Open and shut

FDI in retail will bring competition to non-tradable services, and make Indian firms globally competitive

India removed barriers to trade in goods in the 1990s. Removing protection brought global competition and raised productivity. But introducing global competition in services is harder. In certain services that are tradable, like legal or financial services, the removal of trade barriers can introduce competition and increase productivity. But these often involve complicated and time-consuming multilateral negotiations. In other services that are not tradable, like retail trade, global competition can be introduced and improvement in productivity can be achieved by opening up the sector to foreign direct investment.

Reducing protection in the market for goods, cutting custom duties on imports, and removing quotas and other restrictions on trade raises few questions today. The case for trade liberalisation in goods is well understood by now. Trade liberalisation exposes local firms to global competition. Domestic firms have to innovate, produce better products, improve their technology, and reduce costs of production when imported products enter domestic markets. Under such pressures, these firms become more productive. These productive firms become exporters. The most productive firms invest abroad. Both face further competition in foreign markets and productivity growth continues. In contrast to the pre-trade liberalisation regime, productivity in the economy is higher and keeps growing. This results in higher growth of incomes and standards of living in the country. Trade liberalisation has transformed many countries, such as those in East Asia.

India has also seen the benefits of reducing protection in goods markets. Trade liberalisation in the 1990s, which continued into the early 2000s, saw Indian industry transform. At the same time that barriers to trade were reduced, domestic restrictions on production imposed through the licence raj were removed so that incumbents, who had long outlived the infant industry stage, faced both domestic and global competition. The FDI regime in manufacturing was, however, accommodated continued support to Indian industry. While opening up manufacturing to trade and to foreign investment, policy encouraged joint ventures that gave an advantage to Indian firms by not allowing 100 per cent FDI. The limit on how much could be invested by a foreigner was only slowly raised over the years. Clauses such as Press Note 18, which did not permit the foreign investor to start new ventures without the permission of its domestic partner, were put in place to support Indian firms. The result of higher competition and a carefully calibrated policy environment has been to create Indian firms that are strong enough now to become multinationals. Without the process of reducing tariff barriers and removing protection for Indian industry, Indian firms would not have ended up being so strong in world markets today. More than 300 Indian firms are multinationals now. They compete successfully with foreign companies on their turf.

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