The Economic and Social Impacts to India and Its Citizens from Inward Foreign Direct Investment


: Major constraints to manufacturing FDI



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7.3: Major constraints to manufacturing FDI


The reasons as to why India has been unable to become a successful exporting manufacturer is the subject of debate in the research, with arguments highlighting the Indian government’s inability to discipline its domestic business class to a mercantilist strategy, the lack of investment in infrastructure, stringent labour laws and lack of social policies to supplement the cost of living needed for low cost export oriented labour (see section 4.2.2 and 4.3.1) (Dreze and Sen, 1995; Ghosh, 2010; Mazumdar, 2011). The problems most often cited by respondents in this sample included: insufficient demand, the country’s inefficient infrastructure and power supply, stringent labour laws, and under-skilled labour. Each will be reviewed here.

7.3.1: Demand for manufacturing products


Some elite policy stakeholders from this sample revealed there was a lack of internal demand for manufacturing products in India’s domestic markets. It was explained that embedded structural income inequalities have greatly narrowed India’s domestic market and have decreased the demand for goods and, in particular, manufactured goods. BN is a senior Professor within an academic institution concerned with economic and social development. He discussed the debates concerning supply side and demand side factors holding back manufacturing:

There is an alternative school of thought which feels that most of the reforms have only eased the rules and regulations, which is supply side. But reforms have done very little to ease the demand side constraints. If industry is to grow, then it has to sell the products. Where do you sell the products? We still have a country with a very large proportion of the people dependent upon agriculture with lower levels of income and with only a limited section of the people which has money to spend. But which is a bigger problem is not clear. Some people feel the bigger problem is labour regulations, some people feel the big problem that is going to hit manufacturing is acquiring land and some people feel neither of them are important and that the big problem is demand. We don’t have sufficient demand.

The constricted pattern of demand, the theory holds, also helped to propel the service sector as the increased incomes of the middle and upper classes that were able to participate in the high end growth segments of the market after liberalisation resulted in their diversification of demand in favour of services (Ghosh, 2004, 2010; Mazumdar, 2011). Thus the consumption demand for services over manufactured goods occurred due to the structural inequalities and the substantial increases in income to only a small minority of the population (Ghosh, 2004; Chandrasekhar and Ghosh, 2006 Mazumdar, 2011).

7.3.2: Infrastructure and power supply


Inadequate supply of power, in particular, was the most commonly reported factor responsible for holding back both domestic and foreign investment in the manufacturing sector amongst the respondents in this sample. RO, representative of, and senior economist within an international governmental organisation concerned with monitoring the global economy described infrastructure problems and highlighted the political issues involved:

Power is a real big problem here. And I have seen studies that say that power is the single and most important factor for investors, particularly in manufacturing. You have to have a generator here in India because the power kicks out so often. So think of how that will add to the cost of doing business. But it is not just economic, there are political issues too. Right now the power sector is going through a little crisis because the distribution networks at the state level are not very well managed so there are huge losses and the price mechanism is not there...so all of those issues come in.

The government has recognised the need for improvement in the provision of infrastructure and has made investment, particularly public-private initiatives, in infrastructure a key goal for the Twelfth Five Year Plan (Planning Commission, 2013). The Plan specifically stresses the need for infrastructure development in rural areas as being a development initiative. RW is a Senior Employment Specialist with an international organisation that promotes decent labour standards. His research specialities are in areas of informal employment and working poor as well as labour regulations. He remarked that poor infrastructure in rural areas were holding back investment and keeping these areas from benefitting from the economic expansion of the country:

And until you have this infrastructure, manufacturing won’t take off. India is moving in the right direction but it still remains a huge problem, especially in rural areas. Investment hasn’t gone into rural areas...you have a lot of hubs in India where things are working reasonable well and that is where investment is flowing and FDI has been flowing as well. But as a country as a whole...for the rural poor and the backward regions, it all remains just fantasy. The government has recognised that…so infrastructure is a key issue, particularly power.

As explored in Chapter Four (see section 4.3.3) regional inequalities were correlated with foreign and domestic investment levels (Van Klaveren et al, 2010) and five of India’s 29 states attract 70 per cent of its FDI. As RW emphasises power and infrastructure which are key to investment are needed in rural areas to close the large regional inequalities gap. Rural and urban inequality is addressed further in Chapter Nine.

7.3.3: Labour regulations


Labour regulations are an area that business associations within India have long criticised as problematic and restrictive for business operations (Murali, 2004). As explored in Chapter Four (see section 4.2.2), although business groups have continually called for greater flexibility in labour regulations, they have been unable to influence official reform to the national labour laws due to the politically contentious nature of the issue combined with the country’s shifting coalition politics (Murali, 2010). Murali (2010) lists three main demands from business concerning labour market flexibility: an exit policy, greater freedom for contract labour, and greater flexibility in retrenchment of labour. However, it is important to note, labour regulations often do not feature as a key problematic area in major international business assessments. A survey conducted by the World Bank and ICRIER found that labour regulations were only mentioned by 4 per cent of the respondents as being a primary obstacle for business and that other factors such as infrastructure, tax issues, governance, and finance were of much larger concern (Eichengreen et al, 2010, p.17). Labour regulations were listed by 6.5 per cent of responses in the Global Competitiveness Report for 2014-2015 which is conducted by the World Economic Forum and were placed as the 7th most common problem (out of 16) (WEF, 2014).

Yet labour regulations remain a real ‘political hot potato’ as described by one of my sample. Several respondents, in particular those from liberal market organisations, listed stringent and complicated labour regulations as problematic for foreign as well as domestic companies and also a factor specifically holding back the manufacturing sector. As examined in Chapter Four (see section 4.2.2) labour regulations are principally criticised for size, scope, complexity, and irregularities (Eichengreen et al, 2010). Chapter 5b of the IDA states that firms that have over one hundred workers must obtain permission from the State governments to retrench or lay off workers (Eichengreen et al, 2010). The inability to reduce labour when needed is reported to be a large disincentive for investment as well as a factor keeping businesses from expanding. When companies attempt to retrench labour, the bureaucracy involved is reported to be a cumbersome process. DH, Director of Economic Policy with one of India’s well known business associations summarized the business perspective in calling for liberalisation of labour regulations:

Another big concern for investors is labour laws. Labour laws in the sense of hiring and firing policies is not very free or flexible. If you have hired labour for a period of time, you cannot fire the labour in case you don’t require them. You have to go through a number of cumbersome procedures. There are a number of issues related to labour laws where industry has been asking the government to relax the laws or make them more flexible so that industries are encouraged to hire more labour. Because what is happening is that industry, instead of hiring more labour, they are switching to more capital-intensive technology. Because of seasonal needs industries may require different quantities of labour at different periods of time. But here in India, you do not have the luxury of doing away with labour when they are not required. And if you have to dispose of them, then you have to undergo a very cumbersome process which is not very easy.

The above quote also illustrates that labour laws are often blamed for employers utilising capital-intensive methods as a way to avoid hiring labour that may prove difficult to retrench later on, if needed.

RW, a specialist in the promotion of decent labour standards was not convinced that labour regulations are the main problem for business. He highlighted common concerns expressed by other respondents: 1) that the legislation is only applicable to the organized work sector which is small minority of the workforce; 2) the legislation is often not enforced in the first place; and 3) that businesses find ways to circumvent the legislation with other means such as hiring contract labour:

But the idea, on paper, is that these laws prevent hiring. But the problem is: One, to say this is the main problem of the economy and second, whether it really does prevent hiring. The first part, whether this is the main problem of the Indian economy, I just don’t believe...there is much more of a problem with infrastructure, skills, access to credit, corruption, governance issues...these are much more likely to be a problem for a firm. And whether it really affects hiring decisions of firms and my belief is that often it doesn’t. It can, in certain ways but in a country like India, you have very weak enforcement. In certain states that are pro employer like Gujarat, they are not enforcing these laws. And they have also found ways to avoid this so they are not worried about it being enforced, so they don’t care and they will just fire somebody anyway. And again, it is only covering 6% of the population...can you blame this for the 94% that is stuck outside...I think it is over-played but it remains one of the biggest political issues in this country and elsewhere.

This quote underscores issues of corporate harm and crime as discussed in Chapter Three (see section 3.3.5 and 3.3.5.1). Clinard and Yeager (2006, 1980) and Benson and Simpson (2015, 2009) described corporate culture as being replete with rationalisations and neutralisations that promote beliefs that regulations can be adhered to selectively. The above quote from the business association representative (DH) reveals perceptions that the laws are ‘cumbersome’ and hindering competitiveness whereas other countries have the “luxury” of being able to downsize. These beliefs may rationalise the breaking labour laws. Also, as discussed (see section 3.3.5.3), Paternoster and Simpson (1993) argue that corporations are more likely to break laws they perceive will have little or no formal and informal sanctions, have internalised situational rules-in-use that justify the act, will not experience a loss of self-esteem, judge the benefits of noncompliance and the costs of compliance as high, view the rules as unfair and have broken the laws in the past. RW appears to believe that corporations do not worry about breaking the laws (little formal or informal sanction), have found ways around them (rules-in-use), “don’t care” (will not experience a loss of self-esteem; view rules as unfair) and “will fire somebody anyway” (have broken the laws in the past). Furthermore, the complicity of states in failing to enforce labour laws could be seen as an example of state-facilitated corporate crime (see section 3.3.5.4), specifically, an explicit act of omission (Kauzlarich et al, 2003) as it is failing to enforce labour laws.

Although labour regulations are a divisive issue, most are in agreement that the laws do need amending (Murali, 2010). The legislation is criticized as being complex and at times contradictory (Murali, 2010). RW continues and explains that the laws are in need of change but that often people are focusing on the wrong issues:

And actually, while I think it is not a big problem, I do think these laws need to be changed. I told a colleague this, “Look you are asking the wrong question”...because we ask, particularly as economists: are these labour market regulations causing all these problems for firms? That is the wrong question to ask...the question to ask is: what is the purpose of these regulations? It is to provide protection to workers. Are they doing that? Yes or No? And then you would ask: do they hinder employers from adjusting? We always focus on that last part and end up in a dead end. We should ask the first question...is it providing protection, yes or no? And if it is not...and it is not in India, as most people are not getting protected. So how can we improve these laws so that they provide better worker protection while we look at the concerns of the employers...then there is a reason to revise and reform. So ultimately it is a difficult question but I think it is a red herring and attracts too much attention and ends up in a dead end debate.

RW’s response brings up important issues in the labour market debate. Fist he highlights that the needs of business are considered first when researchers and policy makers are contemplating policy reform. Second, he observes that the debate is centred on liberalisation and not amendment of the laws to better protect workers.


7.3.4: Labour skills


Finally several respondents reported problems with lack of skills as thwarting manufacturing investment. As discussed previously the quality of primary education, aside from private education, is considered to be very poor in India. Also as explored, much of the FDI coming to India is targeting the highly skilled, English speaking and educated segment of the Indian population. The majority of the Indian population, however, does not possess this level of skill and education (Nachane, 2011). AM is a Professor of development economics specializing in pro-poor growth, urban development and the informal sector. He explained that a process of skill upgrading needs to occur for India’s poor populations to benefit from investment:

As far as the strategies for pro poor growth is concerned, I think one important issue is skill up-gradation. Now what we get to see is many companies in the services sector and even in the industrial sector require labour which have certain high degree of skill. But the labour which is largely available, they do not have the requisite amount of skill. So the issue is how to improve the employability of this sector of the labour force so that the mismatches of the supply and demand can be reduced. That is one issue.

Thus far this chapter has focused on the sectoral composition of investment. The proceeding section will explore how foreign investors are accessing Indian markets and explore elite policy stakeholders perceptions of the social impact resulting from the predominate means of market entry of FDI.



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