives similar protection. 25. Lall, S. (1985b), “Multinationals and Technology Development in Host Countries,” in S. Lall (ed.), Multinationals, Technology and Exports: Selected Papers. New York: St. Martin’s Press; Lall (1987, p. 30). 26. Lall (1985b, p. 123). 27. Kaplinsky, R. (1997), “India’s Industrial Development: An Interpretive Study.” World Development, 25:5: 681–694. 28. Sanjay Gandhi, the elder son of then–prime minister Indira Gandhi, started Maruti Ltd. as a private firm to achieve his dream of producing a “national car.” Political problems, however, kept it from starting operation, and it closed down in 1977. Indira Gandhi’s government nationalized the firm in 1980, after the death of Sanjay Gandhi, to achieve her son’s dream. Advised that the project would not succeed without the involvement of foreign technology, Indira Gandhi started searching for a potential partner. The government signed joint-venture and license agreements with Suzuki in 1982 (Interviews with a former CEO, Maruti). In the 1980s, precisely because of its weaker domestic base, Suzuki, searching for a market niche, was eager to go to India, which the major Japanese auto manufacturers then considered to be a high-risk country for investment. 29. Venkataramani, R. (1989), Japan Enters Indian Industry: The MarutiSuzuki Joint Venture. New York: Stosius, p. 2. 30. I calculated these from the data in ACMA, Automotive Industry of India: Facts and Figures, various years.

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31. D’Costa, A.P. (1995), “The Restructuring of the Indian Automobile Industry: Indian State and Japanese Capital.” World Development, 23:3: 485–502; and Humphrey, J., Mukherjee, A., Zilbovicius, M., & Arbix, G. (1998), “Globalization, FDI, and the Restructuring of Supplier Networks: The Motor Industry in Brazil and India,” in M. Kagami, J. Humphrey, & M.J. Piore (eds.), Learning, Liberalization and Economic Adjustment. Tokyo: Institute of Developing Economies, pp.117–189. 32. Sen, A., Sarkar, S., & Vaidya, R.R. (1997), “Industry: Coping with New Challenges,” in K.S. Parikh (ed.), India Development Report 1997. Delhi Oxford University Press for Indira Gandhi Institute of Development Research, p. 138. 33. Economic Times, New Delhi, May 8, 1996. 34. Lall (1987). 35. Lall (1985b); Lall (1987). 36. Lall (1987, p. 176). 37. E.g., the government never granted Tata a license for its proposal to start a joint venture with Honda to produce passenger cars. 38. Venkataramani (1989). 39. Economic Times, New Delhi, November 9, 1996. 40. For more detail, see Okada, A. (2000), “Workers’ Learning through Inter-firm Linkages in the Process of Globalization: Lessons from the Indian Automobile Industry.” Ph.D. Dissertation, Massachusetts Institute of Technology. Cambridge, MA: MIT; Okada, A. (2004), “Skills Development and Interfirm Learning Linkages under Globalization: Lessons from the Indian Automobile Industry.” World Development, 32:7: 1265–1288; and Okada, A., & Siddharthan, N.S. (2008), “Automobile Clusters in India: Evidence from Chennai and the National Capital Region,” in A. Kuchiki, & M. Tsuji (eds.), The Flowchart Approach to Industrial Cluster Policy. London: PalgraveMacmillan, pp. 109–144. 41. Humphrey et al. (1998). 42. Sen, Sarkar, & Vaidya (1997). 43. Bowonder, B. (1998), “Industrialization and Economic Growth of India: Interactions of Indigenous and Foreign Technology.” International Journal of Technology Management, 15:6/7: 622–645. 44. Federation of Indian Chambers of Commerce and Industry (FICCI), “Background Paper,” prepared for a seminar on Economic Reforms and Expansion of Small Scale Industries for Employment Generation, held in Lucknow, December 7, 1994. 45. Calculated from the 1996/1997 annual reports of Maruti and Hindustan Motors. 46. Fujimoto, T. (1997), Seisan System no Shinkaron: Toyota Jidousha ni miru Seishou gata System kara Balance gata System heno Tenkan [Towards the “Lean-on-Balance” System] (Tokyo: Seisansei Shuppan), Figure 3.2. Because the two firms have different product mixes, these figures are not comparable in a strict sense. 47. Humphrey et al. (1998) discuss the implications of the emergence of global supplier networks for supplier relations in the Indian and Brazilian automotive industries.

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48. Kaplinsky (1997, p. 685). 49. Okada (2000; 2004). 50. Kathuria, S. (1996), Competing with Technology and Manufacturing: A Study of the Indian Commercial Vehicle Industry. New Delhi: Oxford University Press. 51. See Amsden (1989). 52. Since 1961, Tata has been exporting trucks to more than 80 countries; even in the early 1980s, it sold over 15% of its outputs sold abroad. See Lall (1987). 53. Customs duty of up to 50% was levied on imported components; it was as high as 131% until 1991. 54. Humphrey et al. (1998). 55. Ibid. 56. For more detail, see Okada (2000; 2004). 57. This section largely draws on Okada (2004). 58. Association for Indian Automobile Manufacturers (AIAM) (1997), The Automobile Industry: Statistical Profile 1997. Mumbai: AIAM. 59. ACMA (1995b), “Present Scenario of Automobile Industry,” Unpublished Presentation Material. Delhi: ACMA. Also see Kumar, A., Mercer, G., Narashimhan, L., & Turcq, D. (1995), “Emerging Components Industries and the Way Ahead: The Example of India,” in The Economist Intelligence Unit, Motor Bureau Asia-Pacific-4th Quarter 1995. London: The Economist Intelligence Unit. 60. Japan Institute for Overseas Investment (JIOI) (2005), Indo no Jidousha Sangyo [The Indian Automobile Industry]. Tokyo: JIOI. 61. ACMA (1995b). 62. R.C. Bhargava, former managing director of Maruti, talk at Harvard, 1998. 63. See Fujimoto & Takeishi (1994). 64. Data are from Maruti’s database accessed in 1997. 65. For detailed discussions on the development of auto clusters, see Okada (2004) and Okada & Siddharthan (2008). 66. My interview with a market research officer at Japan External Trade Organization (JETRO). 67. See Florida, R., & Kenny, M. (1991), “Transplanted Organizations: The Transfer of Japanese Industrial Organization to the U.S.” American Sociological Review, 56: 381–398. 68. ACMA (1995b). 69. This data comes from Maruti’s supplier database. Note that Maruti’s suppliers could be offering false reports to indicate their loyalty to Maruti and thus the actual dependency rate might be lower. 70. See detailed discussions on the formation and development of automobile clusters in India, see Okada & Siddharthan (2008). 71. Interviews with a director of the Maratha Chamber of Commerce, Pune, in April 1997. 72. Humphrey et al. (1998). 73. Interviews with a Japanese manager in Noida and Indian managers in Pune, both working for this firm. 74. For the figures on Japan, see Fujimoto and Takeishi (1994).

118 75. 76. 77. 78. 79. 80. 81. 82. 83. 84.

85. 86. 87. 88. 89.

90. 91. 92. 93. 94. 95. 96. 97. 98. 99.

Aya Okada Interview with a Maruti supplier in April 1997. For details on the Japanese supplier relations, see Nishiguchi (1994). In return for the on-time payment, Maruti takes a 1% commission. Womack, Jones, & Roos (1990, pp. 146–153). Ibid. Nishiguchi (1994). For more detailed discussion on Tata’s changing supplier relations, see Okada (2004). Interview with a Tata supplier in Pune, in March 1997. Interviews with two Tata suppliers in 1997. Interview with a Tata supplier in 1997. For theoretical constructs of institutional isomorphism, see Powell, W.W., & Di Maggio, P. (1991), The New Institutionalism in Organizational Analysis. Chicago and London: The University of Chicago Press. Interviews with Maruti and Tata suppliers in 1997. Interview with a firm owner in Pune, 1997. Williamson (1975). Granovettor (1985). Dore, R. (1973), British Factory Japanese Factory: The Origins of National Diversity in Industrial Relations. London: George Allen & Unwin. Also, see Dore, R. (1996), “Convergence in Whose Interest?” in S. Berger, & R. Dore, (eds.), National Diversity and Global Capitalism. Ithaca and London: Cornell University Press, pp. 366–374. SIAM’s internal document, 2005. JIOI (2005). ACMA (1995b). Ibid. SIAM Web site (http:www.siamindia.com) accessed on November 5, 2007. Interviews with SIAM staff, January 2005. SIAM, internal document, 2005. Ibid. JIOI (2005). These eleven metropolitan cities are Delhi, Mumbai, Chennai, Kolkota, Bangalore, Hyderabad, Ahmedabad, Pune, Surat, Kanpur, and Agra (SIAM, internal document, 2005).

5 Corruption: Market Reform and Technology Murali Patibandla and Amal Sanyal

5.1 Introduction Pro-market reforms and information and communication technology (ICT) are widely believed to be important instruments for enhancing efficiency. Our chapter asks a different question about these two instruments: how effective are they in fighting corruption? We suggest a typology of corruption, and argue that the type of corruption determines which of the instruments would be effective if at all, and to what extent. To make markets contestable and let them find equilibrium without intervention can reduce or eliminate certain types of corruption but not all. In some cases we need contributions from ICT. There are yet others where the two instruments should be used in a complementary way. Finally, some types of corruption are immune against both market reform and ICT. In section 5.2 we define corruption and introduce a typology. Here we also distinguish between two types of intervention: discouraging and monitoring. Section 5.3 discusses the nature of illegal rent from scarcity, and analyses the probable effect of market reforms on this type of corruption. Section 5.4 analyses the special type of corruption in the provision of governance, and the contributions that ICT can make to discouraging and monitoring. In section 5.5 we discuss the possible sources of new rents in the deregulated environment, and explore how ICT can help in coping. Section 5.6 discusses the problem of asymmetric information, and to what extent market reform and technology can help in reducing illegal rent arising from it. In section 5.7, we take a brief view of political corruption. Finally section 5.8 is a short conclusion.

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5.2 A Typology of Corruption An action can be corrupt either morally or legally or in both ways. We will use the legal sense and define corruption as extraction of an illegal rent. Literature usually classifies corruption by the domain of occurrence or the type of event, for example income tax evasion, underinvoicing, kickbacks taken by politicians, and so on. This enables researchers to sort out the optimization exercise of the corrupt agent in a particular kind of offending decision, and helps understanding that type of corruption. Our purpose however is to explore the structural aspects of corruption so that we can relate them to potential solutions. Accordingly we propose to classify it in terms of the source of illegal rent involved in a corrupt action. All illegal rents can be traced to three primitive sources: scarcity, information, and position. Scarcity of a good or service leads to a wide variety of corrupt practices. Scarcity leads to opportunities for corruption in the sense that the ability to create artificially a scarcity also creates opportunities to profit from.1 In case of goods, price regulation, quantity limits, zoning, differential tax treatment in different states, and so on, lead to unavailability of the good at the potential market-clearing price. This creates the opportunity of a scarcity rent. In the case of a service, it is easy to threaten not to provide it unless a bribe is paid, if there is no alternative provider. Monopoly of a service creates this possibility as in the case of government services. Shleifer and Vishny2 distinguish between “complementary” services (as when a builder needs all of several permits) and “substitute” services (as when you can apply several passport windows) and argue that corruption will be excessive due to kind of double marginalization in the former case. In simple micro-economic terms, the policies such as the licensing for entry of firms result in monopolies. The monopoly pricing leaves out the people from the market who can not afford the price which is a form of scarcity. If the monopolist undertakes perfect price discrimination, he charges different prices from different consumers depending on their willingness and ability to pay. The total market is served, and the last and poorest consumer pays a price equal to marginal cost. The monopolist takes away the consumer surplus. This extraction of the total surplus is the rent or a form of corruption that arises out of monopolies. The mechanism can be characterized as the richest consumer pays the highest price instead of standing in the queue while the poorest waits the longest. The poor gets included

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in the market by imposing a transaction cost on them. The perfect price discrimination may not take place if there are transaction costs of identifying consumers with different abilities and if there is price arbitrage. This was a common practice in India prior to reforms in areas such as getting gas and telephone connections. The rich who could pay the bribe got them immediately and the poor had to wait long periods. Another way of defining scarcity is that the economy has the capacity (capital) to produce a particular or several goods but inefficient institutions discourage investments. One element of inefficient institutions is insecure property rights through predation by the government (threat of government taking over) and private agents (mafia). An example is the effect of the Rent Control Act in the cities such as Mumbai. Under the act, a landlord cannot evict a tenant. Consequently, most flats that were built in Mumbai are not put for rent despite huge demand.3 Although this example does not directly refer to government corruption, ill-defined property rights provide strong discretionary powers to government agents to appropriate public and private property. The threat of appropriation leads to payments of corruption. Illegal rent on information arises in a variety of situations. The simplest case is tax evasion. Because a taxpaying unit owns private information about its own income or transactions, it can get an illegal rent by evading taxes. There are many other widespread forms. Insider trading involves a person using a company’s internal information for personal gain. An auditor extracting rent from a tax offender, such as an insider trader, uses the information gathered in his professional capacity for personal rent. Informational asymmetry across different economic agents and between government agents and the populace can arise out of inefficient institutional conditions. If the rules defined in complex or vague terms, a poor and illiterate persons’ ability to receive and process information about her rights and obligations is limited. This gives powers to government agents to extract bribes from her. For example, in several instances one finds in India’s airports that returning emigrants from the gulf, most of who are semi-illiterate, being harassed by the customs officials even though they are eligible to bring in certain amount of foreign goods under the prevailing rules. Similar is the case of a poor and illiterate person’s ability in making use of ration cards in the fair price shops established for the poor. The illiteracy suits the interests of government agents, which is also a larger political economy issue.

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Finally, illegal rent from position is extracted by persons in strategic positions, which enables them to either confer a benefit or inflict harm. Politicians and bureaucrats in strategic positions in the government can extract kickbacks for government purchases, licenses, permits, amnesty, and so on. Persons in the judiciary can behave similarly. Members of the police force can demand bribes for the favor of not prosecuting. Note that rent on position can be extracted by all three constituents of the government: the legislature, the executive as well as the judiciary. They can be extracted outside the government as well, for example by local musclemen, trade union bosses, opposition politicians, and so on. The power of the position increases especially if the formal rules are defined such a way giving high degree of discretionary powers to the government agents, which gives them the powers to define them in accordance with the context to suit them. The government agents can collude, irrespective of competing parties, to augment their powers of discretion. In the parliamentarian democracies the executive is basically the majority in the parliament. This gives them high degree of powers to enact laws to suit their interests (of the executive) with no checks and balances. To give an example in the year 2005 (August), when the Supreme Court ruled against the government’s move to implement reservations in the private unaided educational institutions, the members reacted to make constitutional amendments to restrict the powers of the court. An act of corruption need not always involve a single source of rent. Different types of rent can co-exist in a single corrupt act. For example corrupt rents from position and information combine together in bribe chains.4 The lowest level in the chain collects bribes from members of the public using their position. They in turn pay bribes to their superiors in command because the latter have the information of the goings on. These chains have been reported in police, customs, income taxes and among railway inspectors. 5 But they can potentially exist along the hierarchy of any regulatory authority. We analyze the potential role of reforms and ICT in reducing corruption. For this discussion we introduce a twofold classification of intervening actions. Those that discourage (or in the limit completely disable) choosing a corrupt action will be called discouraging actions, and those that increase the likelihood of being punished of a corrupt action will be called monitoring actions. For example, simpler tax structure, fewer rebates, deduction at source, and so on are discouraging actions for income tax evasion, while better audit of returns and speeding up litigation is a monitoring action.

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5.3 Scarcity Rent and Market Reforms A variety of corrupt practices arise directly from scarcity. In any functioning market, there always exist a set of buyers who are willing to pay more than the equilibrium price, if necessary. In normal market arrangements, they do not pay this amount because the good is freely available at a lower price. But they can be made to pay it by threatening the availability. Any arrangement that hinders the availability of the good at its market-clearing price creates this effect. Price regulation or quantity control, for example, threatens the availability of a good at its market-clearing price, enabling sellers to extract a premium from those who are willing to pay. This is how a black market arises for a rationed good.6 Scarcity rent however does not necessarily arise from government regulation or control. In a monopoly or oligopolistic market, dealers can extract higher than announced price from some buyers. In these markets, a buyer who is able will pay more than the prescribed price if threatened with unavailability or long wait. An example in point is the premium dealers used to charge for new cars and two-wheelers over announced prices, only some years ago.7 In some cases, the scarcity is not transparent because it relates to something, which is not being traded at all. There may be adequate supply of cooking gas cylinders at its current price in a town, and yet to get one, buyers pay a premium over the price of the cylinder. The reason is that the delivery service which is an integral part of the deal is not being openly traded. Consumers are willing to pay for not only the gas but also rapid delivery. But the good “rapid delivery” is not on sale. The delivery person is able to extract an illegal rent for this scarce service. Note that the bribe would disappear if the scarcity of “rapid delivery” was eliminated, for example if the gas company employed more delivery persons or designed an incentive for the delivery person to speed up. Most types of “speed money” are of this variety: when there is demand for so-called speed but no market for it, or the market is underdeveloped.8 When an illegal rent arises directly from scarcity, market reforms are expected to be effective in reducing or even eliminating it. As controls and regulations are removed, product markets tend to find clearing prices, at which all who can and want to, buy it, leaving no space for illegal rents. At the same time, competition and contestability disable rent-seeking based on the threat of unavailability. Apart from reducing scarcity rent directly, competition also helps establish missing markets behind corruption. In the gas cylinder example, if a

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number of gas companies were in the market, they would discover that faster delivery helps them compete better. They would react by buying “rapid delivery” from their delivery people with more incentive compatible contracts. There are however cases where well-developed, not underdeveloped, markets extract rent from scarcity. Can market reform help in these cases? In most cases, it can. Generally a well-developed illegal market is the reflection of a related legal market, which is underdeveloped or regulated. It is the latter that generates the scarcity, while the rent is extracted in the former. For example, transmitting foreign currency through well-developed illegal markets is the result of nonmarket valuation of currency and/or restrictions on the legal market. The illegal market for gold in India sprang up in response to the Gold Control Act of 1962 and the institutions set up to enforce it. Reform of the legal markets can bring the corresponding illegal markets to an end. When market reforms are able to reduce a scarcity rent, the action is “discouraging” in terms of our classification. Corruption disappears in this case because the source of the rent disappears, or becomes too small to warrant a risky action. A discouraging solution through reform is preferable to costly monitoring action. The cost of monitoring is generally large: it includes enactment of laws, setting up regulating institutions and the actual cost of information collection known as auditing. Auditing cost depends on the technology of information gathering and the chance of subversion by venal auditors. Finally the gain is probabilistic. Hence a discouraging solution whenever attainable through market reform is preferable.

5.4 Government Services: Scarcity, Information, and ICT Services produced by the government can be classified as those related to governance and those that are not. The latter can be produced and sold by the private sector as well. The government has opened up some of them to competition, while others are subject to incomplete but steady deregulation. As the government gradually opens up these services to competition, scarcity-related corruption in these sectors are expected to fall. Typically this is the kind of corruption that increases the cost of living most directly: bribes paid for electricity, water and telephone connection and repairs, railway reservation,

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admission to hospitals, buying cooking gas, coal, and kerosene, and the list continues. These bribes, widespread until fairly recently, are receding and hopefully will disappear if reforms continue. But in governance-related services, illegal rent from scarcity eludes easy market solution. In these services corrupt rent is extracted from the interplay of scarcity and position. Services such as registration, passports, birth and death certificates, driving licenses, inheritance and succession, FIR at police stations, getting a date at a law court, and so on, are examples. Those at the front office of these services can charge a rent, which partly arises from their position at the front office of a monopoly provider, and partly from the relatively slow provision rate given the technology of processing. Providers can favor a bribe-payer with faster processing and delivery. Large number of applications and the outdated technology ensure a long queue of un-served applicants at any point of time. This makes the favor of queue-jumping worth paying for. Some countries have been opting for market-based solutions by outsourcing them with performance-related contracts.9 However the transition is difficult for many services, where new laws and institutions are required to protect the privacy of citizens and confidentiality of state information. In India this solution is further limited at the present moment by the fact that the government is the largest employer in the organized sector.10 Any large-scale transition will seriously destabilize the labor market in the short run. It is in this sector that ICT can be of significant help by designing solutions for information processing, storage, verification and certification. There are two separate parts of the solution. The first is housekeeping, retrieving and processing of information within an office, and the second is the front-office interface with the citizen, through which documents are applied, paid for, and received. The technology for the first part of the solution, the monitoring technology, is not very challenging but its implementation is, because it requires inputs other than technology. These projects involve winning over cultural resistance and organized opposition within government departments arising from fear of job loss and shift of intra-office power equations. Hence it requires deft organizational leadership in government departments and overall a political will. Though monitoring technology solutions increase efficiency through faster processing, and for customers, easy access to information, it cannot entirely eliminate corruption. Even when the technology is revolutionized, a rent of position can be extracted unless the application and the delivery process are automated and impersonal. There is no doubt

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however that the incidence of corruption will fall with better monitoring technology, because it helps better supervision of the goings on in the front office. In these services those who do not pay bribes face slower service, often deliberately made tardy. When complaints about tardiness are investigated, offenders typically hide behind the excuse of slow technology. Improvement of in-office technology makes internal supervision more potent by eliminating the habitual offenders’ excuse. But to completely eliminate these bribes, the only sufficient condition is to design discouraging technological solutions, by introducing automated analogues of front-office interfaces. There are two major obstacles to this project. First, illiteracy prevents many from using computer-based applications. The second is that majority of users are not in a position to make on-line payments. Since it is the illiterate and the poor (without bank account) who are more likely prey to front-office bribe, available technology of online application and Internet payment would not liberate the bulk of victims from these bribes. As economists we can only hope that the problems will be circumvented. Perhaps, easy to use tools of Community Informatics11, touch-screen operations and a combination of pictures and icons can tackle the illiteracy problem, and machines that accept rupee notes, the payment problem. If a suitable impersonal delivery system for documents is added, we can see the outlines of a discouraging solution to corruption in government service provision. Like in the case of monitoring solutions, the discouraging solutions, too, are not entirely technical. They require serious support from local support agencies such as Panchayati Raj institutions, nongovernmental organizations (NGOs), Self Help Groups or some other institution such as cooperative societies. Unlike reform-based solutions, which are essential byproducts, ICT solutions require a separate source of funding, and hence sponsors. Many e-governance projects fail to sustain after the initiating funding agency withdraws. There is need for serious innovation so as to build some revenue and employment generation capacity into e-governance projects to make them sustainable.

5.5 ICT: Transition to De-regulated Environment and After In the new environment what are the new sources of positional rent, if any, directly resulting from the reforms? A possibility of new rent

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arises from the fact that de-regulation, quite ironically, does not do away with monitoring. Just as regulation requires monitoring, so does deregulation. Is it possible that the regulators of the new environment will extract rent for “selectively regulating,” thus reestablishing the familiar nexus of big business and the regulator?12 The probability of that however appears small. The chance of capture of an institution monitoring deregulation is much smaller than one monitoring regulation. The reason is that with fewer entry barriers, the number of players in each industry increases significantly, and industry associations become broad-based. With a large number of members each with vested interest in the business environment, associations are expected to keep effective watch over official monitoring institutions.13 In an industry with a broad-based association, the ability of individual members to obtain illegal deals from regulators is small since it hurts the interests of the majority. But there is a second source that is a real possibility. Increased sophistication and complexity of economic activity have been pushing the mode of doing business beyond the traditional and the familiar. There are local firms, foreign firms, joint ventures among private, public and transnational entities, family-owned businesses, PSU’s, alliances and various input and service sharing arrangements in the business scene today. Outputs and trades range from the most traditional to the most awe-inspiring futuristic goods and services. Inputs are bought using both traditional market instruments as well as a variety of contractual instruments involving human capital and intellectual property of a wide variety. All this is leading to novel forms of contracts. Add to them the complexity of contracts introduced by new financial instruments. They are giving birth to a new generation of disputes, which are neither the business of regulators nor of industry associations. Add to them those brought to courts by official institutions such as excise, customs, income-tax, FEMA authorities, and the Registrar of Companies.14 The number of these disputes and their legal complexity are growing very rapidly, and is adding to already existing long queues. Legal settlement is a monopoly service, and as we have seen, delays under monopolistic provision, particularly, when it costs money and business, is a recipe for illegal rent. Rent in this context means payment in excess of the statutory rate to someone in the legal establishment. It takes many forms. Clients are forced to pay at more than the official rate for registration. They pay to fix each date for hearing. Clients for whom the cost of delay is high, are willing to pay large

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sums to get an early hearing. They also pay more than the statutory amount for the documents of each session of hearing. Parties with weak legal positions can pay in order to postpone hearings, wear out the patience or finances of the opposition and force out-of-court settlements. Large illegal income is also generated through out-of-court settlements. India’s competitive edge of well-developed property laws is blunted by unacceptable delay and corruption in getting settlements. Here is an important potential role for ICT not only to de-clog the system and ward off corruption, but also to complement the reform process. To de-congest, the judiciary and the legal profession need solutions to update knowledge and information at a tearing speed, and need all that information at call.15 If in place, the solutions should reduce the length of queues, which will have some effect on the corruption at the lower end. Second, technological solution is required for the management of scheduling and allocation of cases. These would serve as monitoring solutions, enabling the court management to monitor the queuing process and keep queue manipulation in check. Finally, we should strive to let clients register, obtain hearing dates and retrieve session documents impersonally through automated devices as final discouraging intervention. In several regions in India, especially in the North, land records do not exist making property rights of ownership, both the public and the private, tenuous. This results in multiple sale of a given land by the middlemen and also multiple registration by government bodies. This leads to legal disputes among the payees for the land. Apart from this, government agents could threaten to appropriate the land from a person who paid for the land by claiming it as public property. In the southern part of India in cities such as Bangalore, when the land registrations are computerized with proper documentation of proofs including the photographs of the purchaser, the incidence of multiple sales decreased. However, rapid economic growth increased the land transactions, which is not matched by the improvements in technology application. Consequently, stakes of corruption have gone up. When the legal system poses serious problems of high transaction costs, people often prefer to bypass this system and base their business dealing on the enforcement mechanisms that are available based on social networks and norms.16 Nevertheless these systems have their weaknesses, but payoff available using them may serve to place an upper bound on the size of the bribes the formal authorities can demand for their services. If the information technology increases the

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flow of communication and thereby enlarges the sustainable network, then the payoff from dealing within the network will increase and the bribes the formal legal system can extract will decrease.

5.6 Information Rent: Reforms and ICT Illegal rent from asymmetric information presents a difficult challenge. Markets supposedly fail with asymmetry, and hence market reform per se cannot be expected to be a cure. We will make a few observations on the question. In India tort laws are not developed. The legal status of most forms of moral hazard is unclear and they go unpunished. The reason is historical, namely that no interest group has pushed for systematic laws relating to moral hazards. More frequent forms of cheating with asymmetric information have preyed on households or public bodies rather than organized private interests. Households did not have the resource or will to press for legislation. In case of public bodies, offenders, generally insiders, have been treated as per the power equation of the day—either whitewashed or politically victimized, without anyone feeling the need to press for appropriate laws. Indian business has avoided large moral hazards by repetitive interaction among a set of business and caste groups. This historical pattern is changing. With growth of markets and business, forms of moral hazard specific to particular types of contracts are expected to recur with significant frequency. We expect this process to result in pressure from business groups or associations, both domestic and transnational, for laws about the recurrent types. We also expect that more formal and detailed contracts in all areas of business will replace the regime of loose contracts tied to reputation and group loyalty. In this process the government has to take the initiative for discouraging policy, and our technology sector to provide the monitoring options. Discouraging policy in this context involves enacting appropriate laws, disclosure rules and institutions. This is a complex exercise because it has to encompass moral hazards in a wide range of contracts—in traditional business as well as in those involving financial instruments, human capital and intellectual property. The process is well under way with the recent enactments such as The Securities and Exchange Board of India Act, 1992; The Arbitration and Conciliation Act, 1996; Trademarks Act, 1999; and so on. The need for contribution from the technology sector will arise in two areas. First, moral hazard is ideally tackled by formulating

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appropriate contracts and monitoring them effectively. Tort laws usually serve as a threat against breach of contract, and in most cases equilibrium behavior does not entail the actual use of the legal system. Technology will be required to design effective monitoring solutions for widely divergent types of business contracts. Second, to the extent that breaches of contracts or disputes arise, the legal system will come up against a bottleneck of forensic resources. Existing resources in this area are too dated to handle fraud or breach of contract in areas of accounting, finance, human capital, intellectual property, the Internet and electronic data. The technology sector will be very much in demand to come up with new forensic solutions to establish offence or innocence.

5.7 Rent from Political Position: Where are we now? We have earlier argued that rent of position at the lower end of government is expected to decline if governments successfully pursue e-governance.17 But what about corruption at higher positions? De-regulation has the virtue of cutting down the number of centers of authority—the bureaucratic windows that can give or deny. To that extent we would expect some fall in the number of incidents involving upper bureaucracy too, though not an end of them. But corruption by politicians in power—kickbacks for public purchase and illegitimate use of public funds—obviously cannot be eliminated through economic reform. It needs to be addressed by the political system: voters, governments, political parties and the Election Commission. Political development is beyond the scope of this chapter. But in line with the above discussion, we can ask if ongoing reforms and ICT will have any influence at all. Political corruption is more threatening in certain state governments. If in a certain state corrupt governments recur as a rule, rather than exception, it implies that voters do not punish corruption. Of many possible reasons, those relevant for our discussion are as follows: 1. Voters’ preference for private income may be overwhelmingly greater than that for public goods. Corrupt politicians are preferred as they are expected to reward voters through private transfers from the public fisc.

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2. Voters may vote according to historical loyalty unrelated to the current state of politics, and politicians invest in vote banks to keep the historic loyalty unshaken. 3. Under some assumptions, it is optimal for corrupt politicians to use corruption allegations for changing inter-party power equations, for example between ruling and opposition groups, but not to press for sentencing. In this case political corruption is often insinuated but rarely pursued to the end to establish the truth, leaving voters to form subjective beliefs. Those who wish to think that all scandals are just scandal-mongering, can think so without being challenged by facts. Others can believe that all politicians are corrupt, without again being challenged. It is also possible to continue to believe in the honesty of one’s own leader in spite of allegations. The overall effect is that corruption allegations drop out of the equation and elections are contested on the basis of other factors. 4. Following from the above point, when the political process becomes mainly distributional, corruption becomes a means of distributing income between different groups. The repeated interactions of this kind overtime result in corruption becoming an accepted norm.

It is reasonably certain that in the long run, market reforms will have several predictable effects on the first two factors discussed above. Increased geographical mobility and migration across the country can be expected to weaken traditional vote banks, which rely on the cohabitation of similar groups in an election constituency. Remarkably, this effect will be stronger in states where vote-bank politics is more entrenched, because those are the states with more severe poverty and disorder pushing for emigration. Secondly, voters who move across regions and settle down in new places will be much more aware of the quality and provision of public goods than has been the case so far. Third, the numerical growth of the middle classes will alter the income and education composition of the electorate and overall preference for public goods and governance over private transfers. Finally, the omnipresence of visual electronic media, itself a result of economic reforms, is expected to increase the level of awareness of relevant issues including inter-state disparities in economically backward constituencies. These changes are expected to cast positive influences on the political system. ICT can contribute to this environment of change. It can equip the media and activists with technology to monitor and chase alleged political scandals and helping them establish the truth in all alleged cases. We believe that successful conclusions of these cases

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and sentencing when appropriate, could be important in removing the skeptic apathy of voters.

5.8 Conclusions There are two strands of thinking about corruption. One believes that self-interest, that breeds corruption, can be itself harnessed to motivate people not to be corrupt. It requires either well-functioning and competitive markets, or appropriate contracts that force the parties to stay clean. For such law-abiding equilibria, an effective legal system has to stay in the background as a credible and serious threat. A second school believes that the ultimate solution to corruption is technological: to foreclose the possibility of taking a corrupt step. Both schools may be theoretically right. It is possible to visualise a society-wide web of contracts that bind everyone in incentivecompatible clean behaviour. It may similarly be possible to visualise technologies that completely disable corrupt steps. For example if all voters are finger-printed and can vote into any of a system of computers stationed all over the country, the possibility of false voting, and booth-capturing become physically impossible. Or, if there is no paper money, and everyone were to receive or pay with plastic cards through a personal mobile fund-transfer gadget connected through satellites to the banking system, all unaccounted receipts could be traced with certainty. But both types of solutions have resource costs, and so they will materialize only to the extent that someone is willing to pay for them. Secondly, those who would pay would not be paying for the moral cause of eliminating corruption. They would spend in order to cut their losses from corruption. Hence they would buy technology or legal services only to the extent that they cost no more than the corruption they reduce. Therefore in a private society, the solution to corruption is always partial. Corruption, that costs less than it would cost to eliminate it, is tolerated. In this chapter we have examined how corruption may be affected by the reforms, and our ICT if applied. To the extent that corruption falls directly as a result of market reforms, it is a free of cost byproduct of the reforms. But all other solutions will materialize only to the extent that private interests think worthwhile for cutting their losses. Hence we cannot make any statement about the extent to which these effects will proceed. One of the limitations of our approach is that we refer to “market reforms” into a broad category. The way information technology

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affects the outcomes of markets and bureaucracies will differ from context to another. The article by Hart, Shleifer, and Vishny18 has shown the limitations of markets in providing unobserved quality. How changes in information technology will alter the relative merits of markets and bureaucratic alternatives is a subtle matter. This where researching in detail the contextual cases will be a productive area of research.

Notes 1. It is necessary to make this observation, otherwise it may be interpreted that all suppliers and producers in a market are corrupt. 2. Shleifer, A., & Vishny, R.W. (1993), “Corruption.” Quarterly Journal of Economics, 108: 3: 599–617. 3. Patibandla, M. (2006), Evolution of Markets and Institutions. Routledge: London. 4. Wade, R. (1988), Village Republics: Economic Conditions for Collective Action in South India. Cambridge/New York: Cambridge University Press. 5. Sanyal, A. (2000), “Audit Hierarchy in a Corrupt Tax Administration.” Journal of Comparative Economics, 28: 2, June: 364–378. 6. Scitovsky, T. (1942), “The Political Economy of Consumers’ Rationing.” Review of Economic Statistics, 24: 114–124. 7. In some cases, a dealer could charge different rates of premium depending on the customers’ willingness to pay and the market would tend to first degree price discrimination. 8. Bribes extracted with the threat of delay have been analyzed in Sanyal, A. (2004) “Bribes in a Supply Line.” Economica, 71: 1, February: 155–168. 9. The option, however, is not novel. Ottoman, Mughal, Qajar, and Manchu emperors and the sixteenth- and seventeenth-century European rulers often outsourced the collection of taxes to private merchants or noblemen. 10. Wilson, J.Q. (1989), Bureaucracy. New York: Basic Books. 11. For example, Community Software Solution Framework, such as eNRICH (http://enrich. nic.in) developed by NIC. 12. In an interview, Ratan Tata has recently complained that some business pressure groups are slowing down specific reforms (Financial Express, June 27, 2005). 13. NASSCOM, the software industry association has been effectively protecting and pushing for de-regulation, as the association grew in membership in recent years. Certain other industry associations, which were previously dominated by big houses have become broad-based and representative of the industry. 14. All of them except the last one have semi-judicial power, yet the number of disputes they bring to the courts is large. There are 40,000 pending disputes brought in by the Registrar of Companies at the moment, and they take on average about ten years to settle. It is speculated that the new Companies

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15.

16. 17.

18.

Murali Patibandla and Amal Sanyal Act, based on the draft by the J.J. Irani Committee, is considering giving semi-judicial power to the Registrar of Companies as well. These solutions have a large potential demand, expected from the formal legal system, semi-judicial bodies, law firms, industry associations, and business as well as business and law schools. It is difficult to speculate on a time frame, n. 1. Dixit, A. (2005), Lawlessness and Economics: Alternative Modes of Governance. Princeton: Princeton University Press. It is difficult to speculate on a time frame, though. So far e-governance projects have relied on individual leaders at the state level or visionary technocrats at the centre. It can become a self-propelling movement only if politicians spot gains from it for themselves. The example of Mr. Chandra Babu Naidu, might have sent a wrong message—that there are better ways of mobilizing votes. A stronger possibility is e-governance introduced piecemeal by the upper bureaucracy in their individual areas of discretion, for more effective organization and management. Hart, O., Shleifer, A., & Vishy, R. (1997), “The Proper Scope of Government: Theory and Application to Prisons.” Quarterly Journal of Economics: 1119–1158.

6 Accessing Early-Stage Risk Capital in India Rafiq Dossani and Asawari Desai

6.1 Introduction The flow of risk capital to small and medium enterprises (SMEs) in India has increased substantially since 2000. A key problem, however, remains: over 90% of the money is invested in late-stage initiatives by mature firms. Even the remainder mostly finances new firms replicating proven business ideas. As a result, very few innovative startups are funded. The objective of this chapter is to analyze causes and recommend policy changes. Our analysis is based on a questionnaire filled out by forty-two capital providers and venture-funded firms between October 2005 and March 2006. In addition, during this period, 175 face-toface interviews were conducted with capital providers, venture-funded firms, regulators, and policymakers. We find the following causes for the shortage of early-stage investments: ●

●

●

The skills of risk capital providers and entrepreneurs are unsuited to early-stage investments. Inadequate linkages between stages of firm development hamper transition into and from early stage investments. These inadequacies arise from: the state of university-industry linkages, immature domestic product markets, equity markets, complementary capital markets, bureaucratic hurdles, regulation of intellectual property, and the state of social networks. The business environment discourages sophisticated standards of corporate governance.

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An institutional framework is posited to help understand the state of the investment environment. We argue that regulatory barriers raise transaction costs for early stage capital. We also argue that policy mechanisms for reducing the risk of early-stage capital are ineffective. On the other hand, institutions that affect complementary inputs are already well-managed. These include policies that influence education, competition policy and globalization. For our recommendations, we focus on two types of public policy responses to the problem of the shortage of early-stage risk capital: regulatory responses (i.e., better rules of the game) and risk-alteration through public support for startups (such as through public-private partnerships). Among regulatory responses, we recommend rules for the creation of limited liability corporations, accreditation of overseas investors, and a reduction in minimum capital requirements for venture capital firms. Among risk-alteration policies, we consider whether there is a role for public funding for SMEs. We conclude that there is a case for direct public financial support for research and university collaborations. However, there is no strong case for other forms of public funding. This chapter is organized as follows: section 6.2 discusses the importance of risk capital in India. The subsequent four sections analyze the survey data to: understand trends in risk capital (section 6.3), and the roles of domestic markets (section 6.4), social networks (section 6.5), and the operating environment (section 6.6). Section 6.7 discusses policy options. Section 6.8 summarizes the conclusions.

6.2

The Importance of Risk Capital in India

As in most countries, SMEs comprise an important economic sector in India. In India, SMEs account for 45% of employment, 40% of gross domestic product (GDP) and 50% of exports.1 Investment in SMEs generates high returns and balanced economic development. A study of ten portfolio SMEs by the global investment firm, Small Enterprise Assistance Funds (SEAF), concluded that every dollar invested generated, on average, an additional ten dollars in the local economy, created jobs at all skill levels, introduced firms to new business methods, products and services, and integrated SMEs into a wider (sometimes global) supply chain.2 On the other hand, inadequate supply and high costs of SMEs funding, the so-called SME finance gap, often leads to a shortage of firms between the smallest micro-enterprises and larger firms. The problem of the “missing middle” is often worsened by government policies

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that favor larger firms for financial access, for example, through collateral requirements imposed on the banking sector. ●

●

Even developed countries report this problem. A paper by the British government’s Small Business Service notes that, “While most businesses seeking to finance investment, innovation and growth are well-served by a variety of private sector sources of finance, . . . , lenders continue to face uncertainty in assessing credit risk when lending to SMEs and often rely on collateral provided by the borrower to reduce their risk exposure . . . this can create difficulties for entrepreneurs who do not have suitable assets to offer as security.”3 In consequence, smaller firms in most countries tend to rely more on informal sources of finance.

Given their economic and political importance, SMEs attract considerable policy support, ranging from asset subsidies and research grants to legal structures and reservation of fields of activity for SMEs. Although subsidies are the most common policy instrument, restructuring the institutional environment is also important. As Cull et al. (2005) argue, the access to both debt and equity finance by SMEs appears to be dependent on the availability of appropriate legal organizational forms. For example, it was only after Britain adopted statutes in 1907 enabling businesses to organize as private limited liability companies that SMEs were able to access equity finance. Second, while the validity of many policies to help SMEs access finance is debated, careful targeting and sequencing can help.4 For example, policies that create clusters of startups have promoted innovation and growth in areas with high levels of education more successfully than in educationally backward areas. Accordingly, a better sequence of regional development, in such a case, is to support educational development prior to promoting clusters. In India, earlier policies focusing on reservation of industrial applications for SMEs and state-provided equity support failed and are being phased out. Current Indian policy focuses on providing debt finance through state-sponsored financial institutions. However, debt policies cannot succeed without prior access to risk capital. Generally speaking, this means private sources of capital since SMEs cannot immediately access public equity. In the absence of such risk capital, SMEs tend to be smaller with low growth rates and low rates of innovation. Such appears to be the case for India.5 Accessing risk capital may pose its own challenges. The abovementioned British government report notes that many SMEs are not well prepared to receive risk capital, noting that “many lack the skills

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needed to develop a business proposal to a stage where it is ready to attract external investors. There is also evidence that, for some entrepreneurs, the fear of losing control and management freedom is a significant deterrent to seeking equity finance.” Similarly, a study by the Australian Venture Capital Association on “Early Stage Enterprises” (ESEs)6 states that many “ESEs find it difficult to access sufficient capital to grow . . . due to difficulty in attracting formal venture capital or little incentive for investors such as angels to commit high risk capital . . . creating a funding gap.” In addition to control issues and inexperienced management identified in the UK Treasury paper, the study identifies the following obstacles: ●

●

●

●

●

Transaction costs—the costs to an investor of appraising the risks and returns from an investment tend to be fixed and high relative to the size of the investment. Transaction size—venture capital investors typically require a minimum transaction size, which is often higher than the average ESE fund raising. High risk—higher for early stage (and particularly pre-revenue) companies—because the management team or the ESE’s product and market may be unproven. Lack of exit options—there is no secondary market for trading in smaller firms’ shares. Due to the current post “tech-wreck” environment, many venture capitalists have retreated from early stage investments in favor of later stage investments and turnaround opportunities.

It should be noted that not just entrepreneurs but early-stage capital providers need to be of the right kind. Venture capitalists, for example, are most successful when their prior experience includes running a startup. The importance of successful risk capital access is illustrated by a U.S. National Venture Capital (VC) Association study showing that the long-term performance of venture-funded initial public offerings (IPOs) is better than nonventure funded IPOs (Venture Impact, 2004).7 VC-funded firms in the United States employ 10 million workers and lead in technological development in diverse fields such as IT, healthcare and logistics. Some developing countries have a flourishing early-stage risk capital industry, notably China and Israel. Both countries have successfully leveraged the capital and skills of overseas risk capital providers.

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Other countries, including developed countries in Europe, have been less successful at using overseas capital. It should be noted that although overseas investors are more likely to possess technical skills and market awareness than domestic investors, they face difficulties applying the traditionally spatially fixed venture capital model to global investing. Interestingly, China began its development of a risk capital industry more recently than India. But, over the past few years, China has overtaken India in the share of early-stage fundings. The reason for China’s “leap forward” may lie in the differences in the two countries’ institutional framework. Kumar and Worm (2004)8 argue that China has a key advantage over India in introducing reforms—a preference for exploratory learning. In India, the initial progress in venture capital (in 2000) arose from institutional reforms instigated from outside the country, largely by nonresident Indians located in Silicon Valley (Securities and Exchange Board of India [SEBI], 2000; Dossani and Kenney, 2002).9 An example of the Indian difficulty with exploratory learning is shown by the following: the year 2000 reforms retained a large role for state-controlled financial institutions as these were the dominant sources of institutional capital at the time. However, as the SEBI report notes, they were intended to be regularly updated in line with the growth of privately controlled financial institutions. Yet, once the initial reforms were introduced in India in 2000, there was no further reform in line with the growth of private institutional capital. In consequence, even though as of 2008, private financial institutions dominate capital provision in India, the regulatory environment does not reflect this. This appears to have been an important reason for India falling behind in venture capital. In China, on the other hand, the industry was developed by local initiative, both state and private. There was considerable experimentation, even to the extent of exploring parallel approaches to venture capital growth—for instance, in 2001, the state created state-owned funds and allowed them to compete with private funds that received state finance. The regulator explained the parallel approach by stating that the intent was to encourage experimentation with organizational form, so as to learn which one would succeed (Dossani, 2007).10 Reforming a nation’s institutional environment is, however, no easy task. This is particularly the case for normative and cognitive institutions (Kumar and Worm, 2004). However, regulatory institutions might be easier to create, in part because the drivers of regulatory change might be external (such as a multilateral institution or the

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above-noted nonresident Indian). Hence, the recommendations of this chapter focus on policy interventions. In this, we are guided by the principle that regulatory policy is most successful when it removes barriers to entrepreneurship rather than when it tries to create entrepreneurship. A study by the European central bank11 on how public policy can contribute to increase the share of early stage and high-tech venture capital investments argued that “Our results cast more than a passing doubt on the attempt to increase the share of early stage and high-tech venture investments by channeling more funds into venture capital markets, consistent with a ‘money chasing deals’ situation. Rather, we find that policies aimed at increasing the expected return of projects are more successful in altering the composition of venture capital markets toward projects with less collateral, namely early stage projects and projects in high-tech industries. The availability of stock markets targeted at entrepreneurial companies—which provide a lucrative exit channel—and a decrease in capital gains taxation both raise the share of early stage and high-tech investments. Interestingly, we find that a reduction in some barriers to entrepreneurship leads to a large increase in the high-tech ratio. By contrast, the stock of public research and development (R&D) holds no effect on the innovation ratios.” India already has certain key institutional advantages that should be built upon. These include regulatory institutions in telecommunications, which is an important component for enabling venture capital. Second, the education infrastructure is advanced relative to India’s stage of development. Relative to most other countries, skills are not in short supply. Other positive features include: ● ● ●

● ●

●

●

●

Large stock of human capital. The rising number of graduates in various fields. The success of the software and services industry, which has created a cadre of engineers and other domain experts with marketing and product development skills. Well-developed managerial skills among managers of large firms. A cadre of returnees from western countries with advanced technical and business development skills. Opportunities in newly competitive exporters, for example, textiles, the auto components industry and healthcare. The growth of domestic markets in fast-growing sectors such as telecommunications, finance and retail. Presence of risk capital providers in centers outside the main commercial center, Mumbai, and, in consequence, closer to the locations of SMEs.

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Globally connected and flourishing private equity industry with independent management structure, experience of dealing with large, global institutional funds and reliance on institutional capital—several of these attributes are portable to early-stage investing. Expanding pool of multinational firms providing access to the latest technologies in a range of sectors.

6.3

Trends in Indian Risk Capital

The risk capital industry in India began in the early 1990s when a number of World Bank-supported venture capital firms were founded. Following reforms in 2000, several foreign-financed funds were established.12 Table 6.1 shows the decline in early stage funding after the Internet bubble burst in 2001. The few startups that succeeded were “me-too” firms that replicated proven business models, thus creating the strategy for funding that predominates to this day. The strategy favors two types of entrepreneurs: (1) those who were earlier executives in successful firms and need capital to replicate the products or services and business models of their previous employers and (2) those who run closely held, profitable firms which need capital to expand or prepare for a public listing. The profile of risk capital providers, shows a bias toward larger funds interested in later-stage investments. Nevertheless, the industry’s potential to support early-stage investment is indicated by: 1. The rising supply of private risk capital with time implies a growing managerial capacity. Further, the management is mostly independent (59% of funds) rather than strategic or government-dominated (unlike, say, China and Singapore) and the sources of funds are largely institutional, with a long-term focus. 2. The corporate structure—Trusts, limited liability partnership (LLP)s and limited liability corporation (LLC)s—is consonant with developedcountry corporate structure and is superior to the corporate form that predominates in East Asia, particularly in Korea and Taiwan. 3. 71% of the funds are headquartered outside India and 28% of the chief executive officers (CEO) of the funds are located in Silicon Valley, implying exposure to global standards.

Further, overseas respondents indicated a high interest in building a long-term presence in India. Studies by the U.S. National Venture Capital Association (NVCA) support this finding.13

142 Table 6.1

Rafiq Dossani and Asawari Desai Phases of growth of Indian risk capital Phase I

Phase III

Phase IV

1995–1997

1998–2001

2002–2005

30

125

2847

5239

8

20

50

75

Seed, Early-stage and Development— Diversified World Bank, Government

Development— Diversified

5

Pre-1995 Total Funds: ($ m) Number of Funds Primary Stages and Sectors Primary Sources of Funds Seed/early-stage ($ m) Number of Transactions Development ($ m) Number of Transactions Growth/maturity ($ m) Number of Transactions Total Number of Transactions Average Investment ($ m)

Phase II

Early-stage and Development— Telecom & IT Overseas Institutional

Growth/ Maturity— Diversified Overseas Institutional

15

657

250

10

20

273

58

25

110

2168.1

3107

20

45

273

288

21.9

1882

2

100

Government

30

65

548

446

1

2

5.20

11.75

Sources: TSJ Media, IVCA publications and estimates (various years).

In summary, the Indian risk capital industry consists of large funds that mainly invest in late-stage firms, favoring entrepreneurs emerging from or already in successful businesses. Nevertheless, several positive features may be built upon to create a flourishing, early-stage focused, risk capital industry.

6.4 Challenges with Domestic Markets: Size, Global Competitiveness, and Small Manufacturing Base Academic literature argues that startups do best when domestic markets are globally exposed and grow rapidly (Hobday, 1995).14 Domestic markets then become the primary source of learning for startups. For example, it is argued that a logistics firm such as Federal

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Express could not have been conceived outside the deregulated mail markets of the United States—for, how would a startup based in, say, Mumbai have become aware of the market opportunity?15 India has had slow growing domestic markets till recently. Claude Leglise, VP, Intel Capital responsible for managing Intel’s equity investments worldwide states that.16 “Intel Capital started investing in India with the same concept as China—that we would support domestic growth. I think it’s not over-positioning by saying that we were sorely disappointed. The domestic consumption and the ability to grow businesses to support domestic consumption just did not materialize. The businesses that have done well have been essentially off-shoring Western problems. So that was our late-1990s, early-2000 investment thesis. We retargeted it in 2001 and started looking for either export-oriented companies or product companies that had a measurable differential advantage. We’ve been lucky with a few and have seen a few that are quite interesting . . . But even if they start in India, they are immediately export-oriented. That’s their way to survive and grow. So it’s a different style compared to China.” Survey respondents corroborate the concern that domestic markets are not perceived to be attractive enough, either on their own or due to linkages with overseas markets. The reasons why Indian domestic markets constrain new business opportunities are several. They include a proliferation of low-end, low-growth services such as micro-retail outlets, a weak manufacturing base and policies that favor exports over production for domestic markets. The perception among risk capital providers surveyed corroborates the above, that is, that services offer higher returns than products and that export markets offer better opportunities for investment than domestic markets. Combined with the finding that late-stage firms offer higher returns than early-stage firms, these present significant disadvantages for investing in startups. There are, however, indications of a changing environment: 1. The competitiveness of exported services—in software and business process outsourcing (BPO)—is beginning to feed into the domestic services sector. Even as the share of services in total external trade rose from 19.3% in 1995 to 24.9% in 1998 (Banga, 2005, p. 9), foreign direct investment (FDI) inflow into India has increasingly moved toward services, accounting for 28.3% in the period 1995–1999 from 10.5% in 1990–1994 (World Investment Report, 2004)—mostly into telecom services, financial services, retailing and real estate for the domestic market (figure 6.1).17

Pharma/Life Science/Healthcare

Investors’ industry preferences

ICT Retail

Note: Preferences determined by weighted average. Source: Survey data.

Figure 6.1

0

10

20

% 30

40

50

60

Media & Entertainment

Manufacturing

Real Estate

Financial Services

Others

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2. Relative to its state of development, India has an advanced financial markets environment with the capacity to provide capital for secondstage growth.

6.5 Lack of Strong Domestic and Global Networks of Entrepreneurs, Financiers, Large Firms, and Research Institutes The academic literature on social networks identifies “social capital” as a key requirement for startups to innovate and grow. Such social networks offer information and risk-mitigation that is often crucial for startups. In Silicon Valley, for example, it is argued that social capital supports a tolerance for experimentation (and possible failure), provides a network of angel and other risk-tolerant investors, a network of research ideas through linkages with Stanford University and University of California, Berkeley, and opportunities to find the complementary members of a founding team. Silicon Valley’s success has been attributed to a vibrant network of “weak ties,” that is, opportunities for would-be entrepreneurs to interact with financiers, potential co-founders and fellow employees in settings such as meetings of professional associations. On the other hand, strong ties, such as close business associates and friends, have been found to be less useful for entrepreneurship than weak ties because of their overlapping domains of information. India does not have social networks as useful as Silicon Valley’s or even China’s. While the India-U.S. (particularly Silicon Valley) corridor is growing, it does not yet match the China-U.S. corridor, thanks in large part to the mediation provided by Taiwanese engineers and capital, which is of longer standing and is even an important source of capital for Silicon Valley startups. China’s location has made it a focal point for investment by firms in Japan and Korea, apart from Taiwan and Singapore. China’s dense social networks and manufacturing relationships with engineers, entrepreneurs and risk capital providers in Taiwan, Korea and Japan induces early-stage investment for onward supply to intermediate and final goods producers in East Asia. India, by contrast, does not have multicountry supply-chain relationships with the rest of Asia. As a result, spin-offs from large firms and university research, for example, are rare. Where networks are relatively strong, it appears that risk capital providers are more willing to invest. Thus, Bangalore is the most

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desirable destination for investment, arising from its entrepreneurial culture and location of the center of the ITES industry.

6.6 Challenges with the Operating Environment From figure 6.2, it appears that despite several policy initiatives to provide an appropriate regulatory and policy environment, this is still the major concern. In interviews, domestic risk capital providers noted that they were discriminated against relative to overseas risk capital providers, which could freely invest in overseas startups while they were still not permitted to do so (the regulations on this are being liberalized). Taxation emerged as of particular concern. There remain ambiguities on interpretation of the tax code (discussed later). Foreign risk capital providers noted that the regulatory costs of creating tax-efficient structures through favorable tax jurisdictions such as Mauritius were high due to the complexities involved. Respondents indicated that smaller, more startup-focused risk capital providers were particularly deterred from entering India by these costs. The high costs also deterred overseas high net worth investors from investing. The implications of these costs for innovation via SME investment are severe for countries like India since small VC firms and angels are often the primary source of learning for seed and early-stage firms.

Professional Services IP/Data Protection Corporate Governance Legal Systems University-industry Collaboration Policy/Regulation 0

0.5

1

1.5

2

2.5

3

3.5

1 = Worst, 5 = Best

Figure 6.2

The operating environment

Source: Survey data.

4

4.5

5

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The high costs of tax-efficiency, by becoming a barrier to investment, thus also become a barrier to learning. The simplest solution is to offer complete tax exemption to all foreign investors regardless of whether they avail of the Mauritius route or not. However, we recognize that this may raise concerns about the quality of funds. Hence, a partial solution is that SEBI could still register small funds and high net worth individuals, thus establishing standards for disclosure and operation, but that the income of these funds would be tax exempt in India so long as they invest in SMEs and the amounts invested aggregate to less than a threshold of, say, $20 m. Concerns about university-industry collaborations reflected concerns with both the lack of networks of entrepreneurs with university research as well as the lack of university research of adequate quality. Corporate governance is also a concern. One of its impacts is to shift investment away from startups where the risk of poor governance is relatively high (in mature companies, the effect on profits of poor governance is partly offset by a proven business model). The ability to grow the company, management skills, talent and ideas are not significant advantages. This suggests that entrepreneurs’ skills could be enhanced through training. A similar concern arises on entrepreneurs’ operational skills. Risk capital providers do not perceive any competitive advantages. However, a source of competitive advantage appears to be the quality of output. It appears that risk capital funds invest in Indian firms primarily because the quality delivered is competitive with respect to Asian competitors rather than global competitors or for other attributes of firms. In particular, innovation is not a driver of investment. Finally, there are concerns about the low domain expertise of risk capital providers (which may arise from the background of many in financial services rather than in operations). This raises the significant concern that raising risk capital becomes much less attractive to entrepreneurs if it is not accompanied by complementary skill sets such as market knowledge and domain skills. In summary, respondents identified the following causes for the shortage of early-stage risk capital: (1) Risk capital providers were found to be skilled at risk assessment and portfolio diversification, but lack technical skills and market awareness. (2) Entrepreneurs, though skilled at cost-control and technology, lack market awareness, product development skills, team building skills and global standards of

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professional and ethical behavior. Their social networks of professionals, incubators and prior-stage financiers is limited, leading to reliance primarily on brokers. (3) The pipeline of seed-stage firms “graduating” from angel investments or universities is limited. (4) Markets for listing early-stage firms and markets for complementary capital, such as debt finance, are underdeveloped. (5) Low standards of corporate governance, university research, university-industry collaborations, and intellectual property protection. (6) Unsophisticated and small domestic markets. (7) High bureaucratic, regulatory, legal and tax hurdles, including unclear rules and costly creation of tax-efficient structures.

6.7 Policy Analysis The complexity of the challenges makes a single policy or regulatory response inadequate. Instead, India needs a mix of appropriate policies and regulations. At the same time, the wrong choices could have adverse affects, for example, by crowding out private funding or reducing entrepreneurial incentive.

6.7.1

Public Funding for SMEs

Public funding for SMEs can have many goals: addressing the resource mismatch, the shortage of university-industry collaborations and the shortage of intellectual property. However, solutions need to be carefully chosen. For example, consider a program based on the principles of the U.S. Small Business Investment Corporation (SBIC) participating security (PS) program. This is a public-private partnership in which the state provides up to two-thirds of the finance to a private venture capitalist at a low interest rate, with provisions to defer interest and capital repayments until the fund earns profits. The intent of the program was to overcome a shortage of risk capital arising from the high risk-aversion of banks. The SBIC program allowed the government to absorb much of the risk. Such a program works best if it attracts venture capitalists who possess the skills to guide a new entrepreneur. If, however, the program attracts risk capital providers who lack such skills, then the provision of cheap money will result in a lowering of the threshold of return for investments, that is, money will go to projects with high risk and low return.

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The SBIC program has encountered both these situations. When the program was first introduced in the 1960s, there was, as noted above, a shortage of risk capital due to the underdeveloped condition of institutional finance. In consequence, the risk capital firms that came forward to begin SBICs were usually highly skilled and the SBIC program was considered very successful. However, after pension funds and other institutions were allowed to invest in venture capital from 1979 onward, skilled risk capital providers preferred to obtain institutional money rather than SBIC money because they could raise larger amounts with less bureaucracy. Those who turned to the SBIC program were the less-skilled risk capital providers. This resulted in large losses for the program. In recent times, poor investments due to the low quality of due diligence resulted in a loss of over $2 billion to the SBIC program between 2001 and 2004 and the PS program was finally discontinued in 2004.18 One way around the shortage of domestic domain expertise is support funds that are managed jointly with globally successful funds. Israel’s BIRD and Yozma programs did this successfully. Another way is to provide public funds to private risk capital managers who have successfully raised institutional finance. An alternative is to directly finance the entrepreneur. The government of India has introduced the Fund for Technology Development and Application under the Technology Development Board in 1996. This is based on similar programs in the United States such as the Small Business Innovation Research (SBIR) program and other countries. Such funds can perhaps also be given to commercialize university research. The United States has a successful program to do this Small Business Technology Transfer Program (STTR). To summarize, public funds could be provided in several ways, typified below: Type 1: Public funds provided directly to entrepreneurs for research, product development and university collaborations. To improve efficiency, independent reviewers from academia and industry could mediate the process. Type 2: Public funds, in partnership with private funds (Public Private Partnership PPP), invested in independent small ventures. Type 2A: PPP funds for global VC collaborations. Type 2B: PPP funds for domestic funds to leverage institutional finance. Type 3 (Default type): No PPP. Instead, public policy should support the development of institutional finance through regulation.

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An appropriate starting point is to support seed and early-stage entrepreneurs through public R&D funds (Type 1). Private funds should be supported with public money (Type 2) only if private financiers possess domain skills. Since identifying private funds with domain skills is difficult, Type 2 programs will usually fail if public money is allocated without qualifications. Such qualifiers could be: (1) The domestic fund allies with a reputable global fund (Type 2A), (2) The domestic fund receives institutional finance (Type 2B). The growing maturity of institutional finance in India suggests that this might be a viable approach, (3) The determination of which domestic VC funds to support should be a nonbureaucratic process, perhaps involving scientists, technologists, academics and private sector representatives. Further, in order to preserve entrepreneurial incentive, PPP funds should be invested in independently owned ventures rather than be invested in the fund’s subsidiaries, if any, within which portfolio companies reside (as in Taiwan). In the long-term, private funds should be funded with institutional finance, such as pension funds. This should be supported through regulation that permits prudential investment in risk capital funds (Type 3).

6.7.2

Enhancing Investors’ Rights

Globally, investors’ standard practices are to own minority stakes (thus keeping entrepreneurial ownership and incentive high) and to exercise operational influence through membership of the board, of whom the majority are independent board members. In the absence of board membership, investors’ usually seek information rights, such as the right to attend board meetings and to exchange information with officers and board members. Second, investors obtain contingent rights that are triggered by certain outcomes, such as anti-dilution rights in the event of new rounds of financing. These rights are usually part of the terms of financing. In India, however, the low standards of corporate governance pose problems. Respondents reported that holding board seats and minority shareholdings, even when the majority of the board consists of independent directors, were inadequate for influencing startups. Second, since corporate law restricts the tenure of a convertible security to eighteen months, the rights attached to the terms of financing are not exercisable for longer-dated events. This may be improved by enabling long-dated convertible securities with the flexibility to allow disproportionate rights relative to economic interest. Note that

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the J.J. Irani committee under the Ministry of Company Affairs has recommended the enabling of perpetual preference shares.

6.7.3

Regulatory Recommendations

The present venture capital rules in India represent a serious effort to bring the operating environment for venture capital close to global best practice. When they were initially drafted, the intent was to approximate key features of the U.S. model, notably tax pass-through. Some restrictions, such as on the percentage of listed investments, were needed in order to prevent such funds behaving like hedge funds. Other restrictions, such as on the share of a single investment in the total fund, were intended to protect passive investors. With time, the venture capital industry has matured. However, the policy and regulatory structure have not kept pace. Despite a generally pro-investor policy framework, key problems remain. First, by requiring certain kinds of institutions to be established, such as a trust and asset management company, and specifying capitalization floors, policy tacitly favors institutional investment versus individual investment. While this approach is suitable for passive (portfolio) investment, it is not suitable for investment in innovative startups. Such firms require small, staged investments that might accumulate to less than a million dollars in the first two years along with active, operational involvement by the investor. This is typically the domain of angels and small venture capital funds, which are deterred by these regulatory requirements. Further, once invested, the funds are not fungible globally, whereas it is in the nature of innovation that skills be located globally. For example, if the startup needs to hire a technical consultant to solve a specific problem and if that consultant is only available overseas, the funds cannot easily be transferred overseas for such work. Second, while the policy infrastructure is designed to mimic a globally acceptable set of standards, it is not yet simple enough. For example, while tax pass-through has been accepted as a policy goal for institutions that manage money on behalf of passive investors, its implementation through SEBI regulations includes portfolio restrictions that deter investors. The recommendations to simplify the current rules and regulations are as follows: ●

Recommendation 1: Enable the creation of limited liability corporations (LLCs) through an amendment on redeemability under the Companies

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Rafiq Dossani and Asawari Desai Act; extend the applicability of the proposed limited liability partnership (LLP) structure to risk capital funds. Implementing this recommendation will simplify the tax environment and bring it on par with best global practice. Recommendation 2: Accreditation of Overseas Investors. 䊊

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High net-worth investors, often called “angel investors,” can play an important role in early-stage firms by providing professional guidance along with risk capital. In the United States, angel investments by accredited investors often matches that of investments made by venture capitalists. Angel investments for 2003 were approximately $18.1 billion in 42,000 deals, as against a total investment of $18.2 billion in VC funds (Kauffman Foundation, 2004). The high costs of establishing an overseas venture capital fund in India is a serious deterrent, as we have seen, to the establishment of even small (below $50m) funds. It is a bigger deterrent still to overseas angels who are usually nonresident Indians with the skills that domestic entrepreneurs need. Accreditation by SEBI should offer individuals the same rights as registered VC firms. Further, such individuals should be offered tax pass through.

Recommendation 3: Modifications to SEBI VC rules. 䊊

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Under SEBI’s VC rules, there are restrictions on the securities that may be invested, such as that no more than 33.33% of the fund may be invested in listed securities. No more than 25% of a firm’s corpus may be invested in a single firm. These limits reflects past concerns that registered funds might use SEBI registration to realize tax pass-through while using their funds to invest in affiliated or listed companies. As long as investment are made in independent, unaffiliated ventures, which is, in any case, a requirement of the current rules, these concerns will not arise. Hence, we recommend the removal of the current restriction on firms and sectors. The removal of restrictions on listed firms’ securities is important in the Indian environment. In India, by virtue of its past history of favoring listing in order to obtain debt capital, a large number of small corporations are listed. Many of these are ideal candidates for private equity and even venture capital, although typically, these will not be early-stage firms. However, as there may remain a concern that capital providers might behave as hedge funds and pick up large secondary market shares in order to influence management, we recommend a limit of 33.33% of the corpus on securities purchased in secondary markets. The removal of the prohibition on overseas investment by DVCFs is important because it gives domestic fund managers opportunities to learn from more advanced environments as well as leverage Indian

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skills in both more and less advanced environments. Note that this recommendation has also been made by the 2004 Lahiri Committee under the Ministry of Finance and is awaiting implementation. The removal of the minimum capitalization requirement ($500,000) for Indian subsidiaries of foreign funds is needed to encourage small funds to supply risk capital. As discussed earlier, such funds are a very important channel for the flow of domain knowledge.

Recommendation Harmonization. 䊊

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Clarification

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The rules of RBI for foreign investment, of the Central Board of Direct Taxes and of the Ministry of Company Affairs need to be harmonized with the SEBI VC regulations and some of SEBI’s rules need to be clarified.

6.8 Conclusion This chapter showed the importance of risk capital for SMEs in India and how institutional barriers hamper access to such risk capital. The barriers include regulatory barriers that raise transaction costs and ineffective policy mechanisms for reducing the risk of early-stage risk capital. For our recommendations, we focused on two types of public policy responses to the problem of the shortage of early-stage risk capital: regulatory responses (i.e., better rules of the game) and risk-alteration through public support for startups (such as through public-private partnerships). We also argued for careful, integrated and sequenced design. The key recommendations dealt with the design of public funding for SMEs, focusing on investor’s rights and clarifying the rules of investment. The objective of the recommendations are to preserve capital flow while not distorting incentives or crowding-out private initiative, thus aligning capital flows with investors’ economic interest, while minimizing transactions costs. See Appendix for glossary of terms.

Appendix: Definitions 1. Risk capital: Capital whose returns are not guaranteed by contract. Risk capital is hard to measure though easy to define. Risk capital is defined as capital in which repayment of the principal and expected return on capital are at least partly uncertain. Measurement issues arise because contractual certainty does not mean that capital is risk-free. For example,

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banks’ working capital loans to small firms often carry a high element of risk even though they are contractually safe. Long-term loans are even riskier. Hence, many bank loans may be considered risk capital. For our purposes, risk capital is defined as that which is contractually uncertain. This includes equity, whether external, private, listed or internal, as well as capital whose return is partially linked to uncertain outcomes, such as optionally convertible debt. For SMEs, the primary measure of risk capital is private equity, both internal and external—although there will be cases that we will consider where public equity is also relevant risk capital for SMEs. For the difference between venture capital and private equity, see below. 2. Stages of risk capital provision:

Seed/startup: Formalization of concept up to proof of concept. Early Stage: Proof of concept up to preparation of a marketable product/ service. Development: Preparation of marketable product/service to recurring revenue generation. Growth/maturity: Post-revenue to maturity. 3. The difference between private equity and venture capital. Private equity is risk capital invested in listed or unlisted firms that are in the growth/maturity phase and need capital to realize various efficiencies, through consolidation or tax-efficiency (such as via leveraged buy-outs), or to implement a new marketing plan, such as going global. Venture capital is risk capital invested in listed or unlisted firms that may be in seed, startup, early, development, growth or maturity stages and need capital to develop their products, services and other aspects of operations. The two types of risk capital overlap in mature firms where risk capital may be needed for both operational development and marketing. The above includes both risk capital and private equity. 4. Small and medium enterprises (SMEs): Global definitions vary, the Indian definition of small firms (small scale industries) is firms with fixed asset size up to Rs.10 million. World Bank definitions are based on employment: 1. 2. 3. 4. 5.

Microenterprises: less than five employees. Small enterprises: 5–20 employees. Medium: 20–50 employees. Large: 50–250 employees. Very large: Greater than 250 employees.

Notes 1. http://dnbsame.com/news/SmeraLaunch.htm. 2. SEAF (2004), “The Development Impact of Small and Medium Enterprises: Lessons Learned from SEAF Investments,” Report, Small Enterprise Assistance Funds.

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3. HM Treasury (2003), “Bridging the Finance Gap: Next Steps in Improving Growth Capital for Small Businesses,” Report, UK Treasury Department. 4. Cull, R, L, Davis, N. Lamoreaux and J-L. Rosenthal (2005), “Historical Financing Of Small-And Medium Sized Enterprises”, Working Paper 11695, National Bureau Of Economic Research Working Paper Series, http://www. nber.org/papers/w11695; and Dossani, R., & Kenney, M. (2002), “Creating an Environment for Venture Capital in India” World Development, 30:2: 227–253. 5. Bhide, A. (2004), “What Holds Back Bangalore’s Businesses.” Working Paper, Columbia Business School. 6. Utz, C. (2005), “Early Stage Enterprises, Position Paper, Australian Venture Capital Association,” http://www.avcal.com.au/ftp/press/ESEsMay2005final. pdf. 7. Venture Impact. (2004) Report: National Venture Capital Association. www. nvca.org/pdf/Venture_Impact_2004.pdf, downloaded October 20, 2008. 8. Kumar, R., & Worm, V. (2004), “Institutional Dynamics and the Negotiation Process: Comparing India and China.” International Journal of Conflict Management 15:3: 304–334. 9. SEBI (2000), “Chandrasekhar Committee Report,” www.sebi.gov.in (accessed June 3, 2008). Dossani & Kenney (2002). 10. Dossani, R. (2007), India Arriving. New York: AMACOM Books. 11. Da Rin, M., Nicodano, G., & Sembenelli, A. (2005), “Public Policy and the Creation of Active Venture Capital Markets, Ecb-cfs Research Network on Capital Markets and Financial Integration in Europe.” European Central Bank, Working Paper Series No. 430. 12. Venture capital commenced in India with the formation of TDICI in the 1980s. Regional funds such as GVFL and APIDC were setup in the early 1990s, with Government funding. The mid 1990s saw the advent of Foreign Venture Capital funds primarily focused on developmental capital without any sectoral focus, driven by opportunities. Post the success realized by these funds, there was an emergence of a number of India-centric foreign VC firms. Currently there are a number of large funds whose focus is buyouts and PIPEs. 13. Deloitte and Touche—NVCA (2005), “Global Venture Capital Survey.” April. According to the survey of 545 venture capitalists, 20% of U.S.-based respondents plan to increase their global investment activity over the next five years, up from 11% currently investing abroad. The countries of greatest investment interest over the next five years are China (20%), India (18%), Canada/Mexico (13%), Continental Europe (13%), Israel (12%) and the United Kingdom (11%). 42% of respondents plan to invest abroad only with other investors that have a local presence; 39% plan to develop strategic alliances with experienced foreign-based venture capital firms; and 30% plan to open satellite offices in select regions globally. 14. Hobday, M. (1995), Innovation in East Asia: The Challenge to Japan. Cheltenham: Edward Elgar. 15. At the same time, it is important to understand that mature or protected domestic markets usually offer little scope for growth. For example, electric utilities,

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water utilities, and the supermarket have not been recent hotbeds of innovation in developed countries because of universal access and low growth rates. 16. Leglise, C. (2004), quoted in “Ernst and Young Global Venture Capital Report,” p. 69. 17. It is surprising, however, that the share of employment in services has not kept pace with its contribution to GDP, accounting for 28.5 of employment in 1999–2000. Banga R. (2005). “Critical Issues in India’s ServiceLed Growth,” WP 171, ICRIER: Delhi, p. 17 and World Investment Report (2004). Report: UNCTAD, downloaded October 20, 2008. http://www. unctad.org/Templates/webflyer.asp?docid=5209&intItemID=2983&lang=1. Part of the reason is that some modern service sectors such as IT services have very high productivity relative to the rest of the economy. 18. Miller, S. (2006), Personal Interview with Rafiq Dossani (one of the Authors of this chapter), February 13, 2006. The PS program was discontinued in 2004 and replaced with a program that provided up to two-thirds of the finance with deferred capital payments only.

7 Understanding Indians in a Global Era Alan Roland

7.1

Introduction

Over twenty-eight years ago, I first went to India and then to Japan on a clinical psychoanalytic research project. I found significantly different configurations of the self from what I had encountered over the years in a wide variety of Euro-American patients in New York City. I formulated this as a familial self—in India a familial/communal self and in Japan a familial/group self—with various subcategories, in contrast to a Northern European/North American individualized self. I further found that to understand the Indian and Japanese familial self I had to relate it to their indigenous sociocultural patterns, particularly to the extended family, to three psychosocial dimensions of their hierarchical relationships, and to insider and outsider relationships (Roland, 1988). I later realized that much of the rest of the world has one variation or another of the familial self, that it is primarily the Northern European/North American culture area in modern Western history that has developed the individualized self (Roland, 1996).1 I shall first summarize Indian social contexts and then delve into various dimensions of the familial self as related to the extended family and hierarchical relationships. I shall further detail central assumptions of personal destiny, reincarnation, and karma (a complex concept indicating the effect of any action upon the doer, whether man or god, in the past, present, or future life) with the use of astrology, palmistry, psychics, and such to know one’s destiny. I then delve into assumptions of a spiritual reality within that takes effort to realize, and the various paths to it. I explore issues of social change among the large

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numbers of urban educated, particularly the role of women, and not only the new opportunities but also conflicts that social change generates. Finally, I comment on managerial relationships.

7.2 Extended Family, Hierarchical, and Insider/Outsider Relationships The extended family remains dominant whether Indians are living in a unitary or joint household. It is the locus of an Indian’s psychological life for both men and women. The ideals of family honor and reputation, cohesion, harmony, and proper behavior and fulfillment of duties dharma (the traditional established order, which includes all duties—individual, moral, social, and religious; determined by contextual factors such as stage in the life cycle, particular hierarchical relationships, caste, and individual temperament) come first over individual strivings, and help contain the not infrequent conflicts. The family value system or culture is very much tied into the particular community the family is part of, from which marriages are usually arranged. In the family, three psychosocial dimensions of hierarchical relationships prevail. These dimensions are extended to other relationships outside of the family as well. The first psychosocial dimension is the formal hierarchy based on age and gender, where there are culturally internalized expectations for reciprocity. The subordinate is to be deferential, loyal, and obedient to the superior, while the latter is to be nurturing and responsible to the subordinate. This is different from Western contractual relationships of responsibilities and obligations. For instance, the deference that an Indian will display toward a superior is not infrequently misunderstood in the United States as passivity. On the other hand, if an Indian superior does not come through with the expected nurturing and caring, subordinates whether in the family, educational institution, or workplace may become deeply resentful. The second psychosocial dimension is hierarchical intimacy relationships where there is considerable emotional intimacy, affection, enhancing of each other’s esteem, and interdependence. Emotional intimacy usually is present in family, friendships, and other long-standing groups. The formal hierarchy is more male oriented while hierarchical intimacy relationships is more female centered (personal communication, Nandita Chaudhary). The third psychosocial dimension is hierarchy by personal qualities where persons with superior qualities are

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idealized or even venerated regardless of where they are in the formal hierarchy. Thus, a younger brother, wife, daughter, or servant may be silently more respected than others who are their superiors, although they will still show deference to the superior. Formal hierarchical and hierarchical intimacy relationships may change over a period of time. For a newly married woman, the relationship with her mother-in-law is initially governed more by the formal hierarchy. However, after a period of time, especially after a child is born, although the social etiquette of the formal hierarchical relationship is still observed, there usually occurs a much greater emphasis on the intimacy relationship. In organizations, as well as families, junior members may display abilities that are greatly valued. Although they must still defer to their superiors and be obedient and loyal, they are often given responsibilities well beyond those of some of their superiors. Westernizing influences can sometimes complicate the subtleties of these hierarchical relationships and cause difficulties. In one case, a modern software company called in a management consultant because few of their younger members were staying on after their training period was over. The consultant found that the manager in charge of their training was doing a good job but was also trying to establish more equal intimacy relationships with them by being quite chummy and sharing his own problems. This interfered with their need to idealize him as the strong superior. Once his behavior changed, the situation righted itself (personal communication, Sushma Sharma). Insider relationships refer to those relationships within the extended family, friendships, or even in other long-standing groups, while outsider relationships are with those often known only superficially. More consideration and care is given to others in insider relationships, where there is a reciprocal expectation of being cared for by others, than in outsider ones. When the reciprocity is not observed, this can generate considerable anger. This is present with variations in all Asian cultures. In outsider relationships, Indians often try to convert them to insider ones in contrast to East Asians from Confucian cultures, or they may be manipulative and exploitative. Indians will try to pull any significant relationship they have with another into the insider relationships of the extended family, which makes it relatively easy for an outsider or foreigner to enter an Indian family. One tries to have dealings only with someone you or a close associate knows, otherwise they might not be trustworthy.

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When Indians try to convert outsider to insider relationships in America, there often can be considerable misunderstanding on the part of Euro-Americans. I shall discuss this further below. This can also be true of Northern Europeans. In the conference at Aarhus on “Understanding Indians,” it was informally related that one of the problems that Danish corporate managers had with their Indian counterparts was that the latter seemed to want more of an intimate relationship than the Danish were accustomed to. The latter were used to “business being business,” and not particularly used to have a personal relationship with one’s business client. Indians, on the other hand, once a business relationship was established, wanted it to be on a more friendly, intimate basis.

7.3 The Familial Self When the self is described in the Northern European/North American culture zone, it is implicitly an “I-self,” in I and you relationships, although this is rarely reflected upon. In contrast, Indians and other Asians have more of an experiential “we-self,” one that is deeply identified with the family and with others in various emotionally interdependent relationships. The we-self fluctuates experientially depending upon the relationship. It is therefore highly contextual. There is more of an ability to live with inconsistency and dissonance than tends to be characteristic of most Westerners. I was struck by the thoughts in a session some years ago by a South Indian woman artist living in New York City. “Americans seem to have to be one thing. I and my Indian friends are able to be many different kinds of persons in different situations. I feel very comfortable slipping back and forth from being a professor to being a painter to being a mother and wife. I can’t understand these American women who are conflicted between having a career and a family. I don’t have to be one set self or have a single identity. In fact I avoid like the plague having a set identity.” Another view of the Indian self is that it has a dual self-structure, in a variation common to other Asians and written about by Takeo Doi2 on the Japanese. On one hand there is the contextually experienced we-self in intimacy relationships with a more social presentation of self that observes the social etiquette of formal hierarchical relationships, which are also highly contextual. This is counterbalanced by a highly private self that keeps all kinds of thoughts, feelings, and fantasies to oneself that are inappropriate to the etiquette

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of the formal hierarchy, as well as to maintain an inner sanctuary so as not to be engulfed in the closely interdependent intimacy relationships. The ability to keep all kinds of thoughts and feelings secret goes far beyond what most Euro-Americans are capable of. One of my patients in Bombay reported keeping secret from her Indian therapist for a year-and-a-half two of her most salient inner struggles and conflicts because she sensed he would be judgmental about both of them. No Euro-American patient I have ever had could do this, they would either leave therapy or confront the therapist. Related to this dual self-structure are different ego boundaries from Western ones, where the outer boundary between self and other is less distant and more permeable but an inner boundary is more private. Thus, Indians can become semi-merged in their hierarchical intimacy relationships but keep their self well intact through a firmer inner boundary. I have emphasized the we-self as being highly contextual in both intimacy as well as formal hierarchical relationships. The Indian conscience, in terms of its ego-ideal, is also very contextual. Proper behavior or dharma is greatly dependent upon the time, the place, the community to which you belong, the nature of the hierarchical relationship, and the natures of the persons involved. What is proper for one relationship may not be so for another, so that one may say different things about the same matter in different situations. Indians are highly attuned to others’ expectations and what is appropriate in different groups. Behavior in one situation may vary greatly from another without any inner experience of dissonance. The universal is to be avoided. Ramanujan3 discusses this at length. The superego on the other hand is extremely restrictive over the expression of any anger, criticism, or ambivalence toward a superior. Indians may be very angry toward a superior over what the superior has done but will not express it verbally rather manifesting it through looks, behavior, emotional withdrawal, self sabotage, or simply taking it out on someone lower in the hierarchy. Besides this being part of their conscience, there is also the fear of the superior withdrawing his or her support if anger is expressed. We-self esteem is central to Indian relationships, as it is to other Asian ones, and is more salient than in Northern European/North American relationships. Both superior and subordinate try to maintain and enhance the esteem of the other. It is also very much related to the honor and reputation of the family, where a great deal of one’s esteem derives from family reputation and where one is constantly

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trying to reflect well on the family. The centrality of we-self esteem emerged with a patient who was doing a medical fellowship in her specialty in New York City. She contracted with the director of the program to attend part-time for three years instead of full-time for two years to spend more time with a young child at home. Instead, the director pressured her to work much longer hours and to repeat rotations. Instead of being angry at the exploitation and abrogation of their contractual agreement, she kept angrily repeating in session that he doesn’t respect her. Her esteem was more central. She eventually went above him to correct the situation. Many Indians I have talked with who are working or being educated in America have difficulties with maintaining their esteem in American hierarchical relationships. This is true of other Asians as well. They suffer considerable blows to their esteem from the directly critical and confrontational style of American superiors, whether professors or bosses. When this happens, most of my Indian patients do not work well. They feel much less of the devotion and loyalty to the superior than they would characteristically. They almost never directly confront their superiors but rather become noncooperative and therefore accomplish much less. In one instance in an Indian company, the junior managers simply withheld important data from a senior manager whom they felt had not treated them well. Although it is recognized in Western management theory that difficult supervisors affect the workplace adversely, my impression is that Indians are even more affected. I often counsel them to try to change managers or supervisors in these circumstances if at all possible. There is another highly subtle psychological aspect that is quite foreign to Westerners. Indians in their dependency relationships will ask a great deal of another, enhancing the other’s esteem as the superior who can give. Thus, dependent asking is a subtle giving. Although this kind of psychology is present in all Asian insider relationships, Indians will also do it in outsider relationships trying to convert the outsider relationship to an insider one. Most Euro-Americans experience this as an infringement on their autonomy and can become quite resentful. My wife related an example of this when an Indian student approached her to ask permission to take his final exam a week earlier as his family was leaving on vacation for India before the final exam. She agreed. The next day he came to her and said he had approached two of his other professors with the same request but they had refused. He then asked her to speak to his other professors to get them to change their mind. My wife was by then well aware of

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this psychology and politely told him it wasn’t possible. But she was also aware that her other colleagues would respond in a very negative way to this last request. Another important facet of the familial self is the modes of communication. A great deal of Indian communication is nonverbal through the sensing of moods and feelings, facial and body gestures, and actual behavior. Verbal communication is also very present but it may be quite ambiguous at times. Thus, Indian communication is multilayered and highly complex. I have heard Indians complain that they did not know what the other person really meant. At other times, wants are expressed in such subtle ways that one does not realize until later that one did exactly what the other person wanted but never asked directly. Reliance on empathic attunement is very strong although not always present. Indian cognition in certain ways differs considerably from Western universal and dualistic thinking.4 Again, the contextual is greatly accentuated such as in ethics, music, and time. Reality is seen on a monistic continuum rather than the Western mind-body, spiritualmaterial, and other dualistic categories. An Indian mode of metonymy plays a major role in this monistic continuum. Thus, a statue of a goddess or god is not a symbolic depiction but rather a partial manifestation. Indian cognition is further oriented toward ambiguity5 that easily reconciles different kinds and levels of reality such as astrology and science. Thus, to this day important Indian scientists and mathematicians may be involved in astrology, palmistry, and such without experiencing any dissonance. The transcendent and the mundane are more closely related in Indian ways of thinking than in most of the modern West. What is highly dissonant to the Western mind, or what may be labeled as superstitious, or what is considered to be unbreachable dualities, to the Indian mind may simply be different levels of reality along a monistic continuum. Apparently, some Indians think that the considerable contributions to computer technology by Indians is not so much based on mathematical skills as on thinking in ambiguity (personal communication, Rajen Gupta and Satish Kalra). Another issue of the familial self stems from social science contributions on collective societies as contrasted to individualistic ones. There is an implicit assumption that those from collective societies that are not oriented toward individualism have less individuality. Not so, according to two Indian psychotherapists who have lived in the United States (Madhu Sarin, a psychoanalyst now in New Delhi who lived in New York City, and Rashmi Jaipal, a psychologist from New Delhi

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who now lives in New York City). They both see their Indian friends as having decidedly more individuality than their American ones. I believe the issue is one of unreflectingly equating individuality with autonomy. There is no question that Euro-Americans are granted if not imposed upon considerable more autonomy in life’s choices than Indians have. They are brought up to function more independently. But individuality does not derive so much from autonomy as from empathic resonance and acceptance of inner states of mind. That seems in more abundant supply in India, together with an acceptance of all kinds of thoughts and ideas, as long as one observes the social etiquette of the formal hierarchy and family needs. I should say a few words about Indian child rearing in the ways it differs from the Northern European/North American culture belt. First, there is multiple mothering to a greater or lesser extent in the Indian extended family where the mother-in-law and other in-law women as well as women from the mother’s own family, servants, neighbors, and increasingly the men of the family all partake in child rearing. The mother still remains central but the other women play important roles in the child’s life. In infancy and early childhood, child rearing is more symbiotic and interdependent than in Northern Europe/North America. Rather than firm limits being set on toddlers, they are distracted from doing what is not permitted or is dangerous. Around the age of four or five, there begins a severe crackdown for proper behavior in the formal hierarchy that lasts through adolescence. This may begin with the mother but other family members join in. Shaming may be used but not in a way that makes out that the child is a bad person but rather is reflecting badly on the family (personal communication, Zeynep Catay).

7.4 Personal Destiny and the Magic-Cosmic World A central assumption of Indians is that there is personal destiny in everyone’s lives, that this destiny is played out over more than one life (reincarnation), and that what you have done and experienced in past lives will influence this one karma and samskaras (impressions or psychic traces remaining in the mind after an experience in the current or past life, indirectly influencing one’s acts and thoughts), and so on into the future. A further assumption is that one can get glimpses of this destiny through astrology, palmistry, psychics, dreams, observing

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patterns in one’s life, and such. And that destiny may also be altered through following certain rituals, pilgrimages, and such. In my experience, although certain predictions have been made, the person still exerts considerable efforts to fulfill what she wants. A woman doctoral student in her early thirties in New York City, who held a high position in one of the ministries in New Delhi, consulted me about her tremendous anxiety over not being married. She had foregone an arranged marriage in her early twenties to pursue graduate work for a career. Then, when she was ready to be married, her father died and her older brothers did nothing to help, which left her feeling embittered. The one ray of hope was repeated predictions from astrologers and palmists that she would have a very late but very good marriage. What made the marital quest more difficult for her was that her mate had to have a special educational background so that he would fit into her high government social circle: an elite boarding school in India and a college education at Oxford or Cambridge in England. She spent a great deal of time and exerted considerable effort with a friend to place marital ads in the local New York City Indian newspapers, interviewing a number of men. Nothing worked out. A couple of years later after she had stopped therapy, I ran into her at Columbia University. She was indeed married to someone who met all of her qualifications. She had fortuitously met her husband on a flight to Buffalo. With almost all of my Hindu patients, all of them highly educated, I have found that issues of personal destiny with the use of astrology, palmistry, or psychics have played an important role in their lives.6

7.5

The Spiritual Self

There is a further assumption among Indians of a spiritual reality within themselves but that one must make efforts in order to realize it. As one Muslim woman patient said in Bombay years ago, “I know if I get up at 5 a.m. every morning and pray to God, I shall eventually see Him. But with four small children I am just too tired to get up so early.” Although most Westerners involved in an Indian spiritual discipline tend to gravitate to one or another form of meditation, most Indians pursue a devotional path of worshipping one or another of the gods or goddesses through prayer, ritual, and such. The prolific mythology also connects the transcendent with the mundane and is more the realm of women, while men gravitate to philosophy. Although Western social scientists and psychoanalysts have

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tended to follow Freud in reducing spiritual experiences to the early mother-infant egoless experience, my observations are that those who are involved in a spiritual quest become more individuated from the tugs and pulls of emotional merger with others. Or one can say, that the normal mergers of insider relationships are handled with much greater equanimity. It is the opposite of what Freud postulated. This doesn’t mean that some highly spiritual persons are devoid of emotional problems. Mental health and involvement in a spiritual quest tend to be on two independent but interacting continua.7

7.6

Social Change in the Urban Educated

Over the last thirty-plus years that I have been involved in research in India, I have observed certain changes in the middle and upper-middle class, upper caste, urban educated. There are a tremendous number of boys and girls going to college, the latter doing as well or better than the boys, many of them going on for postgraduate work, and increasingly into well-paying jobs of equal pay. As the urban middle and upper-middle classes have grown to approximately 300,000,000 people, they have become increasingly individualized. While only a few decades ago, all decisions from education to marriage were made by the family, now there is increasing consultation with boys and girls on what they want. Marriages have progressed from the family making all arrangements with little say on the child’s part to marriage by introduction where they meet each other and then decide, or to marriage by the child’s choice of mate with family approval. Since women have become increasingly economically independent, they now want adjustments in the formal hierarchical relationships with their in-laws and husbands. This then instigates changes in these relationships but also conflicts. It is only in the last twelve plus years that there is an increasingly escalating need among the urban educated for counseling and psychotherapy.

7.7

Managerial and Organizational Implications

Over the last two to three decades, there has been an increased questioning of the relevance and value of American and Japanese management theories for the Indian workplace.8 The highly individualistic cultural value systems of America with its contractual relationships, egalitarianism, and organizational impersonalness do not fit well

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with the Indian familial-communal self and their kinds of hierarchical relationships. Nor does the Japanese model work well either where familial values and attitudes are carried over into their organizations through the iemoto master-disciple relationship. Indians are still very much oriented toward the extended family being the psychological locus of their lives and so have much less loyalty to the organization. Instead, these theorists have called for Indian managers to consciously institute familial values and attitudes to the organization through more personalized, caring relationships; a more sympathetic, nurturing father-figure; affiliative relationships with openness, trust, collaboration, and such; and tasks and roles clearly spelled out. When this is implemented, worker satisfaction and productivity increase considerably. A second approach to Indianize the workplace is to bring Indian spiritual culture into organizational life as it is in Japan. This approach has been implemented by S.K. Chakraborty.9 He presents Vedanta and Sankyan philosophy in a relevant, modern way to managers, and schools them in the practical use of simple yoga and meditative exercises. Through personal self-transformation, they become better able to handle any emotional turbulence or conflicts among the workers and between themselves. There can also be problems particular to Indian organizations. It is well known that Indian families not infrequently split up when the brothers, who inherit equally, do not get along. This can also be true of a family business or even in an organization where the brothers are more symbolically related. In the former category, an instance I have encountered has been of an oldest brother who was forced out by two younger brothers from a highly successful family business that he had done most to help develop. This occurred after their father had become seriously ill and was no longer the active hierarchical superior. It was fueled by the younger brothers’ tremendous envy of the oldest brother because the father had greatly favored him, giving him a much better education and arranging a more prestigious marriage. The takeover of the business resulted in it going seriously downhill. In the latter category of organizations, I have observed essentially the same process. A symbolic younger brother forced out a more competent and gifted older brother, who had helped him advance in the organization. Again, it was done out of tremendous envy of the other’s talents, successes, and recognition. This only could occur when leaders of an English organization, which had played a major educational role with the Indian organization, undermined the formal Indian

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hierarchy. With the best of intentions, the English leaders elevated some of the more competent junior members over the less competent senior members, valuing competency over age and seniority. This resulted in many of the senior members withdrawing from the organization, thus opening the gates to warfare among the junior members. When the symbolic younger brother won out with the help of other junior members, he took over and what had been a dynamic, developing organization became moribund. It is clear from both instances that the formal hierarchy plays a major role in holding together Indian organizational life. Other problems in male hierarchical relationships emerged from participating in psychoanalytically oriented group and individual sessions with Indian managers in a highly successful, mid-size Mumbai firm. This consulting approach was instituted by Udayan Patel, a Mumbai psychoanalyst, and was considered by the founding director of the company to be more helpful than any other form of management training or consulting that he had tried. The first factor that struck me was that both in the group and individual sessions, the managers were remarkably open and nondefensive, very trusting of Mr. Patel and myself, and of the process. They clearly saw us as caring, helpful facilitators, having their best interests at heart, something I doubt would have occurred so easily in a Western organizational setting. The managerial problems that emerged centered around three junior managers who perceived their senior manager to be very selfinvolved and uncaring of them. Each in his own way had become uncommunicative and uncooperative with him, to the extent of withholding important data he needed. The senior manager, in turn, was very angry at their sabotaging his efforts. As we delved into this in the group and in subsequent individual sessions, it became apparent with both the senior manager and the three junior managers that their problems were directly related to very difficult father-son relationships in their own family. The senior manager had an excessively controlling father who disinherited him when he moved his family away from their joint household. He held in a great deal of anger and anxiety. Each of the junior managers had critical fathers with whom they coped by various forms of noncooperation, never by any direct communication. I highlight this because so much of the psychological literature in India focuses on mother-son relationships, although the father-son or male hierarchical relationship, has much greater relevance for managerial relationships in Indian organizations.

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Notes 1. Roland, A. (1996), Cultural Pluralism and Psychoanalysis: The Asian and North American Experience. New York and London: Routledge. 2. Doi, T. (1986), The Anatomy of Self: The Individual versus the Society. Tokyo: Kodansha International. 3. Ramanujan, A.K. (1990), “Is There an Indian Way of Thinking?: An Informal Essay,” in McKim Marriott (ed.), India through Hindu Categories. New Delhi, London: Sage, pp. 41–58. 4. Ibid. 5. Egnor, M. (1980), “Ambiguity in the Oral Exegesis of a Sacred Text: Tirrukovaiyar.” Unpublished paper. 6. Roland, A. (1988), In Search of Self in India and Japan: Toward a Crosscultural Psychology. Princeton: Princeton University Press. 7. Ibid. 8. Dayal, I. (1977), Change in Work Organization. New Delhi: Concept. Gupta, R. (1991), “Integrating Employees and Organizations in the Indian Context: The Need for Moving beyond American and Japanese Models.” Political and Economic Monthly, May. Sinha, J. (1980), The Nurturant Task Leader: A Model of the Effective Executive. New Delhi: Concept. Sinha, J. (1988), Reorganizing Values for Development. In D. Sinha & H.S.R. Kao (eds.), Social Values and Development: Asian Perspectives. New Delhi: Sage. 9. Chakraborty, S.K. (1987), Managerial Effectiveness and Quality of Worklife: Indian Insights. New Delhi: Tata McGraw-Hill.

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8 Negotiating in India: Does Brahmanical Idealism Play a Constraining or a Facilitative Role? Rajesh Kumar

8.1 Introduction India is now emerging as one of the giants of the twenty-first century. Economic reforms initiated in 1991 have created the foundation on the basis of which the Indian economy has exhibited, and continues to exhibit, a remarkable dynamism. Analysts estimate that India will grow at a rate of 8% per annum till 2020. One key implication of this is that the Indian economy will surpass that of Italy, France, and the United Kingdom by 2017.1 The acceleration of growth in India is paralleled by greater involvement in the world economy. Analysts note that foreign direct investment (FDI) in India has increased from US$100 million in 1990–1991 to US$19.5 billion in 2006–07. 2 Similarly the ratio of trade (goods and services) as a percentage of gross domestic product (GDP) has increased from 16% in 1990–1991 to 49% in 2006–2007. 3 A heightened sense of optimism has also emerged in Indian industry. Many Indian companies are aggressively pursuing overseas acquisitions. Tata Steel has bought Corus, with Tata Motors having recently been successful in the acquisition of Jaguar. Suzlon, a pioneer in the wind energy field has bought companies in Belgium and Germany. It is estimated that in 2007 Indian companies spent US$35 billion on acquisitions.4 These developments are going hand in hand with the continued growth and expansion of Indian IT firms that have paved

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the basis for Indian economic success. A 2007 study of the ten richest people in the world carried out by Forbes noted that four of the ten were Indian.5 Foreign investors are also increasingly paying attention to a country that had been neglected till the onset of economic reforms in 1991. AT Kearney ranks India as the second most preferred destination for foreign direct investment and United Nations Conference on Trade and Development (UNCTAD)’s 2005 World Investment Report makes the same observation.6 As India gains increasing economic clout, its political influence on the world stage is also increasing. As Nicholas Burns, the U.S. under secretary of state for political affairs who led the nuclear negotiations with India noted “India is a rising global power with a rapidly growing economy.”7 As India prepares to take on a new mantle as one of the emerging giants in the twenty-first century it is confronted with a number of key challenges both in the political and in the business realm. At a political level India’s aspirations are to be recognized as a major power on par with China, if not better than it, and one of the key successes would be to become a permanent member of the UN Security Council. Relatedly, the ability of the country to influence and/or shape the agendas of major international institutions such as World Trade Organization (WTO), World Bank, and International Monetary Fund (IMF) would also be viewed by the Indian elite as essential in this endeavor. At a business level, Indian firms are striving to become global players and in this pursuit have engaged in a series of high profile acquisitions. A key question in this regard is the following: How well positioned is India to not only further its interests but to do so in a manner which enhances the reputation and image of India as a major power? As India and Indian firms engage with other major actors both at a political as well as a firm level, they will need to effectively manage the interdependence that exists between them. Interdependence opens up new possibilities while simultaneously increasing the potential costs of engagement. An engaged India might benefit from greater inflows of foreign direct investment and many of its firms may likewise have greater access to opportunities elsewhere. It may also be called upon more frequently than in the past on major policy discussions among the major powers and may likewise have a greater opportunity than before to set forth its views and exert influence. Interdependence can confer tremendous benefits but whether or not and/or the degree to which these benefits are realized depends on the actors negotiating skill.

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The chapter will outline and critically assess the Indian approach to negotiations. Admittedly, this is an ambitious task, as the negotiating style in a country is often shaped by its historical legacy, cultural values/beliefs, negotiating context, and the international negotiating experience possessed by governmental bureaucrats/businesspeople.8 The varied and the multiple determinants of a country’s negotiating behavior no doubt make it a complex subject of study, but on that account, even more important, if one is to unravel the origins and consequences of this complexity. I begin by briefly reviewing the extant literature on Indian negotiating behavior. Scholars have highlighted the importance of Brahmanical idealism in shaping Indian negotiating behavior.9 I build on this concept and show how this concept can help us to make sense of the behavior of Indian business people and Indian bureaucrats. I then sketch out the implications of this concept for foreign investors and international political actors that might be seeking to engage with India.

8.2 Indian Negotiating Behavior; Negotiation and Interdependence: Integrative versus Distributive Approaches Negotiation is a key tool for managing interdependence. In every interdependent situation there are two fundamentally conflicting aims, namely value creation and value claiming.10 Value creation involves the creation of new alternatives that maximize value in a given situation while value claiming involves appropriating the value that is created for one’s interests as opposed to the other. There is an intrinsic dilemma between the two in that strategies designed to maximize value stand in opposition to strategies designed to extract value. Scholars have also referred to these contrasting strategies as integrative versus distributive.11 Integrative strategies require trust which allows the information to flow freely between the parties. Distributive strategies, by contrast, assume that the actor’s goals are in direct opposition to each other and instead of crying to create value the parties are focused on trying to extract the maximum value. The two strategies differ not only in terms of their potential success in reaching an agreement, but they are also likely to be associated with differences in the pleasantness of the interaction among the actors. Although integrative strategies may well be the desired norm there are many barriers to the pursuit of such a strategy. Scholars note that

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integrative agreements are most likely when the actors have high aspiration levels, are able to conceive of a future, and that there is enough common ground among them.12 These conditions are not necessarily easy to fulfill and the ability to realize them in an international context is even more problematical as national cultures differ in terms of how they conceive the interests of their own group with regard to another group. The argument has been made that while in all cultures there exists a distinction between an in group and an out group, the relative saliency of this distinction varies across cultures. In cultures where this distinction is very salient, the actors are likely to perceive their interests as being diametrically opposed.13 This will lessen the probability that the actors will pursue an integrative as opposed to a distributive strategy.

8.3

The Indian Approach to Negotiations

A number of scholars have attempted to characterize the Indian negotiating style. Much of this work has focused on understanding the negotiating stances and strategies of Indian bureaucrats but there are some exceptions.14 Cohen describes the Indian negotiators as being over analyzers who tend to search for interpretations when there might be little need for doing so. He also notes that they have an immense mastery of details and use this to infer that “. . . superior knowledge about a particular issue signifies a superior position.”15 Narlikar describes Indian negotiators as pursuing a “. . . high-risk, defensive hard-line strategy . . .” in spite of the limited successes that this strategy has brought for India.16 Using a different sample drawn from business people and university students Metcalf et al. find Indian negotiators were one of the groups that had the strongest preference for win-lose outcomes (that is a distributive negotiation strategy). The Indian respondents were also extreme in their response in that they either clearly preferred either a win—win or a win—lose outcome. Osmani-Gani et al. in an empirical study of Indian negotiators in Singapore and utilizing Pierre Casse’s characterization of negotiators as being either factual, intuitive, normative, or analytical, noted that Indian negotiators were normative in their orientation that is the negotiator uses all of the tools that he/she has to reach the best bargain.17 But the question still remains: Why the focus on the best bargain among Indian negotiators? Many of these studies are quite incisive in describing the behavior of Indian negotiators and assessing the implications of the Indian approach. But the

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one pressing issue that is not explicitly addressed by these studies is as follows. What is it that motivates the Indian negotiators to pursue distributive negotiation strategies and/or to engage in a process of overanalyzing issues, when there might be little to be gained from doing so? To address this question I will build on the concept of Brahmanical idealism that has been used to explain how Indians negotiate.18 I will further elaborate on this concept making the fundamental observation that Brahmanical Idealism may manifest itself differently in Indian officials as opposed to Indian businesspeople. It is important to make a distinction between the behavior of the Indian businessperson and the Indian bureaucrat as they have different goals/incentive structure confronting them. I will then outline implications for foreign investors/businesspeople seeking to do business in the Indian environment.

8.4 The Concept of Brahmanical Idealism The concept is derived from the fundamental principles of Indian philosophy, and simply put it refers to the desire of the negotiators to obtain the best possible outcome.19 Attaining the best possible outcome implies a deep and a thorough analysis of all of the issues pertaining to the proposal under consideration. It is only such an analysis that will make the negotiators confident of their underlying interests and how they can be best advanced in the negotiating process. It, therefore, also, has the implication that the proposals of the other actors involved in the negotiating process must be thoroughly scrutinized to eliminate or minimize aspects that may be unfavorable to the Indian party. The Indian desire for excessive analysis, over interpretation, and a defensive and a hard-line negotiating strategy may all stem from this underlying principle. As Kumar and Worm (2005, p. 313) note “. . . this mode of thinking fosters never ending debate and argumentation. Individuals find it all too easy to find flaws in the other actor’s argument in their search for a mythical ideal that is all but impossible to attain.”20 An idealistic mode of thinking manifests itself in high aspirational levels. The aspirational levels refer to negotiator expectations about outcomes and/or processes of negotiations. A high aspirational level implies that the negotiator has high demands/expectations from the project or proposal under consideration. Typically, negotiators with high aspirational levels, will request and evaluate a large amount of information, will not be hesitant to have a frank, albeit a contentious

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dialogue with their counterparts, and may not be overly sensitive to the time constraints of the situation. High aspirational levels could either reflect the negotiators desire to maximize positive outcomes, or alternatively, it could imply their desire to minimize negative outcomes.21 The distinction between two alternative ways of construing a negotiating situation is subtle, but important. Promotion focused negotiators view the negotiated outcome through the lens of accomplishment while prevention focused negotiators view the same through the lens of safety. When negotiated outcomes are viewed from an accomplishment perspective the negotiators are keen on a successful negotiation. However, when these outcomes are considered from a prevention standpoint, the goal is to avoid an undesirable outcome even if it means that there is no successful negotiation. Relatedly, for the promotion focused negotiators, attaining or exceeding the aspirational levels brings high level of elation/joy, whereas for prevention focused negotiators, attaining or exceeding aspirational levels contributes to a feeling of safety and security.

8.5

The Indian Businessperson as a Negotiator

The Indian businessperson may either act either in the role of a buyer or a seller. The two roles will trigger high aspirational levels in different ways. As a buyer the Indian negotiator will seek to maximize positive outcomes by getting the best deal possible. This implies that the Indian negotiator will be slow in making concessions. The negotiator may also aggressively seek to challenge the claims being made by the other party with the goal of getting the other to reduce their asking price. The negotiator may also seek to change his/her demands over the course of the negotiation with the goal of putting even greater pressure on the other party. Attempts will be made to check and double check the veracity of the claims being made by the other party. And interestingly enough even when the opposing party concedes the Indian negotiator may not necessarily be satisfied. The Indian negotiator may now begin to wonder as to why has the other party conceded now, and if it might not be possible to push them even more?22 The negotiator may now call into question the sincerity of his/her counterpart on the grounds that the concession implies that their first offer may not have been made in good faith. 23 In doing so, the Indian negotiator attempts to occupy the high moral ground, and hopes that by gaining this high ground, his/her opponent will concede. The strategy of maximizing positive outcomes, in the sense of getting the best

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possible deal has several consequences. First it slows down the negotiation process which may not be appreciated by the time conscious Westerners in particular. Secondly, if the gap in the aspirational levels is extremely large, this may call into question the credibility of the Indian negotiator. Third, the consistency and the sincerity, of the Indian negotiator may also be at issue here. The Indian negotiator may come to be viewed as someone who is solely concerned with his/ her advantage as opposed to the mutual benefit of all involved.24 This will surely undermine trust and make the pursuit of an integrative agreement a difficult undertaking. Consistent with this, a common perception among Western negotiators is well exemplified in the comment made by Wilhelm “The European businessman has a more linear ‘business school like approach’ and is usually surprised by the tug of war atmosphere that prevails in business dealings in India. It is not uncommon to hear comments during negotiations such as ‘are all negotiations as difficult as this?’ ”25 As a seller the Indian negotiator will seek to maximize his positive outcomes through a different tack. With the ultimate objective of effecting a sale the Indian negotiator will demonstrate persistence, may make extravagant promises (which may or may not be fulfilled subsequently), and may initiate the negotiations with a low offer which the other party can hardly refuse. Indeed the offer may be well below what the Western European negotiator may have been expecting. In the attempt to maximize positive outcomes, the Indian negotiator may over commit itself, with the consequence that problems may emergence once the contract reaches the implementation phase. Perhaps this may well explain as to why Indians often prefer ideological over transactional contracting. Ideological contracting implies low codification and a more diffuse set of obligations while transactional contracting implies greater codification and a narrower set of obligations. 26 In the circumstance where the negotiator is prone to over promise or over commit, it is the ideological contracting which may come to his rescue, as in this mode obligations are diffuse and codification is low. If so, then the failure to deliver what has been promised may either be explained or negotiated away, unlike in transactional contracting, where legal enforcement is often enough the norm.

8.6

The Indian Bureaucrat as a Negotiator

High aspirational levels among the Indian bureaucrats manifest themselves as a concern with minimizing negative outcomes. Intrinsic to

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this way of thinking is the recognition that the absence of an agreement is better than an agreement that might have even the slightest possibility of a negative outcome on the country. Although it is widely accepted that on occasions a no agreement may be the more optimal outcome relative to an inferior outcome, a strategy that is focused on finding even the remotest possibility of a negative outcome, makes negotiations that much more challenging and intractable. The origins of this mind set lie in an extensive preoccupation with the actual or perceived diminution of Indian sovereignty in the event of an agreement either with a transnational firm or a major foreign power. 27 With sensitivity to foreign domination a major core issue, the Indian negotiators, often enough display excessive cautiousness in the negotiating process. They are also often enough hesitant, and there is an iterative cycle of evaluation and reevaluation. Compounding this is murkiness/opacity as well as bureaucratic inertia/infighting that may make finalizing or implementing an agreement extremely difficult. 28 The negotiation process is therefore a protracted and a cumbersome one and it may lead the foreign negotiators to wonder how serious are the Indians in negotiating the agreement? They may also wonder if the negotiated agreement will withstand the test of time, or how effectively might the agreement be implemented. The issue as to whether there will ever be finality in the negotiating process is also an issue that arises in this context. A good illustration of these observations is provided both by the behavior of Indian negotiators in negotiating trade agreements and in the ongoing negotiations between India and the United States in connection with the Indo-U.S. nuclear deal. Narlikar (2006) notes that right from the early 1950s the Indian negotiators were pursuing a distributive strategy in the realm of trade negotiations. The Indians focused more on attaining equitable outcomes rather than process legitimacy and this led them to deviate from the policy of reciprocal tariff reductions. Consistent with a focus on avoiding negative outcomes, the Indian negotiators were loath to accept an agreement in which as an Indian delegate noted “. . . A weakling cannot carry the burden of a giant.”29 The Indian negotiating strategy did not change in the 1980s, and even more surprisingly, the Indian negotiators continued with their strategy during the 1990s and 2000, even though previous negotiating approaches had not borne fruit for India. India had ended up being isolated with the developed countries offering bilateral deals to countries that were willing to break away from the coalition being propped up by India. As Narlikar (2006: 64) observes

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“But even its commitment to economic liberalization did not deter it from adopting a distributive strategy in multilateral trade negotiations in support of its highly defensive positions.”30 India had formed a new coalition—the Like Minded Group in 1996—with the objective of highlighting to the developed world the costs that developing countries faced in implementing the agreements that had been reached during the Uruguay around. The group insisted that there will be no new negotiations till the implementation issues had been addressed. Unfortunately for India this coalition collapsed as well with developed countries making bilateral deals with other coalition members. The continuing negotiations between India and the United States over the nuclear deal provide another graphic illustration of the difficulties that the Indian negotiators have had in not only being able to negotiate an agreement, but even when the agreement has been reached, to be able to implement it effectively. The negotiations between the India and the United States began in 2005 and were concluded in August 2007 after some acrimony. 31 U.S. officials expressed frustration at India’s stubborn negotiating stance.32 India is not a signatory to the nuclear non-proliferation treaty and Congressional leaders in the United States were concerned that this deal may allow India to produce more nuclear weapons. India’s concerns, on the other hand, revolved around India’s insistence that it be allowed to engage in nuclear testing, and secondly the freedom to reprocess nuclear fuel even for military purposes.33 Under the terms of the deal the United States would remove any restrictions on nuclear trade with India, help India’s civilian nuclear energy program, and expand the domain of cooperation between India and the United States in energy/satellite technology. 34 India won the right to conduct nuclear weapons testing without the automatic cut off of supplies from the United States and even in the event that this were to occur, the United States would assist India in finding alternative sources for nuclear fuel. The agreement was subsequently approved by the Indian Cabinet on July 25, 2007. As the Economist notes “Overturning more than 30 years of US nuclear policy, the agreement is widely expected to form the foundation for a new strategic alliance between the world’s two largest democracies.”35 Western analysts believe that India has emerged as a winner from this deal. As Squassoni notes “The Indian nuclear establishment is the big winner here- in return for ending its objections to the deal, it gets a new multibillion plant, legitimacy and technology for its reprocessing program, and an end to difficult trade offs between

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separating plutonium for bombs and for electricity development.”36 Other experts have been equally critical of the deal as well. As Henry Sokolski, Executive Director of the Nonproliferation education center noted “We are going to be sending, or allowing others to send, fresh fuel to India—including yellowcake and lightly enriched uraniumthat will free up Indian domestic sources of fuel to be solely dedicated to making many more bombs than they otherwise would have been able to make.”37 The Indian, perspective, represents a mixed picture, and while historically there were many supporters of the deal, there have been many opposing voices, the most prominent of which is the Left that threatened to bring down the United Progressive Alliance (UPA) government if they were to go ahead with the deal. To make the deal operational India had to enter an agreement, first with the International Atomic Energy Agency (IAEA), and then with the Nuclear Suppliers Group. The deal then had to be approved by the Congress in the United States. India negotiated a draft agreement with the IAEA at the end of February 2008. Opponents of the deal in India have cited several concerns. First there is the predominant concern that will compromise India’s foreign policy, drawing it more and more into the U.S. ambit.38 There is also the concern that the deal is a pretext for allowing U.S. companies to make huge profits as they sell these reactors to India. Missing in this line of argument is the recognition that while the U.S. companies are sure to benefit so can India simultaneously! Other objections pertain to the cost of imported reactors, ambiguity concerning the consequences of nuclear testing or of uranium supply, even as India has to agree to allow safeguards inspections of its reactors in perpetuity.39 Proponents of the deal, such as T.P. Srinivasan, governor of IAEA acknowledge that the deal has some ambiguities such as the consequences India might face if they were to conduct future nuclear tests or on issues pertaining to reprocessing.40 But in spite of the ambiguities he notes that the deal is good for India. Other analysts note that the critics of the deal have solely focused on the ambiguities of the deal. As Balachandran notes “The critics in India, focused on some of these ambiguities which could, however, occur only in very exceptional circumstances which most analysts considered as extremely unlikely.” The criticism of the deal is therefore voiced primarily in the concern with avoiding negative outcomes. The recognition that ambiguity may also be positive or at the very least may not necessarily be construed in negative terms appears not to be very salient in critics thinking.

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In any event, for the UPA, led by Manmohan Singh going ahead with the deal was predicated on support from the Communists who said that they will withdraw the support to the government should it go ahead with the deal. This explained the delay in operationalizing the deal even though it had been finalized many months before. The Indian administration continued to maintain that it is committed to the deal but the tangible progress was initially slow given the urgency of the deadlines in view of the looming U.S. presidential election. The American administration was clearly frustrated and as the Economist points out “The Americans also note that India should not expect such generous terms from their next administration; and that this one would be exasperated if three years of painstaking diplomacy came to naught.”41 In other words, the failure to operationalize the deal may call into question the credibility of India as a negotiating partner. It may also be a situation of walking away from the best possible offer that might be on the table for the foreseeable future. Perhaps in the ultimate analysis these considerations led the UPA to reconsider its support of the Communists. They forged new alliances and went ahead with the agreement both with the International Atomic Energy Agency as also with the nuclear suppliers group. The nuclear deal has now been approved by the U.S. Congress and the Indian government has now formally signed the deal with the U.S. government. The final outcome notwithstanding the process of negotiating the deal was without doubt lengthy and a cumbersome one. A preoccupation with minimizing negative outcomes is also evident in the way with which the Indian government is dealing with projects in the infrastructure sector. It is clear that India needs a considerable amount of investment in this sector and we also know that in the 1990s Indian policy to attract investment in power generation went nowhere.42 Consider the case of Cairns Energy, a UK-based company which is producing oil in the state of Rajasthan. The company has reportedly invested US$2.95 bn in the state and the field is expected to commence operations in 2009 with a daily output of 150,000 barrels per day.43 Cairn and its partner ONGC have proposed the construction of a pipeline that would allow oil to be delivered to the state owned refineries. The government is unhappy with this proposal which will cost around US$800 million. They have proposed building a small refinery around the project field and reducing the capacity at peak production. Cairn is unhappy with this proposal as it might delay production “. . . and cutting output would violate its agreements with the government and its commitments to shareholders and lenders.”44

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Analysts note that the Indian proposal could be costly to the government both in terms of deferred production and foregone income. Yet, this aspect seems not to have been factored in Indian thinking. They seem to be primarily focused on the immediate costs, rather than on the tangible as well as intangible factors, that might influence the overall costs of projects in this sector. What is at stake not simply this project but also India’s reputation as a foreign direct investment destination in the infrastructural sector. As a banker familiar with the project noted “The government stands to lose a significant amount of credibility (from these disputes) at a time when India has been a recipient of significant flows of foreign investment.”45 The bureaucratic decision makers seem not to have learned from their past experiences in attracting foreign direct investment in the infrastructural sector.

8.7 Negotiating with Indian Businesspeople: Implications for Foreign Businesspeople The process of selling to an Indian businessperson, whether it be a new technology or a product, and/or negotiating a joint venture agreement can be a lengthy, cyclical, and a frustrating process for the foreign businessperson. In trying to maximize their positive outcomes, the Indian businessperson will go to great lengths to get the best possible deal. How can and should the foreign businessperson as a seller cope with the Indian negotiating approach? First of all, the foreign business person must be cognizant of the Indian approach for it will help him/her to have more accurate expectations and this will lessen any frustration that such an approach might foster. Second, the foreign businessperson must be prepared to adjust his/her negotiating strategy to the Indian approach. They must not demonstrate their over eagerness to sell to the Indians or their rush to conclude the deal. At one level this is clearly not so satisfactory for the foreign businessperson, but on the other hand, such a strategy is a useful corrective to the single dimensional approach being adopted by the Indians. It will prevent the foreign businessperson from playing the game on Indian terms. It may also be worth reminding the Indians, albeit politely, that their strategy may be a short term one, and while it may not be immediately evident, they may incur greater costs down the road. If the middle level Indian negotiators remain unimpressed by this, it would be worthwhile for the foreign businessperson to go to the highest levels of the Indian hierarchy as most decisions are made at that level.46

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Some concessions will surely be made by the foreign businessperson, but it is important, that the foreign businessperson not make all of the concessions all at once, or fail to prioritize between concessions that are substantive and those that are purely of a symbolic nature. The high aspirational levels of the Indians go hand in hand with a relative insensitivity to secular time, and if the foreign businessperson could demonstrate to them the tradeoffs inherent between achieving a less than ideal agreement in a timely way and the consequences of an ideal, albeit a delayed agreement, they may make some headway. In dealing with the Indian seller challenges confronting the Western buyer are incomparably different. The foreign buyer may be offered an incredibly good deal as the Indian seller is keen on a successful negotiation outcome. What is at issue here is the credibility of the Indian seller that is his/her ability to fulfill the commitments that he/ she has agreed to. The foreign businessperson, must first of all, be prepared for potential delays, even where the intentions of the seller are benign and transparent. The Indian seller may be constrained by infrastructural challenges which may prevent him/her from delivering the products on time. Alternatively, there may be a communication gap between the foreign businessperson and the Indian seller which may add to the delay. Understanding the nature of these potential impediments will go a long way in easing the frustration of the Western businessperson. The critical challenges arise when either the seller has over promised at the time of negotiating the contract, or alternatively, when his/ her intentions are not benign. These circumstances call for a thorough and a carefully vetting of the proposed seller prior to the signing of a contract. It also calls for clarity in communication with the need for the foreign businessperson to recognize that Indians are often reluctant to say no. Both of these steps in conjunction may help to minimize, although not eliminate any problems that may occur down the road. In the event, that these problems emerge, legal remedies will surely be sought, but legal enforcement may not be as expedient as the foreign businessperson may be accustomed to elsewhere.47

8.8

Negotiating with Indian Bureaucrats: Implications for Foreign Investors

Negotiating with Indian bureaucrats represents a hurdle of a very different magnitude. As we have noted earlier, these bureaucrats,

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often have the penchant of pursuing a hard-line, distributive strategy. The origins of this behavior lie in the Indian way of thinking, the experience of colonialism, and bureaucratic peculiarities. How should the foreign investors, therefore, approach their interactions with the Indian bureaucracy? First of all, it is imperative that the foreign investors understand the mindset of the Indian bureaucrats and, in particular, their penchant to pursue a distributive strategy. Secondly, the foreign investors must understand that while the relationship between the multinational firms and the Indian government has improved considerably since the onset of liberalization in 1991, vestiges of the old mind set are still present to some degree.48 Foreign investors may be treated with a certain degree of skepticism if the potential size of the transaction is large, if they appear to be overaggressive, and/or if perceptions develop that the foreign investors are getting a better deal than the Indians. This has a number of implications. First of all if the foreign investor is new to India, they must adopt an incremental approach to the Indian market, and especially so in politically sensitive projects such as infrastructural development. Once a certain level of credibility has been established by the foreign player, they can scale up their operations. Secondly, they must keep a low profile, and not adopt overly aggressive tactics which may fuel Indian nationalism. The Indian bureaucrats, will no doubt, be demanding in terms of information, motivated by the obvious desire to minimize negative outcomes. This, to the foreign investor, may appear as an overkill, but they must learn to live with it. Conflicts between different bureaucratic agencies may be another source of aggravation, and may slow down the negotiation phase and/or project implementation. If the foreign investor has to attain success in India, then the investor, must both seek to attain and maintain legitimacy, that is, the proposed project must be seen as valuable and benefiting India.49

8.9 Conclusion India is now emerging as a major player in the global economy. Foreign investors are rushing to India and likewise Indian companies are seeking overseas acquisitions. As the interaction between Indian managers/bureaucrats and their foreign counterparts intensifies, foreign businesspeople/investors will need to come to grips with the Indian approach to negotiations. This chapter has attempted to articulate the underlying logic that is extant in the Indian way of

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negotiating. This logic is best seen through the prism of Brahmanical idealism which highlights the importance for attaining the best possible outcome. The best outcome can be looked at either through the lens of minimizing negative outcomes or the lens of maximizing positive outcomes. The Indian bureaucrat is more concerned with minimizing negative outcomes while the Indian businessperson is more attuned to maximizing positive outcomes. A relentless pursuit for perfection is positive in that it leads negotiators to set high aspiration levels. High aspiration levels are a precondition for obtaining an integrative agreement and insofar as that is the case Brahmanical idealism can only play a positive role. But if the high aspiration levels are not firmly rooted in the realm of possibilities or what might be achievable in an imperfect world, then they become a constraint, although on occasions, they may yield very positive outcomes. On balance, the Indian negotiators, and especially the bureaucrats, have become constrained by this idealistic mode of thinking. This mode of thinking is likely to undergo some shift as India becomes an even more integral part of the global economy, but at least in the short to the medium term, the legacies of this mode of thinking will be all too much in evidence. The chapter sets out some of its implications and recommendations for foreign investors seeking to do business in India.

Notes 1. Johnson, J. (2007), “India on Track to be Global Economic Power.” Financial Times, January 25. 2. Panagariya, A. (2008), “India’s Growing Economy: Song of the Crossroads,” www.brookings.edu/opinions/2008/0218. Accessed November 13, 2008. 3. Ibid. 4. Ibid. 5. “Four Indians in Forbes List of 10 Richest in the World.” Hindustan Times, March 6, 2008. 6. “Foreign Direct Investment,” www.ibef.org. Accessed November 13, 2008. 7. Cited in Johnson, J. (2007), “A Confident New Country.” Financial Times, August 15. 8. Cohen, R. (1991), Negotiating across Cultures: Communication Obstacles in International Diplomacy. Washington, DC: US Institute of Peace. Kumar, R., & Worm, V. (2005 ), “Institutional Dynamics and the Negotiation Process: Comparing India and China.” International Journal of Conflict Management, 15: 304–334. Salacuse, J.W. (2003), The Global Negotiator: Making, Managing, and Mending Deals around the World in the 21st Century. New York: Palgrave Macmillan.

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9. Kumar, R. (2004), “Brahmanical Idealism, Anarchical Individualism, and the Dynamics of Indian Negotiating Behavior.” International Journal of Cross Cultural Management, 4: 39–58. 10. Lax, D.A., & Sebenius, J.K. (1986), The Manager as a Negotiator. New York: Free Press. 11. Walton, R.E., & Mckersie, R.B. (1965), A Behavioural Theory of Labor Negotiations. New York: McGraw Hill. 12. Usunier, J.C. (2003), “Cultural Aspects of International Business Negotiations,” in P.C. Ghauri, & J.C. Usunier (eds.), International Business Negotiations (2nd ed.). Oxford: Pergamon Elsevier, pp. 97–135. 13. Lax & Sebenius (1986). 14. Narlikar, A. (2006), “Peculiar Chauvinism or Strategic Calculation? Explaining the Negotiating Strategy of a Rising India.” International Affairs, 82: 59–76. Cohen, S.P. (2001), Emerging Power: India. Oxford: Oxford University Press. Kumar, R. (2004), “Brahmanical Idealism, Anarchical Individualism, and the Dynamics of Indian Negotiating Behavior.” International Journal of Cross Cultural Management, 4: 39–58. Metcalf, L.E. et al. (2006), “Cultural Tendencies in Negotiations: A Comparison of Finland, India, Mexico, Turkey, and the United States.” Journal of World Business, 41: 382–394. 15. Cited in Cohen, S.P. (2001), Emerging Power: India. Oxford: Oxford University Press p. 23. 16. Narlikar (2006). 17. Gani, A.M.A., & Tan, J.S. (2002), “Influence of Culture on Negotiation Style of Asian Managers: An Empirical Study of Major Cultural/Ethnic Groups in Singapore.” Thunderbird International Business Review, 44: 819–839. 18. Kumar (2004). 19. Gani & Tan (2002). 20. Kumar & Worm (2005). 21. Gani & Tan (2002). Higgins, E.T. (1998), “Promotion and Prevention: Regulatory Focus as a Motivational Principle,” in M.P. Zanna (ed.), Advances in Experimental Social Psychology, 30: 1–46. Amsterdam, The Netherlands: Elsevier. 22. Hughes, M. (2002), A Theoretical and Empirical Analysis of Chinese and Indian Negotiating Behavior. Unpublished Masters thesis, Aarhus School of Business, University of Aarhus. 23. Cohen, R. (1991), Negotiating across Cultures: Communication Obstacles in International Diplomacy. Washington, DC: US Institute of Peace. 24. Knowledge@wharton (n.d.), “Indians Are Privately Smart and Publicly Dumb,” www.littleindia.com/news/126. Accessed November 13, 2008. 25. Wilhelm, C. (2002), “Part 3: Doing Business in India.” Asia Times, February 20. 26. Kumar, R., & Sethi, A. (2005), Doing Business in India: New York: Palgrave Macmillan. 27. Knowledge@wharton (n.d.). 28. Hughes (2002). 29. Narlikar (2006, p. 63).

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30. Ibid., p. 64. 31. King, N. Jr. (2007), “US India Talks on Nuclear Pact Enter Endgame; Congress Likely to Balk at New Delhi’s Terms, Businesses Want a Deal.” Wall Street Journal, July 14. 32. “US India Talks Leave Outcome of Nuclear Deal Uncertain.” Financial Times, July 23, 2007, p. 6. 33. “Nuclear Power Politics,” www.economist.com, July 30, 2007. Accessed November 13, 2008. 34. Pan, E., & Bajoria, J. (2008), “The US India Nuclear Deal,” www.cfr.org/ publications/9663/. Accessed November 13, 2008. 35. Narlikar (2006). 36. Squassoni, S. (2007), “The India Nuclear Deal: The Top Rule Maker Bends the Rules,” www.iht.com/articles/. Accessed November 13, 2008. 37. Cited in Kumar & Sethi (2005, p. 5). 38. Yechuri, S. and others (2007), “Indo-US Nuclear Deal: A Debate.” Vikalpa, 32: 87–111. 39. Narlikar (2006). 40. Ibid. 41. “Asia: Beginning the Long Goodbye, Indian Politics.” The Economist, March 1, 2008. 42. Knowledge@wharton (n.d.). 43. Leahy, J. (2007), “Red Tape Threat to Cairn Oil Projects.” Financial Times, June 15. 44. Leahy, J. (2007), “IFC Concern over Cairn India Delays.” Financial Times, June 20, p. 1. 45. Leahy, J. (2007), “Red Tape Threat to Cairn Oil Projects.” 46. Kumar & Sethi (2005). 47. Kumar & Worm (2005). 48. Ibid. 49. Ibid.

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Index

Note: Page numbers with “f” denote figures, whereas those with “t” denote tables. accelerated internationalization 45 ACMA see Automotive Component Manufacturers’ Association adaptability xii, xiii, 65 Africa 22, 33, 38, 43 angel investors 152 Anglo-Saxon model, of capitalism 74 AOTS see Association of Overseas Technical Scholarship APIDC 155n12 The Arbitration and Conciliation Act (1996) 129 Arcelor Mittal steel company 32 ASEAN 84, 111 ASEAN-India FTA 35 Ashok Leyland 108 Asia 7, 83 automobile industry in 84 Asian model, of network capitalism 74 Association of Overseas Technical Scholarship (AOTS) 106, 107 Australia 37 Australian Venture Capital Association 138 automobile industry xiv, 83 challenges 110–111 developments 107–110

economic reforms in 88–92 evolution and development of 84 local supplier base, creating 97–99 structural transformation of 92–96 supplier relations, changing 99–101 supplier upgrading 101–107 Automotive Component Manufacturers’ Association (ACMA) 106 backwardness 44, 112 Bajaj Auto 110 Bangalore 63 in global value chains 67–70 growth and transformation 66–67 industrial transformation, implications for 73–75 local market organization in 70–73 Bangladesh 109 Bangladesh-India-MyanmarSri Lanka-Thailand Economic Cooperation (BIMSTEC) 35 Belgium 171

190

Index

Bermuda 38 Bharat Forge 29n47, 110 Bharty Tele Ventures 56n4 Billionaire Club 28n39 BIMSTEC see Bangladesh-IndiaMyanmar-Sri Lanka-Thailand Economic Cooperation Birla 33 body-shopping model 67–68, 79n9 Bombay Club 28n40 BPM see business process modeling 77 BPO see business process outsourcing Brahmanical idealism xv, 175–176 Brazil 26n1, 29n48, 95, 110 breach of contract 130 Bretton Woods Institutions 3, 4 BRIC (Brazil, Russia, India, and China) 26n1 Britain 109, 137 business process modeling (BPM) 77 business process outsourcing (BPO) 37 C3 37 Cairns Energy 181 Canada 37 capitalism Anglo-Saxon model of 74–75 global 3, 11, 64 Cemex 32 Chennai 100 China xi, 32, 39, 110, 111 automobile industry in 83, 84, 95 early-stage risk capital industry in 138, 139 economic globalization in company level 21–23 global level 19–21 national level 19–21 sector level 21–23 strategy 24–25

foreign direct investment 20, 23, 30n53 in global economy 6 Go Global policy 40 China-India Free Trade Agreement 35 China National Petroleum Corporation (CNPC) 32 CII see Confederation of Indian Industry CKD see complete knockdown cognition 163 communication 163 implications for foreign businessperson 183 nonverbal 163 verbal 163 Community Informatics 126 complete knockdown (CKD) 96, 97, 98 Computer Policy of 1984 28n33 Confederation of Indian Industry (CII) 28n40, 106 contracting 22, 70, 71, 125, 129, 132 complexity of 127 ideological 177 transactional 177 see also in-sourcing; outsourcing; subcontracting converged firms 46 CorPay Solutions 37 corporate governance 147, 150 corporate profitability, in India 14, 15f corruption iv, 119 asymmetric information, problem of 129–130 in government services 124–126 ICT 126–129 political 130–132 scarcity rent and market reforms 123–124 typology of 120–122

Index Corus group 40, 171 Crompton Greaves Ltd.

16–17

Daewoo 39, 93, 96, 98 Daimler Chrysler 93, 98, 101 Daksh eServices 37 Datamatics Technologies 37 debt crisis 4–5, 8 finance 137 Delphi 93, 97 Denmark 7 Denso India 93 deregulation 119, 124, 127 dharma 158, 161 Dr. Reddy’s Laboratories 29n47 Dunning, John 42 DVCF 152 Early Stage Enterprises (ESEs) 138 Early-stage risk capital causes for shortage of 135, 147–148 challenges with domestic markets 142–145 challenges with operating environment 146–148 importance of 136–141 obstacles to 138 phases of 142t policy analysis 148–153 social network, lacking of 145–146 trends in 141–142 economic globalization 2–4 see also global economy economic liberalization 18, 29n48 economic partnership agreement (EPA) 84 education 18, 47, 140 ego boundaries 161 ego-ideal 161 e-governance 126, 134n17

191

employee stock option schemes (ESOPs) 71 EPA see economic partnership agreement equity 89, 92–93, 143, 154 finance 137 private 154 ESEs see Early Stage Enterprises ESOPs see employee stock option schemes (ESOPs) EU see European Union Europe 7, 17, 109, 110, 139 European Central Bank 140 European Union (EU) 6, 20 Expert Information Services Pty. Ltd 39 export 6, 7f, 19–20, 21 processed 20 software 13, 66 textile products 13 vehicles 91–92, 95, 109t extended family 158 hierarchical relationships, psychosocial dimensions of 158–159 insider/outsider relationships 159–160 familial self xv, 160–164 dual self-structure 160–161 Faridabad 100 Faridabad Small-Scale Industry Association (FSSIA) 106 Federation of Indian Chambers of Commerce and Industry (FICCI) 116n44 Fiat 93, 96, 110 FICCI see Federation of Indian Chambers of Commerce and Industry firms converged 46 latecomer 44–45 market failures 61n89

192

Index

firms—continued structure, in India 52 venture capital funded 138 Flag Telecom 39 Flextronics 32 Forbes 14, 56n4, 172 Ford 93, 98 Fordism 24f, 28n32 foreign direct investment (FDI) xiii global 6, 20, 23 inward 15, 31, 51 outward see outward foreign direct investment traditional theories of 42–43 foreignness, disadvantages of 42 France 20, 110, 171 free trade agreement (FTA) 84, 110, 111 French Regulation School 10 FSSIA see Faridabad Small-Scale Industry Association FTA see free trade agreement Fund for Technology Development and Application (India) 149 Gazprom 32 Germany 109, 110, 171 global capitalism 3, 11, 64 global commodity chain 87 global economy in China 20, 24, 25 in India 5–8, 18 see also economic globalization global supply platform model 75 global value chains 64–66, 73, 75, 77, 78n1, 87 Bangalore in 67–70 economic 2–4 GM 93, 98 Go Global policy 40 Gold Control Act (1962) 124 government services

ICT solutions for 125–126 scarcity-related corruption in 124–125 Gurgaon 90, 92, 99, 100, 102 GVFL 155n12 Haier 23 Haryana 100, 101 Haryana State Industrial Development Corporation (HSIDC) 99 HCL Technologies 37 hierarchical relationships, psychosocial dimensions of 158–159, 162 Hindalco 37 Hinduja TMT Ltd 37 Hindu rate of growth xi, 10 Hindustan Motors (HML) 93, 97, 99 Honda 98, 110 Hong Kong 20, 32, 38, 49 HSIDC see Haryana State Industrial Development Corporation Huawey 23 human development 18 Hymer—Caves—Kindleberger tradition 42 Hyundai 32, 93, 108, 109 IAEA see International Atomic Energy Agency IBM 23 ICT see information and communication technology IDP see investment development path IFDI see inward foreign direct investment I-Flex 39 illegal rent asymmetric information, problem of 129–130

Index on information 121, 122 from position 122 scarcity rent 120–121 IMF see International Monetary Fund India xi, 1 economic globalization in 4–19 background 4–5 company level challenges and changes 14–17 global level 5–8 national economy, performance of 8–10 sector level development 10–14 strategy 24 foreign direct investment 6, 15, 29–30n53 institutional imperfection xi–xiii and United States, negotiations between 178, 179 see also individual entries Indian bureaucrat as negotiator 177–182 Indian businessperson as negotiator 176–177 Indian Ocean Rim Association for Regional Cooperation 35 Indian Oil Corporation 37 Indian workplace American and Japanese management theories for 166–168 individuality 163–164 Indo-Lanka Free Trade Agreement 35 Indonesia 110 Indo-U.S. nuclear deal 178, 179–181 industrial transformation, 66, 86 implications for 73–75 information and communication technology (ICT) 119, 125, 126–129, 131

193

market reforms and 129–130 information technology (IT) industry xiv, 17, 51, 128–129, 132–133 foreign investment in 12, 15, 28n37 operational cluster 65, 74 technology cluster 65, 74 Infosys Technologies 32, 37, 39, 59n4, 68, 69, 77 initial public offerings (IPOs) 138 insider/outsider relationships 159–160 in-sourcing 71 see also contracting; outsourcing; subcontracting institutional change and industrial development 83, 85–87 institutionalization 105 Institutions, in India dimension xii imperfection xi–xiii Intel Capital 143 interchangeability 72 International Atomic Energy Agency (IAEA) 180, 181 internationalization 42, 44, 51, 55 accelerated 45 theory of FDI 41 Uppsala theory of 59n61 International Monetary Fund (IMF) 4, 5, 26n15, 172 investment development path (IDP) 46–47, 60n79 positioning theories in 48f inward foreign direct investment (IFDI) 15, 31, 51 IPOs see initial public offerings Iran 37 I-self 160 ISO certification 104, 105

194

Index

Israel Binational Industrial Research and Development (BIRD) program 149 early-stage risk capital industry in 138 Yozma program 149 IT see information technology industry Italy 109, 171 Japan 6, 20, 24, 97, 98, 101, 110, 111 automobile industry in 83, 84 network capitalism in 74 JIT see just-in-time J.J. Irani Committee 134n14, 151 just-in-time (JIT) 101 kaizen 104 karma 157, 164 Kirloskar 33 Korea 32, 141, 145 automobile industry in 83, 84, 111 network capitalism in 74 Kshema Technologies 68, 80n14 Lahiri Committee (2004) 153 Lakshmi Mittal 28n39, 57n26 latecomer firms 44–45 Latin America 43 Lenovo 23, 32 liberalization xiii, 6, 16, 17, 26n15, 33, 40, 49, 55, 84, 88, 90, 92, 108 Like Minded Group 179 limited liability corporations (LLCs) 136, 137 limited liability partnerships (LLPs) 141 Linkage, Leverage and Learn model (LLL) model 45 localized technological change 43

local market organization 64–66, 77 in Bangalore 70–73 Lucas-TVS 93 Mafatlal 33 Mahindra & Mahindra 99, 108, 110 Malaysia 33, 49, 110 M&As see mergers and acquisitions Manmohan Singh 40, 181 Maratha Chamber of Commerce 106 market reform xiv, 132–133 scarcity rent and 123–124 Maruti-Suzuki India Ltd. xiv, 84, 85, 89–92, 94, 95, 96, 108, 109, 110, 115n28 and HSIDC 99 local supplier base, creating 97–98 supplier relations, changing 100, 101 supplier upgrading 101–103, 105, 107 Maruti Udyog Ltd. see Maruti-Suzuki India Ltd. Mauritius 38, 146, 147 Memorandum of Understanding (MoU) 96, 97 MERCOSUR (Mercado Comun del Sur) 111 mergers and acquisitions (M&As) 36, 37f, 38, 50, 52 Mexico 37, 95 MG Rover 23 MICO 93 Microsoft 68 Ministry of Company Affairs (India) 151 Motherson Sumi 101 MoU see Memorandum of Understanding

Index MsourcE (India) Private Ltd. 37 Mumbai 121, 140, 143 Nanjing Automobile Group 23 Narayana Murthy 73 NASSCOM 133n13 National Textile Policy of 1985 28n33 negotiation xv, 171 attitude toward contracts 177 foreign businesspeople, implications for 182–183 foreign investors, implications for 183–184 integrative versus distributive strategies 173–174 negative outcomes, minimizing 177–182 overanalyzing process and 174–174 negotiators Indian bureaucrat as 177–182 Indian business person as 176–177 prevention focused 176 promotion focused 176 neoliberalism 84 Nepal 49, 109 Nerve Wire Inc. 39 Netherlands, the 20, 109 network capitalism Asian model of 74–75 New Industrial Policy (1991) 35, 84 Nigeria 33 Nissan 97 North America 110 Nuclear Suppliers Group 180, 181 NVCA see U.S. National Venture Capital Association OECD 27n30, 42, 67, 71, 75 OFDI see outward foreign direct investment offshore model 67–68, 77, 79–80n9

195

Oil and Natural Gas Corporation Ltd. (ONGC) 37, 181 OLI framework 42, 43, 45 ONGC see Oil and Natural Gas Corporation Ltd. open business model 77 Open Door Policy 40 operating environment 146–148 outsourcing 37, 55, 67, 68, 69, 76 see also contracting; in-sourcing; sub-contracting outward foreign direct investment (OFDI) xiii, 31 developing country OFDI, theories of 41–48 converged firms 46 investment development path 46–47, 48f latecomer firms 44–45 synthesis 47–48 traditional FDI theory 42–43 TWMNCs 43–44 from India early phase 33–34, 41t firm structure 52 history 32–41 industry structure of Indian economy 50–51 path, puzzles of 48–50 policies and regulations 52–54 start-up phase 34–36, 37, 41t takeoff phase 36–41, 41t Pakistan 110 Patel, Udayan 168 PCS 37 personal destiny 164–165 Peugeot 93, 96 Phased Manufacturing Program (PMP) 95, 97, 98 Philippines 37, 109 Piore, Michael 86 PMP see Phased Manufacturing Program

196

Index

policy analysis 148–153 investors’ rights, enhancing 150–151 public funding, for SMEs 148–150 regulatory recommendations 151–153 policy change 12, 28n33, 89 Post-Fordism 24f power 73, 99, 122 generation 181 Premier Auto (PAL) 93, 96, 97 private equity and venture capital, difference between 154 private self 160 privatization 29n48 public-private partnership 149, 150 Pune 100, 101, 106 purchasing power parity 32 Ranbaxy Technologies 33, 40 Reliance Infocomm 39 Renault-Nissan 110 Rent Control Act 121 Reserve Bank of India 17, 28n43 risk capital definition 153–154 early-stage see early-stage risk capital provision, stages of 154 RPG Aventi 40 Russia 26n1, 37, 38, 110, 111 Sabel, Charles 86 SAFTA see South Asia Free Trade Area samskaras 164 Samsung 32 Satyam 36 SBIC see U.S. Small Business Investment Corporation SBIR see Small Business Innovation Research

scarcity rent 120–121, 124–125 and market reforms 123–124 SEAF see Small Enterprise Assistance Funds Securities and Exchange Board of India (SEBI) 139, 151, 152 Securities and Exchange Board of India Act (1992) 129 Selective Targeting Policy 40 self 157 familial xv, 157, 160–164 spiritual xv, 165–166 Sen, Amartya 29n50 simultaneous engineering 103 Singapore 32, 33, 38, 49, 110 Skoda 110 small and medium enterprises (SMEs) 36, 52, 70, 135, 137, 147 definition 154 finance gap 136 public funding for 136, 148–150, 153 Small Business Innovation Research (SBIR) 149 Small Business Technology Transfer Program (STTR) 149 Small Enterprise Assistance Funds (SEAF) 136 small-scale industry (SSI) 88, 115n24 SMEs see small and medium enterprises social capital 145 social change, in urban educated 166 social development 18 social network 145–146 software industry structural transformation in xiv Software Policy of 1986 28n33 Sona Steering 110 South Africa 110, 111

Index South Asia 43 South Asia Free Trade Area (SAFTA) 35 Southeast Asia 33 South Korea 24, 110 Soviet Union 5 SPC see Statistical Process Control spiritual self xv, 165–166 Sri Lanka 33, 49, 109 SSI see small-scale industry Statistical Process Control (SPC) 104 STTR see Small Business Technology Transfer Program subcontracting 71 see also contracting; in-sourcing; outsourcing Sudan 37, 38 superego 161 Supersolutions Corp. 39 sustainable development xi–xii Suzlon Energy 29n47, 171 Taiwan 32, 141 network capitalism in 74 Tata Chemicals 17 Tata Consultancy Services 36, 39 Tata Engineering and Locomotive Co. Ltd. see Tata Motors Ltd. Tata Motors Ltd. 17, 29n47, 39, 85, 89, 91, 94–95, 96, 99, 108, 109, 110, 171 Engineering Research Center 103 local supplier base, creating 97, 99, 101 supplier upgrading 103, 107 Tata Steel 17, 29n47, 40, 171 Tata Tea 17, 40 tax pass-through, for venture capital 146, 151 TDICI 155n12

197

Technology Development Board (India) 149 Tetley Tea 40 textile industry foreign investment in 12–13, 28n37 Thailand 33, 110, 111 Third World Multinationals (TWMNCs) 43–44 Tokyo 106 total quality management (TQM) 104 Toyota 93, 97, 98, 110 TQM see total quality management Trademarks Act (1999) 129 trusts 141 TWMNCs see Third World Multinationals UNCTAD see United Nations Conference on Trade and Development United Kingdom 20, 36, 171 United Nations Conference on Trade and Development (UNCTAD) 49, 51, 79–80n9, 172 United Progressive Alliance (UPA) 180, 181 United States xi, 4, 6, 20, 36, 39 and India, negotiations between 178, 179 industrial organization, models of 74 venture capital funded firms in 138 UPA see United Progressive Alliance Uppsala theory, of internationalization 59n61 Uruguay 179 U.S. National Venture Capital Association (NVCA) 138, 141

198

Index

U.S. Small Business Investment Corporation (SBIC) participating security program 148–149 Uganda 33 venture capital 138, 155n12 and private equity, difference between 154 tax pass-through for 151 vertical integration 86, 89 Virgin Islands 38

vitrual extension model 68–69, 76 Volvo 110 we-self 160 we-self esteem 161–162 West Asia 43 Wipro 14, 36, 39, 77 World Bank 4, 5, 26nn15,16, 29n52, 141, 154, 172 World Trade Organization (WTO) 3, 4, 5, 172